VNET: In-Line Q3 EBITDA Overshadowed By Downward Guidance Revision

Elevator Pitch

VNET Group, Inc. (NASDAQ:VNET) stock is still rated as a Hold.

Earlier, my August 25, 2023 write-up touched on VNET’s latest corporate developments, and the company’s mixed financial performance for the second quarter of this year.

I perform a review of VNET’s Q3 2023 financial results and assess its full-year prospects with the current article. In my opinion, a Hold rating for VNET is fair, considering both the company’s third quarter EBITDA which met expectations, and its updated FY 2023 guidance that was disappointing.

Third Quarter EBITDA Met The Market’s Expectations

VNET revealed the company’s most recent third quarter results on Wednesday November 15, 2023 after the market closed. The company’s actual Q3 2023 normalized EBITDA was in line with the sell side’s expectations, even though it suffered from a revenue miss in the recent quarter.

The company’s non-GAAP adjusted EBITDA grew by +11.6% YoY to RMB507.9 million in the third quarter of this year, and this was just marginally (+0.6%) above the analysts’ consensus forecast of RMB505.0 million (source: S&P Capital IQ). As such, it is fair to say that VNET’s Q3 2023 EBITDA was in line with expectations, rather than referring to this as an EBITDA beat.

However, VNET’s actual Q3 2023 top line of RMB1,886.9 million fell short of the sell-side analysts’ consensus revenue estimate of RMB1,949.0 million by -3.2% based on S&P Capital IQ data. The YoY revenue expansion for the company also slowed from +5.6% in Q2 2023 to +4.0% for Q3 2023.

In its Q3 2023 earnings press release, VNET emphasized that “we continued to concentrate on high-quality revenues” in the recent quarter, and this explains why the company witnessed a top line miss and in-line EBITDA for the third quarter.

A focus on “high-quality revenues” indicates that VNET is prioritizing profit margin expansion over top line growth, which is reflected in the company’s financial metrics. VNET’s normalized EBITDA margin improved by +180 basis points YoY from 25.1% for Q3 2022 to 26.9% in Q3 2023., and this allowed the company to achieve in-line EBITDA despite registering slower-than-expected revenue growth.

VNET’s shares declined by -1.1% (source: Seeking Alpha price data) during post-market trading hours after releasing its Q3 2023 results. This suggests that the company’s in-line Q3 2023 EBITDA was overshadowed by its FY 2023 guidance revision detailed in the next section.

The Lowering Of Full-Year Guidance Was A Negative Surprise

VNET chose to revise the company’s full-year fiscal 2023 guidance downwards after it disclosed its third quarter financial performance.

Prior to VNET’s Q3 2023 earnings announcement, the company guided for full-year top line and non-GAAP adjusted EBITDA of RMB7,750 million and RMB2,075 million, respectively as per the mid-point of guidance. In comparison, VNET’s updated FY 2023 revenue and normalized EBITDA guidance post-Q3 results were RMB7,500 million and RMB2,030 million, respectively as indicated in its latest November 2023 investor presentation.

In other words, VNET lowered its top line and EBITDA guidance for FY 2023 by -3.2% and -2.2%, respectively. VNET’s updated management guidance also implies that the company’s revenue growth is expected to moderate from +14.1% in FY 2022 to +6.2% for FY 2023, while the projected FY 2023 EBITDA expansion of +8.4% (as per new guidance) is better than the company’s FY 2022 EBITDA increase of +6.8%.

At its Q3 2023 earnings call (event transcript sourced from S&P Capital IQ), VNET shared that it had exited certain “low profit businesses” such as data centers serving “traditional retail customers”, while shifting its emphasis to “high-profit businesses” relating to “wholesale and AI-driven demand.” This explains why VNET revised its revenue guidance downwards by -3.2%, although the cut to EBITDA guidance was milder at -2.2%.

Nevertheless, the changes VNET made to its full-year guidance was a negative surprise for investors, and this is reflected in the 26% stock price decline for VNET during trading hours on Thursday.

Overhang Relating To Convertible Bond Hasn’t Been Removed Yet

In my late-August update for VNET, I highlighted that the company has to deal with the “refinancing of the company’s $600 million convertible bond” which holders have the right to request for repurchase in February next year. This is an overhang for the stock, as investors are concerned about how VNET will get the necessary funds needed to refinance this substantial convertible bond.

VNET noted at the company’s third quarter results briefing that it “needs some time” to complete the relevant fund raising deals, and it stressed that it “will make a public announcement if there is any concrete progress” on this front.

Until VNET formally discloses that it has successfully raised sufficient funds to meet the repurchase of its $0.6 billion convertible bond, there will still likely be a valuation discount assigned to VNET’s shares to account for this risk factor.

Concluding Thoughts

I am impressed that VNET has managed to deliver in-line third quarter EBITDA as the company continues to place an emphasis on revenue quality. But I am disappointed that VNET made the decision to lower its top line and EBITDA guidance for full-year FY 2023. Furthermore, there is still an overhang for VNET’s shares relating to the need to repurchase its $600 million convertible bond. In that respect, I think it is justified to maintain a Hold rating for VNET.