Megaport (ASX: MP1) recently announced a capital raise at a small discount to the current trading price. The company placed $62m worth of shares, representing around 5% of the company’s market cap. This will almost double their cash balance, and provide an avenue for the business to capitalise on the share price rally from the last few years of successful execution of their global growth strategy. While the company does not need additional capital to get to profitability on our financial projections, management is raising capital so they can spend more money on research and development. While this will dilute existing shareholders to a small degree, management believes that it will create a stronger, more profitable company over the long run. While the capital raise was at a small discount, it takes demand for shares off the market and has driven the share price slightly lower in today’s trading session.
Megaport also had an impressive set of results for FY19 a few months ago, with monthly recurring revenue up 82% to $3.6m. This puts the company’s annualised revenue at $43.3m, helping provide fundamental support to the firm’s recent share price growth. Megaport created 24 new cloud on-ramps and announced two new cloud partners over FY19, SAP and Nutanix, which helps support their value proposition. North America was by far the strongest area for growth, with revenue rising 154% to $13.6m, showcasing the company’s ability to successfully compete with Equinix’s cross-connect based solution within the mid-market.
Megaport’s business model is based on facilitating interconnection within data centres, enabling smaller DCs to compete with dominant market giants like Equinix. The company’s interconnection-based systems allow enterprise customers to pick and choose which aspects of the cloud they want, and when. A traditional small DC will have one cloud and one server, requiring customers to rent a certain amount of data space for a long period, even if they only need it for 1 day a year. Megaport’s interconnections will allow customers to pick and choose a plan; a customer requiring DC space for one day a year, like a retailer needing the space for Boxing day sales, only rents the extra space for a day a year while other customers rent it the rest of the time. They can also pick and choose what they want from each of the cloud offerings on the Megaport platform, instead of being stuck with all the downsides of one cloud provider.
The business has high fixed costs to make a data centre “Megaport enabled”, and it takes a few years for enough customers to find enough use cases for additional services so that the company can make a profit. Megaport is focussed on dominating a large share of the DC market, especially within smaller data centres. This means that it will likely continue to make losses for a couple of years.
Nevertheless, the company’s network effects provide a huge competitive moat that allows Megaport to increase pricing and maintain high margins. Their main competitor is Equinix, offering a cross-connect based solution for the more premium end of the market, with better latency at a much higher price. A new competitor would have to offer an inferior product for a long time before getting market domination, making it much harder than when Megaport entered the market.
The market also likes the management team and attaches high valuations to most of the companies that Bevan Slattery, Megaport’s founder, listed. The company has rallied substantially this year and also trades on expensive multiples as institutional attention has been attracted to the stock.
This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
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