The Good

• Recurring revenue increased 27% QoQ to $884k.
• Sold full capacity of the 2.4MW MidWest DC. Which is a positive move for the direction, but also puts a cap on a growth channel until the potential Vic biogas DC is commissioned somewhere in H2 this year.

The Not So Good

• Trading halt for capital raise to fund “strategic shift in operations”. The strategic shift is to borrow money to start mining bitcoin from the Bibra Lakes DC. Seems like the sales team are finding it tough to sell space. Some serious red flags here with rising interest rates and a crypto meltdown. I don’t know how the numbers stack up in terms of a floor price of bitcoin where mining is currently sustainable.
• Most of the space hired through the MidWest DC is for mining crypto currency which is also a risk at the moment.
• The Tier III accreditation which may have helped with sales to enterprise and government customers is still out in the great unknown.
• $1m in cash outflow. Only $466k in cash left and $1.75m from the recent capital raise still only gives another two quarters before the cash runs out again. The current quarter doesn’t include the cash flow from a fully sold out MidWest DC but they are going to need much more than that to stop the bleeding. Based on the current product manufacturing and operating costs %, revenue will need to increase to over $2m a quarter to reach breakeven on operating cash flows alone.
• Some musical chairs for the management team, but no one is actually leaving. Not sure what has really been achieved there.

What To Watch

• My sales order on SelfWealth go through for an expensive lesson. That’s for another straw.

Another 4C review that I am late on. The rest of my updates are going to need to become Half Year reviews instead…

The Good

• Annual Recurring Revenue (ARR) increased again to $694,703 for the quarter, and is starting to show a slight trend of ongoing growth. Taking cues from the recent Baby Giants podcast episode, I had a look if they have outlined how this figure is reported, however nothing was listed in this quarterly. It will be one to have a look for in the upcoming H1 Update. 

The Bad

• Still no update on Tier III accreditation. Previously indicated outcome expected during February, which gives them one week to get something across the line. If a company misses an announced target once, it can be accepted with the right reasons, however it is concerning when they miss a deadline for a second time.
• A portion of the update contains a fair bit of fluff about Directors on market purchases and industry tailwinds. This is pretty meaningless and ultimately doesn’t provide any insight into company operations.
• With a cash balance of $1.352m there is only 2 quarters of operating cash left. This should hopefully be offset slightly by previously upfront costs for Joule energy contract, which is due for completion and final payments in Q3, but unless there a some significant changes over Q3 there is a capital issue.
• No update on previously announced Mid-West capacity increase or the progress of the Collie project. 

(EDIT: It was announced on 17 Feb that the Mid-West upgrade has been completed. As these projects are completed it should assist in reducing the amount of investment cash flow that is required.

In this update it was also mentioned that the 1MW Collie DC is nearing commissioning but no timeline was provided. Having a bit of a scan around the internet, it looks as though there is a 12 month construction timeline which kicked off in July 21. I would expect that commissioning of the DC would likely be after that, so sometime in Q1FY23 is likely when this will be completed.

WA Gov Media Statement)

What To Watch

• Critical for Tier III design accreditation to be achieved this coming quarter otherwise confidence in management will be further eroded.
• Mentioned Vic DC will be online in Q4 FY22. (EDIT: This timeline was reinforced in the 17 Feb update.)
• Given the current cash position there is likely another capital raise on the horizon.
• Large portion of previous 2 quarters from modular crypto contracts which are now up and running. Further growth needs to come from sales of Bibra capacity.
• EDIT: 03-02-21  Achieved VMWare Cloud Verified Status. I am currently unsure on the significance of this to operations and position in the industry. Will need to carry out further research in this area.

Impacts to Price Forecast

• Revenue currently inline with previous forecast
• Review other DC provider multiples for comparison rather than IT Service Industry

Executive Director, Blake Burton was on Small Caps podcast recently and talked up plans for expansion of the DC and cloud business. 

The recently reported increase in recurring revenue is apositive as are the plans for commercialisation of its data centre in Victoria Joule Energy has signed an order for 500k where DC2 2ill provide a modular unit for Joule renewable energy.

The idea to align to renewables to power the centres is a positive. ESG for data centres is only going to increase. Hitching to crypto is likely also a good strategy, although they offer DC, not compute so I feel this is somewhat marketeering. Happy to be otherwise set straight. 

As @bradburt has stated they are going for Tier III design accreditation. This is an importantly step and follows on from the ISO27001 certification. Important as these are both elements almost every potential customer will seek as a minimum.

Burton referenced “over east” on several occasions. This is a very Western Australian expression, and it makes me wonder if they are ready, or if they will adequately plan for such an expansion. As Western Australians know, businesses that attempt to long-line it from the east coast to service WA customers, are rarely successful. 

Burton also mentioned NextDC and MaqTel – these are formidable competitors, and neither should be underestimated especially.

Shares are trading at about half the listing price with the business about at the listing anniversary. Managing Director, Justin Thomas holds around 21% of the float. Thomas has made several on market purchases, including around $50k worth in October. Other director holdings are negligible. 

While this is a significant and growing market, it is one that has large and continual capex requirements, and its a space that is fiercely competitive. Will be watching from the sidelines for now.

DC2 released their 4C Wednesday this week and it appears that there is a positive shift in progress after previous delays and capital raising requirements. So what did we get?

Total revenue of $847k which has them on track with my forecast for FY22 Rev of $3.5m. This was made up of recurring revenue of $568k continuing growth each quarter. This number will also improve by about 8% next quarter before any further contracts with the latest Mid-West contract kicking off this month.

Cashflow is still going to be a concern for the DC2 until the final Tier III accreditation is completed, however between the latest capital raise and the improving recurring revenue, outflows should be at manageable levels by the end of Q3.

There were mentions on new customers and contracts, however no indication of time or value.

Announced targets for Q2 to watch that confirm that management are delivering on promises:

-         Completion of Tier III Design Accreditation of Bibra Lakes

-         Capacity increase of the Mid-West Data Centre.

 I am relatively happy with this update, however there is still pressure on the company to deliver the Bibra Lakes data centre which will de-risk the next stages of growth.

DC Two has gone into a trading halt pending an announcement of a capital raise on Monday. Given the timing and steady decline in share price this isn’t a great look, however from my perspective it could play out several ways:

First and likely the most positive outcome would be that the capital raise is to fund one or several contracts that have been signed for the setup of further data centres. Based on previous announcements the company was aiming to finalise agreements this month for the data centre installation with Cannaponics Collie. Using the Joule energy announcement earlier in the month as a guide for build costs, another deal like that one would be pushing the limits of the cash balance.

Second and probably the least preferable outcome is that the raise is for working capital because as of the last 4C there were only 2 quarters of cash runway left. This would mean DC2 has had to spend more than anticipated in completing the Bilbra Lake Facility / Tier III accreditation and or the rate at which customers are being signed up is not as high as anticipated. Knowing that the upcoming quarterly won’t be great, they are getting ahead of a further share price decline. This would be the scenario that @Rocket6 described and was wary of starting to play out.

Third possibility is now that the company has completed most of the works on the Bilbra centre they have now found a further acquisition / potential site to continue the expansion of hosting capacity and need the funding to continue the capital works growth. I think it is too early for the company to be heading in this direction.

I need to just wait and see how this plays out, but so far DC2 has not been a great performer that I have averaged down into and likely entered too early before the significant execution risks had been reduced / removed. Hopefully not a case of watering the weeds but I need to keep a close eye on this one over the near term.

Disclosure: Held

Today DC2 announced that Joule Energy will be purchasing a prefabricated modular data centre for $482,396. From the tone in the announcement I doubt there will be any significant commercial outcomes from this deal other than an uptick in overall FY22 revenue with the delivery and commissioning likely to be completed by the end of Jan 22.

The main positive I have taken from this update is the mention of progressing other agreements for DC2 data centre installations at the renewable energy sites. Continuing growth of the modular business arm will help provide small boosts to overall capacity and ARR which should assist in reducing the cash burn which is a concern at present. This part of the business is also a point of difference from the bigger competitors in the market, so having demand for these services is also a positive sign going forward.

Overview 

DC Two Limited owns, builds, and manages cloud computing, hosting, and data center services in Australia. It offers data center and cloud hosted services, data center hosting and colocation, data center and cloud automation software, and modular data center and hosting solutions. DC Two Limited was founded in 2012 and is based in Osborne Park, WA. 

What are data centres?  

Data centers, often referred to as a singular thing, are composed of a number of technical elements. These can be broken down into three main categories: 

• Compute: The memory and processing power to run the applications, generally provided by high-end servers 
• Storage: Important enterprise data is generally housed in a data center, on media ranging from tape to solid-state drives, with multiple backups 
• Networking: Interconnections between data center components and to the outside world, including routers, switches, application-delivery controllers and more.  

The short of it is, data centres store and manage critical resources and are fundamental to the continuous operations of an organisation – both large and small.   

DC Two (DC2) – recent activity  

HY FY21 

The last time I checked in on DC Two, revenue hadn’t progressed as hoped. HY reports noted sales revenue of $831,689. It was on track (based on its HY figures) to have FY revenue decrease to numbers observed in 2018 (FY2020 – $1,856,000; FY2019 – $1,961,000; FY2018 – $1,400,000). Even with other ventures progressing in the background (namely Bibra Lake data centre), my main concern was that the market wouldn’t respond well to a newly listed company tracking backwards quarter into quarter. So, I avoided it and told myself I would come back in a few months. 

Q4 FY21 

Q3 and Q4 reports were slightly better news for the company (with 692k and 632k in sales respectively). This should see the company report total revenue over $2 million for the year (an increase of around 15% YoY). Again, this isn’t what I would consider exciting growth – particularly with the tailwinds the data centre industry has.

They did secure a fixed term agreement to provide services to a cryptocurrency miner, estimated to be worth a minimum of 926k over a 5-year term (initial revenues expected to begin in August 2021). A small contract, but positive to see it securing long term deals and provides a small tailwind to revenue figures in FY22. There are some opportunities for DC2 to target cryptocurrency miners, but they definitely shouldn't be their core market. 

The Bibra Lake data centre (stage 1) became operational in Q4 FY21, with Tier 3 accreditation expected in the coming months. The data centre will host DC Two servers, cloud services and offer co-location to customers. This is key for DC Two and will underpin its nationwide expansion. It will provide the company with the infrastructure needed to secure mid-market and enterprise customers (that specifically require Tier 3 accreditation). Design and construction accreditation is expected in H2 CY21. When this is complete, DC Two will be only company in WA with an Uptime Institute accredited Tier 3 data centre. This should provide a competitive edge when tendering for larger companies. It will also allow the company to transition some internal resources from development into commercial activities.  

Recent reporting shows a cash balance of $1.89 million. 4Q saw cashburn of $848,000 – up from $293,000 in 3Q. This increase was mainly due to manufacturing and operating costs, presumably due to the Bibra Lake facility? $202,000 was also spent on R&D. This is a red flag. This sort of spending is unsustainable and will result in dilution many times over.

While it is pleasing to see a little more stability in the revenue numbers, cash burn is concerning. Bibra Lake opened to customers in May 2021 (albeit without Tier 3 accreditation yet). The bad news is revenues didn’t increase significantly with the new capacity. The second red flag for me is: why? This suggests demand potentially isn’t there for facilities that aren’t Tier 3 accreditation. So there is a bit of a ‘wait and see’ with this one – it’s hard to judge DC2 too much without Bibra Lake being Tier 3. 

The risk/reward is a little more attractive for me this time around, in contrast to a few months ago. That said, there are still a few red flags and it wouldn’t surprise me if shareholders are diluted in the near-future. I should probably explain a little about why I continue to check in on DC2 and why the industry interests me:

Thesis

Data centres will play a more important role in the future data economy, with the world increasingly shifting to cloud and digital services. The Australian Government Department of Energy has stated that ‘the average Australian data centre is now over 20 years old and many are inefficiently designed’. Unlike 20 years ago, almost every modern business, government and consumer has data stored in a data centre. They host websites and manage e-mail, power hyper-scale platforms (Google, for instance) and support almost all cloud storage and applications. 

Telsyte, a technology insight company, reported in 2020 that 45 percent of organisations were looking to increase cloud infrastructure spending. A further 59 percent of Australian businesses also had a “cloud first” policy at the time.  

The issue with data centres is their cost – they are expensive and resource intensive to establish, and then subsequently maintain over time. This represents somewhat of an economical moat for the company. It doesn’t mean they are without competition though – there are multiple competitors in Australia but the WA market lacks a Tier 3 site. DC2 has capacity now, and is expected to have a Tier 3 site in the coming months – they now need to convert some of the alleged interest into revenue. To summarise, there are some nice tailwinds for the data centre industry – physical and cloud.  

What else do I like? DC2 tick a lot of boxes: 

• Debt free 
• Founder led (CEO) with 24.5% ownership.  
• Competent and experienced BOD, with 2 of the 3 having purchased shares in 2021.   
  • Justin Thomas (CEO) – Thomas has an impressive background, having successfully built and sold two startups – a software business sold to RP Data in 2007 and a data centre sold to Amcom (now Vocus) in 2012. In short, its not his first rodeo. He recently purchased shares in Jan 2021 at 0.34c (well above current share price).  
  • Cameron McLean (chair) – 20 years’ experience leading and managing businesses, including London based geo-technology company iBase Limited and CFO of multiple resource companies. Cameron McLean recently purchased shares at 40c (also well above current share price).   
  • Blake Burton (director) – brings experience within the IT industry. Founded his own web hosting company, which he took to a successful trade sale to Australia's largest privately owned web host. 
• No insider selling since listing on the ASX. 
• ESG play – the company is progressive: it wants to use wind, solar and other renewable power sources to offer a ‘green powered’ service to Australian customers seeking more eco-credentials across their business. This should also reduce capex for the company through cheaper energy.  

This is long winded, but this one isn’t quite there for me yet. I don’t think the risk/reward balance is favourable, despite it being close. 

What I want to see before purchasing

• Monitor the key metrics closely in Q1 FY22 reporting – make sure DC2 is not burning through cash with little increase to its bottom line/revenue. This is a risk for data centre providers, particularly if they are not run well overtime (ASX: DXN an e.g., of this). If cash burn remains at similar rates as it was in Q4 I will be running for the hills. If this is the case, the company will almost certainly have to raise cash multiple times in a short window and dilute shareholders.
• Bibra Lake is a point of difference in the WA market and is key to the investment thesis. Tier 3 should occur in 2021 - if it doesn't management have overdelivered. With Tier 3, track the ability of the company to both market the facility and increase their revenues. 
• Monitor Collie Data Centre and its progress towards commercialization.  

Happy to hear any thoughts other members might have.

DISC: Not held. Added a tiny portion to Strawman portfolio to assist with monitoring them overtime and let other members know I am interested, just not sold on the stock yet.