14 November 2014 – Fitch Ratings
Fitch Ratings has upgraded data centre owner Global Switch Holdings Ltd’s (Global Switch) Long-term Issuer Default Rating (IDR) and senior unsecured rating to ‘BBB+’ from ‘BBB’. Its wholly owned subsidiary Global Switch Property (Australia) Pty Limited’s senior unsecured rating has also been upgraded to ‘BBB+’ from ‘BBB’. The Outlook on the Long-term IDR is Stable. The Short-term IDR has also been upgraded to ‘F2’ from ‘F3’.
The upgrade reflects Global Switch’s increasingly mature business profile, improved access to debt capital markets, increased support from its banks to provide liquidity facilities and a proven track record in maintaining leverage metrics comfortably below our guidance for the ratings.
Cash flow continues to be resilient, driven by a geographically diversified portfolio (valued at GBP3.8bn) of large scale data centres that generate contractual rental income with an average lease length prolife of 5.4 years. The upgrade also reflects a conservative capital structure with a Fitch forecast of net debt/EBITDA remaining below 4.5x in 2014 and 2015. Given the niche sub-sector Global Switch operates in and moderate concentrations in portfolio tenants and buildings a further upgrade is unlikely.
KEY RATING DRIVERS
Improved Access to Debt Capital
Over the last 12 months, Global Switch has successfully issued bonds in AUD and GBP. Those bonds followed its inaugural bond issue in 2011. While some of the proceeds were used to finance a EUR600m exceptional dividend, Fitch positively notes the increased diversification and extension of the debt maturity profile. With sizeable data centres in London and Sydney the local currency issuance is viewed positively as a natural hedge.
Relative Low Leverage
Global Switch’s net debt/EBITDA of 3.4x as at financial year to March 2014 (1.9x at FY13) and loan-to-value (LTV) of 21% (11%) compare favourably with Fitch-investment grade rated real estate peers, whose metrics average 7.5x net debt/EBITDA and 40% LTV. This offsets the somewhat higher operating risk profile that Global Switch exhibits compared with a typically commercial real estate company. Its immediate rated peer is Digital Realty Trust, Inc. (BBB/Stable) has a similar business model, albeit focused on the US market. Its net debt/EBITDA has been around 5.5x to 6.0x over the last few years.
Asset and Liabilities Matched
With contractual average lease lengths securing cash flow, Global Switch has a conservative approach to matching debt obligations. The average debt maturity profile of around five years matches its current average lease profile of 5.4 years. This is an important credit positive for such a capital-intensive industry, as it means that interest coverage can be protected. The average cost of debt is around 5% and the majority of debt is fixed-rate bonds.
Prime Portfolio of Data Centres
Global Switch is one of the world’s leading players with market dominance in a sector with high barriers to entry. The portfolio consists of high-specification data centres located in strategic city locations close to business and telecommunication hubs, benefiting from reliable power supplies, high levels of security, a strong operating track record and a well-positioned development pipeline securing future growth. We believe rental income should benefit from structural growth in the medium term, largely correlated to global internet traffic, bandwidth requirements, outsourcing trend and cloud computing.
Measured Development Risk
There is potential for around GBP330m of new developments with a new site in Hong Kong and extensions in Sydney, providing a greater global footprint in growth cities. This is not committed spend and would be spread over a three-to-four year period and therefore manageable from a cash flow perspective. Overall this is low risk with a focus on increasing capacity at existing locations. Unlike greenfield development this limits risks with difficult-to- source power supplies already in place, and a high level of pre-lets are achieved ensuring cash flow generation upon completion.
Over the medium term Global Switch benefits from owning development sites at existing locations with an ability to grow capacity in line with demand conditions without being dependent on acquisitions to grow the business.
Geographically Diversified Property Portfolio
Global Switch has a portfolio of 10 data centres with some single building concentrations; notably, the largest London data centre represents around 25% of the company’s GBP3.8bn portfolio. However, these assets are multi-tenanted and in prime locations. Geographical diversification is solid with the portfolio spread across seven countries, across Europe and Asia-Pacific.
Stable Rental Income Growth
The lease maturity profile has shown resilience through-the-cycle with retention rates remaining high at 98.5% at FYE14. Fitch believes retention rates will remain high as tenants are reluctant to move due to significant switching costs and interruption risk. To some extent this rental income stream is less correlated to the economic cycle compared with the rental income stream of an office or retail real estate owner. Limited supply of data centres and structural growth have maintained pricing power, with management expecting above-inflation rental growth rates upon renewal of contracts.
Compared with Fitch-rated real estate peer group tenant concentration is high, with the top 10 tenants making up 50% of total rental income and the top 20 tenants representing 68%. However, the tenant profile is strong with a majority of the largest tenants being investment- grade and individually holding numerous lease contracts across multiple sites, although with a bias to the TMT sector and financial institutions.
Niche Asset Class
Data centres are specialised properties and technological obsolescence over the long term is possible. However, there are significant barriers to entry and medium-term IT trends are favourable.
Compared with other real estate assets data centres have a less liquid investment market with fewer potential buyers making these assets potentially more difficult to divest in a depressed market. While intrinsically the financial metrics are consistent with an ‘A’ category profile the ratings are constrained by the data centre properties being a less-than-mature asset class, the less liquid market for trading these assets, and the risk of a fast-changing technological environment.
Negative: Future developments that could, individually or collectively, lead to negative rating action include:
– Aggressive committed development capex not covered by existing liquidity
– Significant deterioration of the average lease length
– EBITDA NIC below 3.5x on a sustained basis
– Leverage above 4.5x net debt/EBITDA on a sustained basis
– A material move towards secured debt at the expense of unsecured bond holders
Positive: Given the niche asset class Global Switch is operating Fitch currently view a further upgrade as unlikely.
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