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Why this hot tech stock has shed over 20% of its value in 2 weeks

Cracks are appearing in this once mighty tech stock as its share price has collapsed by 21.5% in just two weeks.

The stock is data centre operator Nextdc Ltd (ASX: NXT) which has fallen 2.2% to $5.84 on yesterday as the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) hovered at around breakeven.

The stock was up nearly 60% over the year before the latest sell-off and it’s still 25% in the black compared to a 7.5% gain by the top 200 index over the past 12 months – but I think there is further downside risk to its share price.

If you thought this was just a tech-based sell-off that is related to a similar trend in the US, you’d be wrong as shares in Appen Ltd (ASX: APX), WiseTech Global Ltd (ASX: WTC) and Altium Limited (ASX: ALU) are outperforming.

So, what went wrong?

It does appear that stocks with high price-earnings (P/E) multiples are taking the brunt of the latest market meltdown, just look at CSL Limited (ASX: CSL) and Afterpay Touch Group Ltd (ASX: APT), but the strong showing from the tech stars listed above shows this isn’t necessarily true.

There are two probable reasons for NextDC’s underperformance. The first is the company’s failed court bid to prevent 360 Capital FM Limited, part of 360 Capital Group Ltd (ASX: TGP), from voting in the wind-up of Asia Pacific Data Centre Group (ASX: AJD).

It looks like NextDC won’t be able to get wind-up AJD now, although the company is considering appealing the decision. AJD is the landlord to NextDC’s data centres.

I had the opportunity to chat with NextDC’s chief executive Craig Scroggie last week following the release of the company’s results and asked him if he had a “Plan B” if he failed to block 360 Capital in the courts.

He said things will just go on as they were, and he wasn’t concerned as NextDC had very long leases locked in and the ownership of AJD wouldn’t impact on NextDC’s ambitious growth plans.

I was less sanguine about Plan B. Having a very hostile landlord hanging over your head sounds like a lose-lose situation for everyone. AJD could make life challenging for NextDC in some shape or form and management doesn’t need to be distracted by that – not when it’s targeting revenue and earnings growth of up to 25%-30% in FY19.

This brings me to the second issue – growth. Sceptics point out that growth is slowing as the company only added one megawatt of contracted utilisation in the second half of FY18. NextDC doesn’t need such doubts clouding its outlook when it is spending big to expand its data centre facilities around the country.

There’s no doubt that Scroggie is a big bull when it comes to demand for data centres though. He believes we are only at the tip of the iceberg due to the explosion of data creation and the exponential growth that lies ahead.

I just wish I could tell you that the stock is looking good value after its big fall but the stock is still trading on a FY18 price-earnings (P/E) of well over 100 times (based on Reuters data) as many hot-to-trot tech stocks are.

My main issue is that high P/E stocks may struggle to outperform in a late stage bull market, and for this reason I am cautious on the nearer-term outlook for NextDC even though I think the stock is well placed in the long-term given its market leadership position in the industry.

Barring a new catalyst, there’s just no need to buy the stock now – not till maybe closer to its next set of results when it can prove the naysayers wrong.

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Motley Fool contributor Brendon Lau owns shares of AFTERPAY T FPO. The Motley Fool Australia owns shares of AFTERPAY T FPO, Altium, Appen Ltd, and WiseTech Global. 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 Scott Phillips.

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