Is NextDC Ltd the next takeover target?

Data-centre operator Nextdc Ltd (ASX: NXT) has been a market darling for the past year with the stock hovering close to a record high thanks to its strong market position and the demand outlook for cloud computing, but there may be a new reason to get excited about the stock.

There is growing speculation of corporate interest in NextDC with the Australian reporting that Singapore sovereign wealth fund Temasek Holdings is running the ruler across the company even after the stock’s 90% plus gain over the past 12-months vs the modest 1.6% gain by the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.

While I don’t advocate buying stocks on their takeover appeal, I believe the speculation has legs. Any merger and acquisition (M&A) activity is just cream on the cake as far as I am concerned. I own the stock and believe NextDC is well placed to outperform based on fundamentals.

But coming back to the spicier topic of M&A, NextDC looks to be a more exciting target for potential suitors because Asia Pacific Data Centre Group (ASX: AJD) has hung a “For Sale” sign on its front door

Asia Pacific Data Centre (or APDC) owns the centres that NextDC operates in and NextDC has been in a big stoush with its landlord which prompted the decision by APDC’s board to sell itself.

Being able to swallow both NextDC and APDC in one bite could make the deal more enticing to a would-be buyer as they would probably prefer to own both the assets and the datacentre operator, although any bidder will need pretty deep pockets given NextDC’s market cap of around $1.8 billion and APDC’s market value of around $600 million.

Here’s where Temasek comes in. It has circa $265 billion in assets and it owns interests in data centres in the region. One would assume it would comfortable acquiring NextDC/APDC and pretty motivated as well.

That’s important because any buyer will need to be motivated as NextDC is not cheap with the stock trading on an FY19 consensus price-earnings (P/E) of over 70 times!

It’s not unprecedented for a fast-growing stock to command such a hefty premium, particularly if it is under an M&A spotlight.

It is also a business with some high barriers to entry that could increase its takeover appeal. You only need to consider the large upfront capital investment, the time required to build a data centre, and the first mover advantage from high switching costs for customers to get an appreciation for what I mean.

But what the high valuation means is that rumours about private equity firm Blackstone circling the company should be taken with a pinch of salt.

Private equity is all about buying things on the cheap (or where they can load up companies with debt) and flogging them at a big premium. Just look at now defunct Dick Smith and Myer Holdings Ltd (ASX: MYR)!

A more likely acquirer is a trade buyer, particularly a US-based one that can benefit from tax concessions. Media reports have nominated Equinix as an obvious candidate.

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Motley Fool contributor Brendon Lau owns shares of NEXTDC Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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