VNET Group Inc

NASDAQ:VNET

Earnings Call Analysis

VNET Delivers Solid Growth Amid Challenges

VNET Group, Inc. reported a year-over-year net revenue increase of 4% to CNY 1.89 billion in Q3 2023, highlighting its solid main business growth. However, gross profit fell by 3.2% to CNY 306.5 million. On a brighter note, the company experienced an 11.6% surge in adjusted EBITDA, reaching CNY 507.9 million, while maintaining a strong adjusted EBITDA margin of 26.9%.

Third Quarter Performance Overview

The company experienced solid growth in the third quarter, showcasing a clear focus on pursuing high-quality business opportunities. They saw a commendable increase in their total cabinets under management, with the count rising to approximately 88,900 from 82,660 the previous year. The number of utilized cabinets also saw an uptake, which, in turn, elevated the overall utilization rate to 59%. A highlight was the retail Monthly Recurring Revenue (MRR) per cabinet, which maintained a high at RMB 9,495. Net revenues increased by 4% year-over-year to RMB 1.89 billion, and adjusted EBITDA grew by 11.6% to RMB 507.9 million. AI's growing demand in the computing power sector has been met by the company's high-power density capabilities, especially in large language model training and deployment for Internet platforms. An indicative achievement was securing an extended order of 45 megawatts from a major Internet customer, which speaks to the company's excellence in the wholesale services market.

Business Strategy Adjustment for Revenue and EBITDA

In terms of financial nuance, the third quarter saw a slight decrease in gross profit by 3.2% compared to the same period last year, with a gross margin of 16.2%. However, adjusted cash gross margin improved slightly to 39.1%. There was also a reduction in adjusted operating expenses, which dropped to 14% of net revenue. The net loss for the company saw a significant improvement, decreasing from a loss of CNY 425.2 million to CNY 50.5 million, marked by a reduced loss per share. The company has adjusted its full-year net revenue expectation to between CNY 7,400 million and CNY 7,600 million and the adjusted EBITDA to CNY 2,000 million to CNY 2,060 million, connoting a focus on high-quality, sustainable operations. Despite the downward revision, the minor decrease in EBITDA guidance around 2%, indicates a strategy pivot towards higher-margin IDC resources, such as AI-driven wholesale business lines, while reducing exposure to low-margin sectors.

Financial Stability and Capital Expenditure (CapEx) Plans

As for liquidity and solvency, the company's cash and cash equivalents stood strong at CNY 3.02 billion. They generated net cash of CNY 454.3 million from operating activities during the quarter and reported a capital expenditure of CNY 964.7 million. Addressing the upcoming convertible bond repayment, the CFO emphasized asset monetization strategies like new equity and debt investment, negotiations with creditors, and other funding mechanisms like minority asset sales and potential Real Estate Investment Trust (REIT) issuance. For the future, the company projected an increase in full-year CapEx for the subsequent year, primarily due to rising demand in the wholesale data center business and the growth of AI-driven demand. The specific figures for this increase will be announced in the following year's full guidance.

Demand Dynamics and Industry Focus

The demand for the company's data centers, especially those with high-power density capabilities, is witnessing a surge, notably from wholesale customers in industries such as short videos and e-commerce. Their IDC offerings are well-positioned to cater to emerging AI-driven needs across various sectors. The company also spotlights the significance of the AI trend on the retail side, with increasing demands from local services, healthcare, VR, and fintech. The emerging AI demands, compounded by supportive government policies, herald a promising frontier for the company to capitalize upon. The preparedness and resource allocation towards these high-growth domains underline the strategic foresight in predicting and adapting to the tech industry's evolving landscape.

Earnings Call Transcript 2023-Q3

[Operator]

Hello, ladies and gentlemen. Thank you for standing by for the Third Quarter 2023 Earnings Conference Call for VNET Group, Inc. [Operator Instructions] Participants from our management include Mr. Jeff Dong, Chief Executive Officer; Mr. Qiyu Wang, Chief Financial Officer; Mr. Tim Chen, Chief Strategy Officer; and Ms. Xinyuan Liu, Investor Relations Director of the company. Please note that today's conference call is being recorded.

I'd now like to turn the call over to the first speaker today, Ms. Xinyuan Liu, please go ahead.

[Xinyuan Liu, executive]

Thank you, operator. Hello, everyone, and welcome to our third quarter 2023 earnings conference call. Our earnings release was distributed earlier today, and you can find a copy on our IR website as well as on newswire services.

Please note that today's call will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. For detailed discussions of these risks and uncertainties, please refer to our latest annual report and other documents filed with the SEC. VNET does not undertake any obligation to update any forward-looking statements, except as required under applicable laws.

Please also note that VNET's earnings press release and this conference call include the disclosure of unaudited GAAP and non-GAAP financial measures. VNET's earnings press release contains a reconciliation of the unaudited non-GAAP measures to the audited GAAP measures.

As a reminder, this conference is being recorded. In addition, a webcast of this conference call will also be available on our IR website at ir.vnet.com. I will now turn the call over to our CEO, Jeff.

[Jeff Dong, executive]

Thank you, Xinyuan. Good morning and good evening, everyone. Thank you for joining our call today. I'd like to start with the overview of our third quarter performance. Our solid growth in the third quarter reflects our continued focus on high-quality business opportunities. Cabinet deliveries are progressing smoothly. By the end of the quarter, we had grown our total cabinets under management to approx 88,900 compared with approx 82,660 a year ago. The number of utilized cabinets increased by 1,092 to 52,408 in the third quarter, driving our overall utilization rate to 59%. Furthermore, our retail MRR per cabinet during the quarter stayed high at RMB 9,495. We remain dedicated to ending high-quality revenues in both the wholesale and the retail IDC market in the third quarter, generating solid year-over-year growth with our total net revenues increasing by 4% to RMB 1.89 billion and adjusted EBITDA growing by 11.6% to RMB 507.9 million.

With the rapid pace of large language model training and AI application deployments, computing power is becoming a new productive force. To meet the growing need for computing power, China's governing authorities have recently unveiled an action plan for the high-quality development of computing power infrastructure nationwide. As the industry leading player, we are seeing increasing demand for premium IDC services, and we remain a clear choice for customers who ride the wave of digital transformation.

Now let's take a closer look at our third quarter business update. First, AI is driving increasing demand for computing power and IDC services. Our wholesale data center continue to meet the increasing AI demand driven by our customer traffic-growing business. Equipped with high-power density capabilities we excel in powering large language model training and deployment for Internet platforms.

Our core competencies, [ spending ] resources and execution capabilities enable us to support our customers who are evolving and to sustain business development needs. As we mentioned on our last call, in August, we won an extended order of 45 megawatts from an existing Internet giant customer, which speaks to our superior wholesale service offerings appeal amidst the competitive landscape.

Moreover, our company deployment execution has been stellar. During the third quarter, we successfully delivered over 2,600 high-power density cabinets in the Yangtze River Delta region to one wholesale customer and approx 800 high-power density cabinets in the northern region of China to another wholesale customer. Throughout the delivery process, we maintain strict quality standards, we are offering customization options tailored to customer requirements. This execution is a testament to our commitment to timely delivery and top-notch quality, which has earned us a reputation for reliability and customer satisfaction.

Our retail customers' AI-driven demand continue to rise, particularly from existing customers in the industries such as local services, health care and VR. Building on this momentum, we expect to attract more retail customers from a wider range of industries such as autonomous driving and AI solutions. I'd also like to highlight our distinctive proficiency in designing and implementing power and equipment upgrades for our cabinets to meet existing customers' high-power density computing needs. This capability is well supported by our engineering experience and expertise as well as our existing high-power density cabinets, which allows us to promptly address growing diverse AI demand from retail customers. In addition, we further expanded and diversified our retail customer base in the third quarter, attracting new customers and securing extended contracts from existing customer in various industries, including IoT, financial services, gaming and mobility. It's also worth noting, we recently won a new order of 1.5 megawatts from an existing customer, a world-leading consumer electronic tech brand.

Now turning to our value-add services. During the third quarter, our full stack one-stop Bare Metal as-a-service solution continued to gain new customers, one of which is a pioneering unicorn in VR industry. We won the contract based on our flexible computing power resources that can rapidly meet this customer's specific demand during peak business hours, underpinning the rapid growth of its metaverse business.

Our diverse IDC services offerings include a solid IT infrastructure, premium operations and management services and impressive cost-efficient solutions, making VNET an outstanding choice for potential customers looking for a trusted partner to support their current and future business development needs.

We have also attracted a leading Chinese EV automaker for our interconnectivity services throughout our robust data center and network resources nationwide. The customer can store their business data in adjacent data centers and transmit with low latency backhaul. This customer reaffirms our compelling value proposition and advanced interconnectivity services capabilities.

In summary, our robust third quarter results showcase our ability to effectively address both wholesale and retail business IDC needs backed by timely and strong execution. Looking ahead, AI's prevalence and adoption is emerging across industries, and the supportive government policies will accelerate the development of computing power infrastructure in China. As a dedicated industry leader, we look forward to meeting this newest wave of demand driven by AI application and [ further unleashing ] our long-term growth potential.

Thank you, everyone. I will now turn the call to Qiyu to discuss our financial performance for this quarter.

[Qiyu Wang, executive]

Thank you, Jeff. Good morning and good evening, everyone. Before we start the detailed discussion of our financials, please note that we will present non-GAAP measures today. Our non-GAAP results include certain noncash expenses, which are not part of our core operations. The details of these expenses may be found in the reconciliation tables included in our earnings press release. Please also note that unless otherwise stated, all the financials we present today are for the third quarter of 2023 and in Renminbi terms.

Now let me walk you through our third quarter financial results. Unless otherwise specified, the growth rates I will be reviewing are all on a year-over-year basis. In the third quarter, we continued to deliver solid results with our focus on high-quality revenues. Our net revenue increased by 4% to CNY 1.89 billion from the same period last year, mainly driven by the continued growth of our main business.

Gross profit was CNY 306.5 million in the third quarter of 2023, representing a decrease of 3.2% from the same period of 2022. Gross margin was 16.2% in the third quarter of 2023 compared to the 17.5% in the same period of 2022. Adjusted cash gross profit, which excludes depreciation, amortization and share-based compensation expenses, was CNY 738.4 million in the third quarter of 2023, an increase of 4.3% from the same period of 2022.

Adjusted cash gross margin in the third quarter of 2023 was 39.1% compared to 39% in the same period of 2022. Adjusted operating expenses, which excludes share-based compensation expenses and the compensation for the post-combination employment in the acquisition, were CNY 264.8 million in the third quarter of 2023 compared to CNY 275.1 million in the same period of 2022.

As a percentage of the net revenue, adjusted operating expenses in the third quarter of 2023 were 14% compared to 15.2% in the same period of 2022. Adjusted EBITDA in the third quarter of 2023 was CNY 507.9 million, representing an increase of 11.6% from the same period of 2022. Adjusted EBITDA in the third quarter of 2023 excludes share-based compensation expenses of CNY 9.5 million.

Adjusted EBITDA margin was 26.9% in the third quarter of 2023 compared to 25.1% in the same period of 2022. Our net loss attributable to VNET Group in the third quarter of 2023 was CNY 50.5 million compared to a net loss of CNY 425.2 million in the same period of 2022. Basic and diluted loss were both CNY 0.06 per ordinary share and both CNY 0.36 per ADS. Each ADS represents 6 Class A ordinary shares.

Turning to our balance sheet. As of September 30, 2023, the aggregate amount of the company's cash, cash equivalents and restricted cash was CNY 3.02 billion. Meanwhile, net cash generated from operating activities in the third quarter of 2023 was CNY 454.3 million compared to CNY 607.4 million in the same period of 2022. Our capital expenditure in the third quarter of 2023 was CNY 964.7 million.

Before I conclude, I'd like to provide an update on our financial outlook for full year 2023. For the full year of 2023, the company currently expects total net revenue to be between CNY 7,400 million and CNY 7,600 million, representing a year-over-year growth of 4.7% to 7.6%, and adjusted EBITDA to be in the range of CNY 2,000 million to CNY 2,060 million, representing a year-over-year growth of 6.8% to 10%. This compares with total net revenue expected between CNY 7,600 million and CNY 7,900 million and adjusted EBITDA between CNY 2,025 million and CNY 2,125 million as previously stated.

The outlook update is mainly due to our continuous focus on high-quality revenues to maintain the long-term sustainability of our operations. The focus reflects the company's current and preliminary views on the market and its operational conditions and is subject to change.

Moving forward, we will stay focused on our high-quality growth strategy, promoting our premium IDC services to empower digital transformation across a broader swath of industries. As always, we remain committed to create sustainable growth for all our stakeholders.

This concludes our prepared remarks for today. Operator, we are now ready to take questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Yang Liu from Morgan Stanley.

[Yang Liu, analyst]

I would like to have an update in terms of the company's upcoming convertible bond repayment in February next year. What has been done? Or what is the current progress of the asset monetization to prepare for the repayment? Both for the potential REIT issuance and also the [ sell income ] -- minority stakes of existing projects, et cetera, whatever you can share now.

[Qiyu Wang, executive]

Yes. Thank you. I know this is the most important question for us. Taking the liability management issue has been my top priority since I -- task since I took the CFO position. We are busy working on 2 major ways for resolve the issue. One is write new funding from new equity and debt investment because we need to follow the NASDAQ rules. So we will be dedicated to pursuing new investors and then, it's the right time, we will make the public announcement if there's any concrete progress.

Also continue to activity engaging with our CB creditors to find the best way forward. Also -- we also try our best to present OpEx management and all positive progress in other funding raising, just you say, including the asset sell minority share and also the C-REITs. There are -- both have some significant progress, but also need some time to closing this deal. So yes, we will -- so we will try our best to leverage this incoming CBs. So we are a firm plan to the [ put ] and are leveraging on both internal and external resources. Yes. Thank you.

[Yang Liu, analyst]

May I follow up with another question on the business update? For the downward revision of the revenue and the EBITDA guidance, where do you see more weakness come from? Is it from the traditional retail business or more from the wholesale business?

[Qiyu Wang, executive]

Yes, we do some change to our guidance. What I want to share is with close to 13 years of IDC industry experience and market insights, we will be navigating our business towards where we focus greater profit margin business in short or midterm. For example, this year, we have allocating more of the IDC resources to areas such the AI-driven wholesale business line, where clearly, the booming market and promote our profit margin. So we focus this high profit business, and then we try to close some low-profit business.

So you can see, if you compare the revenue and EBITDA guidance, the EBITDA guidance, we only decreased very minor, around 2%. So in additional, we're planning to certain do core value governance practice within this year, so as our ongoing financial statement could better reflect the nature and transmission of our business. And then we continue to focus the high-profit business, for example, the wholesale and the AI-driven demand business.

[Operator]

Our next question comes from the line of Charlie Bai from Jefferies.

[Tianyu Bai, analyst]

This is Charlie Bai from Jefferies. My first question is about third quarter MRR. I saw a quarter-on-quarter decline on both utilization rate and retail MRR. May I know what's the reason behind it?

[Jeff Dong, executive]

In terms of MRR, I would say for Q3, still say at a high level and is in line with our expectation. There might be some fluctuations from quarter-to-quarter, which is quite normal. So we believe at the end of the year, and it's come up again. And also in terms of utilization rates, our estimate of UR by the end of 2023 will be on par of the Q3 2023 level with a faster growth, especially for our wholesale customers. Particularly those in the short video sectors, we expect a higher utilization rate in 2024.

[Tianyu Bai, analyst]

May I follow up with another question? May I have some color on the outlook of the CapEx plan this year and in 2024?

[Qiyu Wang, executive]

Yes. This year, the full year CapEx is expected to be around CNY 3.8 billion, which is about 10% more than our guidance. The main reason is that the demand for wholesale data center business is growing faster. And next year, there will be a significant increase in the full year CapEx, mainly due to the increased growth rate of the wholesale business and high -- and AI-driven demand. So we will specific figure the CapEx announced in the full year guidance early next year.

[Operator]

Our next question comes from the line of Timothy Zhao from Goldman Sachs.

[Timothy Zhao, analyst]

Sure. I want to understand more about your updated guidance for this year. Just wondering, could you share a little bit more in terms of the revenue breakdown for the full year guidance for your wholesale IDC, retail IDC and also the non-IDC business? And you mentioned that you are going to turn down or reduce the exposure to those low-margin business. Could you elaborate more on what exactly are those lower-margin business? I believe those include the retail business. And like how much more do you expect to reduce the exposure, I think, in this segment?

[Qiyu Wang, executive]

Yes. Because now -- because the wholesale and the AI-driven demand is increase faster, so we try to find more resources. For example, in some retail data center, we shut down and we closed some business for traditional retail customer and then move the space and the power supplied to the AI customer. So this is the main reason our reduced revenue guidance. And on the same way, you'll see the EBITDA impact -- this impact EBITDA is very minor.

So I think this is not our business is -- the speed of our business is low down. It's -- on the other way, this is the signal is that the EBITDA margin and then the EBITDA is more positive than before.

[Operator]

Our next question comes from the line of Daley Li from Bank America Securities.

[Huiqun Li, analyst]

Just one on the AI space. You mentioned more high-power density deployment for your data center. Could you please share the demand trend driven by AI? Do we have any like breakdown, how much demand from AI for the retail or for the wholesale business? And looking into next year, how do we view the AI demand for our data center business?

[Jeff Dong, executive]

Okay. In terms of AI, which is very popular since this year, we have seen actually the rapid growth of AIGC in China. Dozens of large language modeling across different sectors has already been launched since early this year. Many of them are still being trained, and the generic models are dominated by actually the Internet giants, whether the verticals are led by the leading players in specific industries. Some tech start-ups as well aside from the Internet giants.

Back to the impact on our IDC demand. I would say from the wholesale side, the AI-driven demand from wholesale customers are mainly searched by Internet giant customers, especially the short video e-commerce business. Notably, we delivered, as announced this quarter, around 3,500 cabinets during the quarter to 2 wholesale customers, all of which actually are high-power density cabinets. And in terms of the retail side, we are steadily receiving increasing AI demand from retail customers across various industries, such as local services, health care and VR. And also, we are further exploring into the demand from some new economy industries such as fintech. We are in dialogue with them.

And in terms of high-power density cabinets, actually, those cabinets locate from VNET -- locate in the Greater Beijing Area, Yangtze River Delta and also Greater Bay Area. In terms of the size, we obviously see about from up to 40 kilowatts to an over 30 kilowatts for the wholesale and the retail. And so far, we have -- from all delivered, we received this quarter about over 90%, I would say it's coming from a high-power density area.

[Operator]

Thank you. We have reached the end of the question-and-answer session. And with that, ladies and gentlemen, that concludes our conference for today. Thank you for participating. You may now disconnect your lines. Have a good day.