How do investors view domestic data centers? UBS: With ample supply, price increases are difficult; companies with a higher proportion of northern projects are more favored
UBS analysts released a research report on China's Internet Data Center (IDC) industry, pointing out that although AI drives demand growth, market supply is sufficient, making price increases difficult. The report emphasizes that investors should focus on the order reserves of IDC operators and the layout of northern projects, believing that the profit prospects for leading IDC manufacturers are optimistic. Analysis shows that capital expenditures of hyperscale enterprises are highly correlated with IDC demand, and the industry utilization rate is expected to grow at a compound annual growth rate of 20%
On March 7, UBS analysts Sara Wang, Jasmine Huang, and Navin Killa released a research report on China's Internet Data Center (IDC) industry, delving into the current supply and demand dynamics, pricing trends, and future investment opportunities in the IDC market.
The report addresses five key questions from investors: How much IDC demand is implied by the capital expenditure plans of hyperscale companies? How to track the supply and demand dynamics in the industry? What is the appropriate valuation multiple for IDC operators (especially ADR)? Is there potential for IDC rents to rise? How to view the potential new orders for IDC operators?
The report points out that despite the strong IDC demand driven by the development of artificial intelligence (AI), there remains a divergence among investors regarding the sustainability of demand and the valuation of IDC operators. UBS analysts believe that investors should focus on the order backlog, utilization rates, and project layouts in northern regions of IDC operators, maintaining an optimistic outlook on the profitability prospects of leading IDC manufacturers.
AI-Driven Demand Growth, But Supply Abundance Makes Price Increases Difficult
UBS analysts indicate that the demand in China's IDC market is closely related to the capital expenditure plans of hyperscale data centers. Based on historical data analysis, the capital expenditures of internet giants such as Baidu, Alibaba, and Tencent show a high correlation with new orders from third-party IDC operators.
Data shows that every RMB 100 billion in server capital expenditure can translate into nearly 1GW of IDC demand, with the industry utilization rate expected to grow at a compound annual growth rate of 20% between 2024 and 2026.
From a supply and demand perspective, existing orders are a key indicator of demand, while capacity utilization is a proxy indicator of supply (especially in an upward cycle). These data can be used to calculate the demand/supply ratio. In the last cloud computing cycle, if investors had high confidence in the conversion of orders to EBITDA, valuations gradually shifted from being based on future year EBITDA to being based on existing orders, while the demand/supply ratio also increased.
Regarding valuation multiples, the report notes that several factors, including the potential launch of project-level REITs, have driven a revaluation, with the EBITDA valuation multiple in its mature stage being 13-15 times, which should support the valuation multiples of growing companies.
Additionally, the report emphasizes that in terms of IDC rents, wholesale or hyperscale projects are unlikely to see increases, but there is potential for retail assets.
Analysis indicates that all leading IDC operators have ample resource reserves, meaning that if demand accelerates, new supply will emerge, thus price increases for wholesale or hyperscale projects are unlikely. Furthermore, leading IDC companies typically have multiple IDC parks targeting hyperscale customers, and to allow other more competitive parks to win more orders, they would not choose to raise prices for any single park
However, in terms of retail IDC, UBS analysts believe that retail assets are mainly located in first-tier cities, with limited new supply, and the customer base is more diversified and less sensitive to price. As companies like DeepSeek reduce inference costs, traditional industry clients' adoption of AI will accelerate, thereby increasing demand for retail IDC, which may lead to price increases.
Optimistic about Planning Projects in North China
In the report, UBS analysts expressed optimism about companies with a high proportion of IDC projects in North China:
"Due to the high energy demand of GPUs, the lower temperatures and electricity prices in the northern region are crucial during the AI cycle."
Therefore, they are optimistic about companies with abundant IDC resources in North China. Regarding potential new orders, UBS believes, "Leading IDC companies have ample reserves that can more than double their existing IDC revenue."
The report concludes that UBS analysts hold an optimistic view on the long-term development of China's IDC industry and suggest that investors pay attention to leading companies with growth potential. Although ample supply in the short term may limit price increases, AI-driven demand growth and catalysts such as REITs are expected to drive a revaluation of IDC operators.
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