Megaport (ASX.MP1) is raising around $827 million in a fully underwritten offering at a 1 for 3.08 pro rata accelerated nonrenounceable entitlement to fund four new large GPU contracts and the establishment of a new on-demand GPU pool.

Why it matters: The company is seeing significant demand growth for its GPU compute offering. Although we believe the current global scramble for compute plays a role, the contract wins also suggest to us that its flexible, distributed capacity offers a differentiated service in the market.

  • Megaport is leaning into this demand through a new strategic direction, focused on building a globally distributed AI inference cloud, both for fixed and variable contracts, meaning it will provide the compute for AI companies to run consumer- or business-facing AI applications.

The bottom line: We increase our fair value estimate for no-moat Megaport by 13% to $17. We also increase our Morningstar Capital Allocation Rating to Standard, from Poor. Shares screen as around fairly valued at last close before the equity raise announcement.

  • Our upgrade reflects our belief that the current contracts will generate internal rates of return of over 20% over their five-year expected useful life and our increasing conviction that the company can utilize its existing assets in data centers for a lucrative new purpose.
  • Assuming it is in line with their individual investing goals, we recommend shareholders subscribe to the offer on valuation grounds at $14.30, representing an 11% discount to the theoretical ex-rights price and a 16% discount to our upgraded fair value estimate.

Key stats: The retail offer opens on June 11 and closes on June 29.

  • Proceeds are first to fund $366 million in capital expenditure to support existing contracts with a combined total value of $459 million. The contracts are expected to have a 27-month payback period, and we expect them to generate another $600 million in adjusted EBITDA following that payback.

Megaport’s Compute Business Can Leverage Existing Presence in Data Centers

We expect Megaport’s strategy in the near term will revolve around helping AI companies address the global shortage of compute through its new compute offerings. To that, Megaport can leverage its existing presence in over 1,000 data centers to install small amounts of GPU capacity per center, that is then tied together with its networking technology to create capacity of sufficient scale to be interesting to AI companies.

In the medium term, we expect the industry for its original networking technology to shake out, following years of intensifying competition. We expect Megaport, as the scaled provider, to come out as the winner.

Bulls Say

  • Megaport is one of the leading companies in a lucrative, nascent industry.
  • Megaport’s industry-leading net revenue retention implies tremendous latent revenue and profitability growth.
  • The SDN industry has significant barriers to entry, which we expect to lead to a limited number of scaled providers.

Bears Say

  • Megaport’s products and services are not protected from competition by an economic moat. We expect eventual commoditisation and price-based competition, albeit among a relatively small number of providers.
  • Gross customer growth has been slowing, and customer acquisition costs have been growing rapidly.
  • Customer churn has been increasing and is relatively high compared with the software-as-a-service industry.

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