Next DC: Is it time to ride the data centre wave?

Obviously being a commodity producer isn’t all bad. Just ask investors in BHP Billiton (ASX: BHP) over the past decade. Even after the recent price declines, investors are still up 267%. This compares with the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO), which has increased 58% in the last 10 years.

One sector that has garnered attention recently for its potential to end up with low pricing power, and hence to become a commodity-type business, is the data centre space. Data centres (DCs) are critical infrastructure and demand is increasing as the use of data and cloud based services expands.

One of the first movers into the DC space in Australia to satisfy this demand has been Next DC (ASX: NXT). Next DC was founded by entrepreneur Mr Bevan Slattery and boasts DCs in most major Australian capital cities. The company recently spun off its property assets into a trust, APDC (ASX: AJD), which stands for Asia Pacific Data Centres. This was a smart move as it has freed up Next DC’s balance sheet for further expansion. The spinoff also marked a milestone for the business, which has led Slattery to announce his retirement from the board to pursue other interests.

In investing it is always handy to be able to use comparisons to assess one investment against another. In the case of DCs, overseas examples provide some of the most worthwhile comparisons. A recent article in the Financial Times discussed the tough time data storage centres are facing in the UK as they try to sell their space. The article highlighted that the problem  in the UK is that there is no shortage of supply and, equally important, no shortage of potential supply of DCs. This doesn’t make for great business economics.

A brand new $430 million facility, the Cobalt Data Centre Campus, opened earlier this year and is reportedly yet to sign up any customers, while “another regional flagship – Next Generation Data in south Wales – has leased only one-ninth of its space since opening in 2009”. Next Generation has the capacity to be one of the world’s largest DCs, however at current growth rates, market watchers suggest it may take three more years just to fill one-third of its capacity.

Foolish takeaway

There is a lot to like about Next DC, including its early mover advantage. There are also important variables between DCs which can minimise the “commoditisation” issue. These variables include security, property positioning and customer relationships. However, the wide acknowledgement that there will be high demand for DCs in the future is attracting plenty of supply. Decisions by large domestic firms like Telstra (ASX: TLS) and foreign competitors such as Amazon (Nasdaq: AMZN) could lead to significant increases in DC supply that ultimately could push down pricing and affect the profitability of incumbents.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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