High-Performance Data Centers And AI Demand Will Fuel Success

Key Takeaways

• VNET's substantial order wins in cloud and AI sectors boost revenue potential, while JV structures aim to optimize capital efficiency and margins.
  
• AI-driven demand sustains high-performance data center growth, with supply shortages in Tier 1 cities potentially enhancing pricing and net margins.
  
• Significant capital expenditure for wholesale IDC expansion could strain cash flow, while reliance on joint ventures and competition may affect future revenue and margins.

Catalysts

An investment holding company, provides hosting and related services in China.

• VNET Group has experienced substantial growth in its wholesale business, driven by significant order wins, including a total of 252.5 megawatts in orders from various industries such as Internet, cloud computing, and intelligent driving. This increase in demand is expected to enhance net revenue and adjusted EBITDA moving forward.
  
• The company plans to utilize joint venture structures to expand its customer base while minimizing balance sheet impact, which is expected to improve capital efficiency and optimize net margins.
  
• VNET Group's delivery of high-performance data centers is poised to meet the rising demand driven by domestic AI development breakthroughs. This should sustain future revenue growth, particularly as AI applications continue to expand.
  
• The company anticipates supply shortages in Tier 1 cities, such as the Greater Beijing Area, which could lead to a favorable pricing environment and increase revenue and net margins.
  
• Persistent demand for high-performance data centers fueled by AI adoption may lead to substantial opportunities for VNET's retail IDC business. This is expected to improve the utilization rates, boost IRR (Internal Rate of Return), and positively impact both revenue and earnings.

VNET Group Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming VNET Group's revenue will grow by 16.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 2.2% today to 0.7% in 3 years time.
• Analysts expect earnings to reach CN¥96.1 million (and earnings per share of CN¥0.73) by about April 2028, down from CN¥183.2 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting CN¥238 million in earnings, and the most bearish expecting CN¥-50.3 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 473.4x on those 2028 earnings, up from 57.6x today. This future PE is greater than the current PE for the US IT industry at 33.4x.
• Analysts expect the number of shares outstanding to grow by 2.55% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 13.29%, as per the Simply Wall St company report.

VNET Group Future Earnings Per Share Growth

Risks

• The company has projected a significant increase in capital expenditure for 2025, up 101% to 141%, primarily for expanding its wholesale IDC business. This surge in CapEx could strain the company’s cash flow and potentially impact net margins if not managed alongside revenue growth.
  
• Despite strong expectations for demand, there is a potential risk of supply fluctuations and rising equipment costs due to intensified upstream demand for key components, which could increase unit CapEx and pressurize earnings.
  
• The reliance on joint ventures, such as the one with Changzhou Gaoxin Group, to expand capacity without impacting the balance sheet may introduce uncertainties in revenue realization from these projects since profits are dependent on management and capital operation fees.
  
• With China's data center supply chain described as efficient, the entry of new competitors or increased capacities by incumbents in the wholesale IDC sector could lead to increased competition, potentially affecting future revenue and profitability.
  
• The substantial investment required for AI and large language model applications in the retail IDC space, involving high-power density cabinet retrofits and premium services, could challenge net margins if the anticipated increase in demand does not materialize or if pricing pressures emerge.

Valuation

• The analysts have a consensus price target of $14.956 for VNET Group based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $22.86, and the most bearish reporting a price target of just $4.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CN¥13.2 billion, earnings will come to CN¥96.1 million, and it would be trading on a PE ratio of 473.4x, assuming you use a discount rate of 13.3%.
  
• Given the current share price of $5.42, the analyst price target of $14.96 is 63.8% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.