Two high profile tech companies, NextDC (NXT) and Appen (APX) are currently raising capital from their shareholders. They are “high profile” for different reasons. NextDC, because it has been one of the ASX’s growth success stories, while the other is a former highflyer whose shares once traded above $40 and now languish around $2. Both are in industry sectors with strong tailwinds – data centres and artificial intelligence.
In this article, I’ll look at the capital raisings and share my perspective on whether you should take part or not.
- NextDC (NXT)
NextDC builds, operates and owns high grade data centres. It says “it is building the infrastructure platform for the digital economy, delivering the critical power, security and connectivity for global cloud computing providers, enterprise and Government”. It is Australia’s only operator of ‘Uptime Institute certified Tier IV facilities”.
NextDC has data centres in Sydney, Melbourne, Brisbane, Perth and Canberra, and is planning to expand to Auckland and Kuala Lumpur.
To do so, it is raising $618 million through a fully underwritten pro-rata accelerated non-renounceable entitlement offer. The funds will be used for new data centre developments in Kuala Lumpur (KL1) and Auckland (AK1), and to accelerate the fit out of a new data centre in Sydney in Artarmon (S3), due to an increase in contracted utilisation at that site.
NextDC describes its investment highlights as follows:
- Compelling industry fundamentals underpin significant long-term growth for NextDC;
- Proven business model and substantial experience delivering and operating greenfield data centre projects in Australia;
- Recurring revenue model with exposure to long-term contracts;
- Strong track record in delivering growth in contracted utilisation, revenue and EBITDA;
- Highly disciplined approach to capital investment; and
- Robust balance sheet, supported by substantial liquidity to fund future expansion and growth.
To support this investment thesis, NextDC points to a 5-year CAGR (compound annual growth rate) to 30 June 2022 of 21% in contracted utilisation and 28% in EBITDA. Further, contracted utilisation has increased by 43% since 31 December 2022, following significant contract wins. The company has access to $2.6 billion in liquidity and gearing is 10.7% (on a proforma basis at 31 December 22 and inclusive of capital raising but before capital expenditure to build the data centres).
In conjunction with the capital raising, NextDC updated the market on how they are trading. The revised guidance for FY23 is:
- Revenue from data centre services in range of A$350 million to A$360 million (previously upper end of A$340 million to A$355 million);
- Underlying EBITDA of A$192 million to A$196 million (previously A$190 to A$198 million); and
- Capex of A$670 million to A$720 million (previously A$620 to A$670, but it now includes the cost of acquiring land for K1 of A$53 million).
NextDC is raising $618 million via an entitlement offer to shareholders of 1 new share for every 8 shares owned. The offer price for each new share is A$10.80. If, for example, you own 1,000 NextDC shares, you will be entitled to buy 125 new shares at a price of $10.80 which will cost $1,350.
The first part of the entitlement offer, to institutional shareholders, was very well received, with 99% of shareholders taking up their entitlement in full. The balance of 1% was allocated on a proportional basis to shareholders who elected to bid for more. This raised about A$416 million.
The second part of the entitlement offer, to retail shareholders, is now open. It is scheduled to close at 5.00pm on Wednesday 31 May. Retail shareholders may also apply for additional shares in excess of their entitlement, up to a maximum of 100% of their entitlement. These shares will only be available if there is a shortfall in retail applications, and may be subject to a scale back.
How to play this
Firstly, let’s start with the major brokers. According to FN Arena, the major brokers are fairly bullish on NextDC. The consensus target price is $13.68, 15.8% higher than the last ASX price of $11.81 and 26.7% above the entitlement price. The range of target prices is a low of $11.20 through to a high of $15.30.
Secondly, the market reaction to the entitlement offer has been very positive. On Friday, the stock closed at $11.81, a material premium to the entitlement price of $10.80.
Finally, NextDC boasts a very credible record on execution and growing EBITDA. So, I think this is a company you back.
My only reservation is that the NextDC share price has risen quite strongly over the last few months and on multiples of EBITDA, the pricing is fairly heady. But that’s what goes when a company has the track record.
NextDC – last 12 months
If you don’t want to add to your holding and you have the cash, an option is to sell approximately 1/8th of your shares on the ASX now and replace the same in the entitlement offer.
- Appen (APX)
Artificial intelligence platform services business Appen (APX) is an entirely different proposition. It has been such a disappointment, with strategy changes, numerous earnings downgrades, management changes and other issues. A little under three years ago, the stock was testing $40. On Friday, it closed at $2.42. The question with this raising is whether this is another “falling knife” to catch?
Appen (APX) – last 12 months
Following a further downgrade to earnings in early May, Appen has been forced by the market to raise capital. All up, Appen is raising around $60 million to provide balance sheet flexibility and working capital requirements to support Appen’s return to profitability and one-off costs associated with a cost reduction program and transaction costs.
Approximately $38.3 million is being raised by an entitlement offer, and $21.2 million by an institutional placement.
The placement and entitlement offers are priced at $1.85 per new share. Existing shareholders will be offered entitlements on a 1 for 6 basis. That is, if you own 1,000 Appen shares, you will be entitled to 167 new shares at a price of $1.85.
All up, Appen’s share count will increase by around 26%.
The first parts of the offer, the institutional entitlement and placement, have been completed. The institutional entitlement received strong support with approximately 95% of shareholders taking up the shares.
The retail component of the entitlement offer is due to open on Tuesday (23 May) and close on Tuesday 6 June. The entitlements are non-renounceable, meaning that they can’t be transferred and if not taken up, lapse.
Under new CEO Armughan Ahmad, a strategy refresh has been implemented and Appen is pivoting to service the generative AI market, which includes models like OpenAI’s ChatGPT. These require large volumes of human feedback to create experiences that are comparable to humans and avoids risks such as bias, hallucination and toxicity. This involves fine tuning of instruction datasets and assurance and certification.
Appen says that the generative AI market is estimated to reach more than $110 billion by 2030, up from an estimated $8 billion in 2021.
Focussing on generative AI is expected to improve customer diversification (and remove some of Appen’s existing dependency on large tech customers), improve gross margins, increase recurring revenue and generate a strong return on investment.
In the short term, the focus is on cost control with annualised cost savings of $46 million already announced and a targeted run-rate cost base of around $113 million by the end of FY23 (31 December). Appen hopes to exit FY23 with a return to underlying EBITDA and underlying cash EBITDA profitability.
How to play this
According to FN Arena, the major brokers aren’t convinced that Appen’s share price has bottomed. Notwithstanding the market’s positive response to the capital raising (with Appen’s shares closing on Friday at $2.42 compared to the entitlement price of $1.85), the brokers’ consensus target price is $1.89. This is 22% lower that the closing ASX price and just 2% higher than the entitlement price.
Macquarie’s target price of j1.35 weighs down the consensus, but higher targets of $2.20 are still short of the current price. Most brokers agree that the capital raising will provide the company sufficient headroom and avoid any need for a further raising for at least three years or take on new debt.
But the test will be whether Appen’s new strategy can generate positive EBITDA and grow revenue.
I am a bit “each way” on Appen. On the one hand, I would like to think it has bottomed and $1.85 looks like a “screaming buy”. On the other, while the refreshed strategy appears to make sense, pivoting to service the generative AI market while at the same time cutting costs could be challenging.
I have been burnt by Appen in the past, so my recommendation for those who aren’t big risk takers would be to sell on the ASX now about 1/6th of your shares and replace those shares in the entitlement offer. Thrill seekers can follow the market (institutional investors) and take up their entitlements.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
