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21Vianet Group (NASDAQ:VNET)

Q2 2014 Earnings Conference Call

August 27, 2014 8:00 p.m. ET


Frank Meng – President

Shang Hsiao – CFO

Eric Chu – VP Capital markets and Business Development


Greg Miller – Canaccord Genuity

Colin McCallum – Credit Suisse AG

Kai Qian – CICC

John Choi – Daiwa

Louie DiPalma – William Blair

Lingling Hu – Goldman Sachs


Good morning, ladies and gentlemen. Thank you everyone and welcome to the 21Vianet Group's Second Quarter 2014 Earnings Conference Call.

[Operator Instructions]

Before we begin, I will read the Safe Harbor Statements. This call may contain forward-looking statements made pursuant to the Safe Harbor provisions for the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and observations that involve known and unknown risks, uncertainties and other factors not under the company's control, which may cause actual results, performance or achievements of the company to be materially different from the results, performance or expectations implied by these forward-looking statements.

All forward-looking statements are expressly qualified in their entirety by the cautionary statements, risk factors and details of the company's filings with the SEC. 21Vianet undertakes no duty to revise or update any forward-looking statements for selected events or circumstances after the date of this conference call.

With us today are Mr. Frank Meng, President, Mr. Shang Hsiao, Chief Financial Officer, and Mr. Eric Chu, Vice President of Capital Markets and Business Development. Following management's prepared remarks, we will conduct the Q&A.

At this time, I would now like to turn the conference call over to Mr. Frank Meng, 21Vianet's President, for opening remarks.

Frank Meng

Good morning and good evening everyone, and welcome to 21Vianet's second quarter 2014 earnings conference call. We had a very exciting second quarter filled with numerous new initiatives which I will highlight in more detail shortly. We made a significant progress doing our core IDC CDN and cloud services, improving our profitability as well as expanding our product and service offerings, which further cements our position as the leading integrated internet infrastructure service provider.

For our core IDC business, we increased our total cabinets to almost 17,000 cabinets, with approximately 67.8% of those cabinets in our sales field data centers. We are confident we're on track to deploy a total of 10,000 cabinets by the end of 2014, bringing our total cabinets to approximately 24,000.

In addition, we saw a record-low hosting churn rate of 0.28%. Even more impressive was our utilization rate which increased to 73.9% this quarter, even as we added close to 1,900 cabinets, exceeding both of our internal and industry expectations. Looking ahead, we expect our utilization to decrease slightly in Q3 and Q4 as a large number of cabinets then come online.

Primarily driven by our expanding IDC business, our net revenue by an impressive 39.7% year-over-year. This shows the strong customer demand for our IDC services as we increased our capacity and continued to build scale and leverage into our business.

Furthermore, we saw impression [ph] of our adjusted EBITDA margin to 20.1%, supported by improved utilization rates, large portion of our high margin sales build cabinets, and growing incremental contribution from our cloud business. We are seeing tremendous growth and momentum in Microsoft Azure and Office 365, both in terms of the net revenues and net new customers, which should continue to help our adjusted EBITDA and EBIT margins going forward. However, we note that our adjusted EBITDA could fluctuate from quarter to quarter as we continue to expand our IDC capacity, ramp up our cloud business, and invest in new business initiatives.

Now looking at our cloud business, we are very pleased with the performance of both Azure and Office 365 services during the first quarter when both product lines were commercially available. The Windows Azure platform now supports over 9,000 active users, including not only many multinational corporations but also a significant number of domestic companies. For the Office 365 services, we have also seen tremendous traction now with over 20,000 customers who have signed up for the services. Overall we are very excited to share with you that the earlier results from both Azure and Office 365 exceeded our internal expectations.

For the IBM Private Cloud business, the partnership continues to very actively prepare for the commercial launch which is now expected towards the end of Q3.

Moving on to one of the new initiatives this past quarter, was our strategic investment in Aipu. Aipu is one of the largest regional internet service providers that engages in last-mile wired broadband access and other value-added services to internet users. Through this investment, not only are we able to incorporate a substantially growing business, but we are also able to expand our network footprint into selected last-mile markets, allowing us to capture additional growth opportunities at a time when China's vibrant internet economy become increasingly cloud and content-centric. Furthermore, by leveraging Aipu's network, we will be able to realize attractive cost savings in bandwidth and other areas of our cost of structure.

In August, we have also entered into definitive agreementsto acquire Dermot Entities from DYXnet Group for a total consideration of approximately RMB1.05 billion. Dermot Entities operates the VPN business unit within DYXnet Group. Through this transaction, we are not only acquiring a VPN market leader in the greater China region, but also expecting to generate potential synergies with our public and private cloud business.

This past quarter, we also completed the offering of RMB2 billion in bonds. Because of the continued strong demand for our services, we plan on using the proceeds of this offering to add new data center fund activations and for other general corporate purposes. In addition, we repurchased a significant portion of our outstanding bonds due in March 2016. As such, we realized a one-time loss on debt extinguishment for this transaction of RMB41.6 million due to the current lower interest rate environment and to compensate the previous bondholders for selling their bonds accordingly.

Earlier this week, we were awarded with the MVNO license by the Ministry of Industry and Information Technology. We are evaluating strategic approaches to monetize this valuable asset, particularly business model that would allow us to leverage our large and growing enterprise customer base.

One last item I wanted to highlight was the well-known trademark award we received for our Xhu Xi Fu Lien [ph] trademark in July by the Trademark Office of the State Administration for Industry and Commerce of the People's Republic of China. We are extremely honored by this award as it represents the strong nationwide recognition of the company's brand and the reputation it has obtained throughout the year, as well as being able to protect the company from trademark and copyright infringements.

At this point, I would like to turn the call over to Eric, our VP of Capital Markets and Business Development to go through our financial results.

Eric Chu

Thank you, Frank. Good morning and good evening everyone.

Bbefore I go in to the financial results, I'd like to state that we will present non-GAAP measures today. Our non-GAAP results exclude certain non-cash expenses which are not a part of our core operations. The details on these expenses may be found in the reconciliation tables included in our earlier release. Also note that all financial numbers we're presenting today are in renminbi amounts unless otherwise noted.

Our net revenue for the second quarter of 2014 increased by 39.7% year-over-year, to RMB658 million, net revenue from hosting and related services increased by 59.4% year-over-year to RMB466.9 million, primarily due to the increase in total cabinet under management, the increased demand for the company's CDN services as well as the incremental contribution from cloud services. The MRR per cabinet was RMB10,789 in the second quarter of 2104, as compared to RMB10,753 in the first quarter of 2014.

Net revenue from managed network services increased RMB191.1 million in the second quarter of 2014. That increase was primarily because of an increase in network capacity demand for data transmission services.

For the second quarter of 2014, adjusted gross profit increased by 45.7% to RMB 197.9 million. Adjusted gross margin was 30.1% in the second quarter of 2014, compared with the 28.8% in the prior year and 29.2% in the first quarter of 2014. The increase in gross margins were primarily due to an increase in utilization rates and incremental revenue contribution from higher-margin cloud services.

Adjusted operating expenses increased to RMB132.9 million. As a percentage of the net revenue, adjusted operating expenses were 20.2% compared with 18.2% in the prior-year period and 18.8% in the first quarter of 2014. More specifically, adjusted sales and marketing expenses increased to RMB56.6 million from RMB 34.7 million in the prior-year period, due to the expansion of our sale and service support team and our marketing effort associated with the launch of Microsoft premier cloud service.

Adjusted general and administrative expenses increased to approximately RMB 41.1 million from RMB34.7 million in the prior-year period, due to the expansion of our sales and service personnel, the larger accrued bonuses for sales and service personnel. Adjusted general and administrative expenses increased to approximately RMB51.8 million from RMB32.6 million in the prior-year period, primarily due to an increase in headcount, office rentals and other expansion related expenses associated with our efforts to expand our cloud computing service offering.

Adjusted research and development expenses increased to RMB24.4 million from RMB18.6 million, which reflect our effort to further strengthen our research and development capability and expand our cloud computing service offering.

The difference between adjusted operating expenses and our higher GAAP total operating expenses amount is primarily due to the changes in the fair value of contingent purchase consideration payable which was a loss of RMB8.8 million and share-based compensation expense of RMB16.9 million. The changes in the fair value of contingent purchase consideration payable resulted from an increase in the present value of estimate cash and share consideration as June 30, 2014, associated with our company, past acquisition.

Now, from a profitability perspective, adjusted EBITDA for the second quarter of 2014 increased by 51.3% to RMB132 million from RMB87.2 million in the comparative period in 2013. Adjusted EBITDA margin for the quarter increased to 20.1% from 18.5% in the prior-year period and 19.3% in the first quarter of 2014.

Our adjusted net profit for the quarter increased by 23.2% to RMB23.2 million from RMB18.8 million in the prior year period. Adjusted net profit margin was 3.5% compared to 4.0% in the prior year period and 5.6% in the first quarter of 2014. Adjusted diluted earnings per share for the quarter was RMB0.05, which represents the equivalent of RMB 0.30 or USD0.05 per ADS.

As of June 30, 2014, we had a total of 399 million ordinary shares outstanding or the equivalent of 66.5 million ADS. Our cash and cash equivalents and short term investments were RMB3.2b, equivalent to $522.6 million.

Now, looking at our financial outlook, currently we expect third quarter 2014 net revenue to be in the range of RMB777 million to RMB830 million which at the midpoint represents growth of approximately 55% from the comparative period in 2013. Adjusted EBITDA is expected to be in the range of RMB153 million to RMB170 million which at the midpoint, represents growth of approximately 69% from the comparative period in 2013. Net revenue for the full year 2014 are expected to be in the range of RMB2.94b to RMB3.02b which at the midpoint represents approximately 52% growth over 2013. For the full year 2014, adjusted EBITDA is expected to be in the range of RMB600 million to RMB630 million which at the midpoint represents approximately 68% growth over 2013.

We note that the increase in our full year 2014 outlook primarily reflect the expected contributions from the recently announced transaction. This forecast reflects the company's current and preliminary view which is subject to change.

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

Question-and-Answer Session


Thank you. Ladies and gentlemen, we will now begin the question-and-answer session.

[Operator Instructions]

Your first question comes from the line of Greg Miller of Canaccord. Please ask your question.

Greg Miller – Canaccord Genuity

Thanks for taking the question, guys, and congratulations on a very solid quarter and a very strong outlook even if it was in part driven by acquisitions. Maybe we can talk a little bit about the gross margin and utilization right now, we should be expecting that going forward, I know you have talked about a little bit of potential volatility and look forward to EBITDA as you build out cabinets but with a pretty strong positions here in the quarter, how should we be thinking about that in the next couple of quarters?

And then maybe you could talk a little about the Microsoft contribution in the most recent quarter since I didn’t see it broken out in the press release.

Shang Hsiao

Okay, thank you, Greg. This is Shang. And actually, we are very pleased, Okay, that those margins increased to more than 30% compared to the previous quarter, 28%. Two main reasons, okay? One is because the data center business increased utilization rate, most importantly, in the second quarter of this year, we are acting more than 900 [indiscernible] cabinet, okay? So that's one. Second one is Microsoft, the revenue continue to increase, because the cloud business represent a higher gross margin, so somewhat contribute to increase of our gross margin. Okay?

But going forward, okay, this is starting from the utilization rate, right now, we have currently around 73,9%. I think this utilization rate probably will be between 70% to 71% in the third quarter. Again, probably 69% to 70% in the fourth quarter.

So the reason is we are going to have large cabinets to be deployed in the Q3 and Q4. At this moment we forecast the company will be deploy somewhere around 3,000 cabinet in Q3 and 4,000 cabinet in the Q4. So that will make up totally our new cabinet to be deployed in this year, around 10,000 cabinets. So that's what, okay? So utilization rate probably will come down at 1% or 2% of it for the next two quarter.

Back to the gross margin, I think that you particularly mentioned about Microsoft cloud. If we can recall, in the second quarter, I did mention about it, the Microsoft cloud revenue was somewhere around RMB3 million, and in the third quarter, actually, the revenue, again, right now we do have quite close to just $6 million, so I always mentioned because we just commercialized this business and so that those actually are very, very strong, okay. So, nearly triple-digit growth quarter by quarter.

So everything is going very, very well. Particularly, one thing totally exceed management expectation is the number of the customer size under the Window Azure and Office 365 and two of them, okay, as of today, already more than 30,000 enterprise customer. So the base to generate the revenue because very, very big and so at this moment, the actual users, because the way we charge our customer is based on actual usage, and the actual usage right now, OK, still exceed our expectation, hopefully by Q3 and Q4, okay, and we can have a higher actual usage.

So that is for the Microsoft cloud, and for the other cloud, IBM, we mentioned the split, and we are shooting, okay, to commercialize IBM SCE plus private cloud in China sometime in September, we already have our customer waiting on the sideline to sign, once this cloud commercialized.

Okay, Greg?

Greg Miller – Canaccord Genuity

That is very helpful, thank you very much. I will hop back into the queue and turn over to somebody else.

Shang Hsiao

Thank you.


Your next question comes from the line of Colin McCallum of Credit Suisse. Please ask your question.

Colin McCallum – Credit Suisse

Yes, thanks very much. So just -- first of all, can I just clarify, Shang, the numbers on cloud? Did you say $3 million revenue in second quarter? I think the first quarter number was $3 million if I'm not wrong. And did you mean that it was $3 million in the first quarter and then $6 million in the second quarter, is that what you meant there? If you could just clarify please the quarterly revenue from cloud, that would be helpful.

Secondly, can I just ask -- not a major issue but it does seem that the IBM launch has maybe been pushed back a little bit. I think you talked about August, and now it seem that you are talking more September. Can you just tell us why that has been maybe delayed a little bit?

And then if you could also just mention has there been any impact from these measures against Microsoft on the Windows 8 and IBM, talked about in financial services, has there been any impact of those sort of regulatory pressures on Microsoft and IBM on your business? That would be great. Thank you.

Shang Hsiao

Thank you, Colin. Okay, let me clarify, okay? So in the first quarter, okay, the cloud revenue, $3 million, the second quarter, the cloud revenue okay reached close to $6 million. Okay? So it has nearly doubled, okay, in the second quarter compared to the first quarter.

And second question is regarding IBM. Yes, okay. Earlier, the management did mention about it. We are shooting to deploy, okay, the IBM -- actually its commercialized IBM [SGE] product sometime in July or in August. Right now delayed a little bit as the primary reason is due to the, again, technology issue. So a lot of software technology there, working on it. But the good thing is that the server from the IBM already putting in our Beijing [Daxhing] data center, okay, that had been put over there for more than three months, and at least, from the infrastructure side, 21Vianet, we are ready to do the commercialization. Right now, it is finalizing, IBM is testing the technology. So hopefully, everything goes smoothly, we can commercialize this in the next month.

Coming back to the political issue impact, Microsoft and IBM. Right now, the answer would be no, okay? First of all, we understand the government actually pick up certain issue Microsoft Win 8 and also the monopoly position in China. But those issues have nothing to do with the new product, okay? With the Window Azure and Office 365. 21Vianet have not been contacted by the Chinese government for any issue related to Microsoft and so far so good, we are being very, very smoothly and continue to work not only with Microsoft and we also work with the Chinese Government particularly the ministry of the IT and we updated the partners and everything, okay? Particularly every quarter, we need to update on those security regulation we are complying with that.

So everything is doing fine. And for IBM, they have issued the Chinese government, MIIT and server, okay, as well as to the financial institution. Again, that is the server, that is fixed equipment and we are doing the cloud over here. And the government branch have not challenged 21Vianet and also our partnership with IBM and everything is going smoothly.

I just want you to know when we commercialize Microsoft cloud in April and in May, okay, before we can do the commercialization, okay, we also report to the ministry, MIIT, and we 100% follow the Chinese information activity regulation to deploy and commercialize our cloud.

And so far so good, that has not impacted us at all. Okay?

Thank you, Colin.

Colin McCallum – Credit Suisse

Thank you.


Your next question comes from the line of Kai Qian of CICC. Please ask your question.

Kai Qian – CICC

Hi, Shang. This is Kai from CICC. And I have two questions.

The first one is related to the M&A in the second quarter recently, and then you acquired Aipu, the [indiscernible]. So could you please me -- have more color about this M&A in terms of the revenue margin in this year and next year? This is my first question.

And my second question is about your license. And we noticed that you got a workflow network operator license [indiscernible] from MIIT, and we also -- you have autonomy to [indiscernible] in Guangdong and apply for the, you know, like broadband, basic telecom service license. So if you could give more color about the two kinds of license. Thank you very much.

Shang Hsiao

Thank you, Kai. For the first acquisition, the Aipu, Aipu actually is the second largest non-state owned last-mile company in China. And we were delighted in able to acquire this company. And Aipu, right now, you mentioned about their revenue and also the gross margin.

In this company, at this moment, for the projection for the next year, I think we will provide that towards the end of this year but in terms of the profitability, they are doing very, very well, and their gross margin actually is higher than our organic business. And also their EBITDA margin is also higher. So it is very, very valuable acquisition and it is accretive, okay, transaction.

And from a strategic point of view, because the addition of the Aipu, so for the second area, right now, the company [indiscernible] particularly for the internet company [indiscernible] okay, we can transmit their data from our data center and also continue to transmit their data to our back bone. For certain areas, we can also transmit those data all the way to the end user, without the interface of the China Telecom and China Unicom. So this is starting point, okay? So we start Aipu, okay, that has been final element on our interconnectivity business. Okay.

The other one, for the [indiscernible] this is a VPN business, and I think that you guys recall, when we mentioned about the IBM cloud, because this is a private cloud, most of the customer will be considered as a big company. And they don't want to do the cloud through the public internet network. Typically, they will sign the contract with 21Vianet to provide the VPN service before they engage for the IBM cloud service.

So it's very, very value-added to our existing service offering. So it's very important for the next couple year for our network business in China. So that's the strategic reason.

In term of the revenue contribution, okay, please give us some more time. Probably sometime next quarter, when we provide next year, annual guidance, then we will provide the projection from each company we acquire. Even for the DYXnet, their profitability -- for the DYXnet profitability, actually for their EBITDA is close to our organic business. So the gross margin, again, they are higher than our gross margin.

So that's your first question. For your second question, regarding to the MVNO and broadband license, the company, one month ago, we signed with China Mobile to become their partner for the MVNO. You guys know this is a wireless business. So then once we sign this thing in last week, we just received approval from the MIIT, okay, they allow us to officially engage in MVNO business in China.

Right now the company is still in the preparation of the MVNO business. But I can assure you the way we do it will be different than other MVNO operator in China. We will try to focus on B and B business. What that means is our customer will be the company, not individuals. So by doing that, we will also utilize our common resource, our regional office, and [indiscernible] office to do the deployment and everything.

So it's CapEx. Once we decide to deploy this business, the CapEx for this business will be limited. Again, we will focus on B and B. We will target the company, and soon the company will reach their employee. So this is different from other MVNO operator. So that's one.

And second one, let me talk about MVNO. In China, it's like this. Once you get a license for this, this is a very, very valuable asset because you don't know when the Chinese government will issue this license again, maybe 10 or 20 years later. So just by getting this license, it's a valuable asset for 21Vianet. And remember, this is a wireless business.

And finally, come down to the broadband license because if you look at the news into earlier of this year, the MIIT, they plan to do the [indiscernible] for the non-state owned company, to engage in bolt-in [ph] business. Right now, the [indiscernible] has not been started yet. And the 21Vianet, we are closely working with our people in [indiscernible] branch. And hopefully we can be on top of the [trial run.].

And also, during the last quarter, the management mentioned this [indiscernible] is on time in the second half of this year as judgment, we think if that happen, and the license could be grant in the second half of the next year. So the trial need to happen first. Then the license could be issued one years later.

Okay. Kai, that's my answer. Thank you.

Kai Qian – CICC

Okay. Thank you very much.


Your next question comes from the line of John Choi of Daiwa. Please ask your question.

John Choi – Daiwa

Good morning guys. Thanks for taking my question. I have actually a couple question on, first of all, can you share some more color on the pricing, especially compared to tier one cities and tier -- the two and three cities, because I remember early this year, end of last year, there had been some concerns about the pricing. And it seems like, based on your current MOR [ph], at least from the blended version, it seem slightly rebounding out. So it would be great if you guys could give us more color.

Second is on -- regards to the newly acquired businesses. I understand that you just talked about it. But I'd like to have a bit more color, especially on the VPN business. Other than that IBM -- the cloud business that you guys are talking about, is there any other opportunities to fully leverage the VPN business and other sorts [ph]? Thank you.

Shang Hsiao

Thank you, John. I think probably your question relate to our MRR per cabinet Probably we increased a little bit, between the Q1 and Q2.

And the pricing for us is like this. In Beijing area, let's say Beijing, Tianjin, the Sichuan east [ph] area, typically our MRR per cabinet could reach RMB13,000 per cabinet per month. The same cabinet, if you're around the Shanghai area, then that MRR should be between RMB9,000 to RMB10,000 per cabinet per month. If you go down to further south, Guangzhou and Shenzhen, then MRR per cabinet will be around RMB8,000 to RMB9,000 cabinet.

So the expectation of [indiscernible] management because we -- already we deploy many cabinets. But if you pay attention on that one -- and actually, in second quarter, we released the new deployment, 1,900 cabinet, 50% of that actually is in the northern part of China. The other 50% is in the southern part of China. With available cabinet, additional 900 cabinet is again same thing. Okay.

But when we move into the third quarter and first quarter, that's where our Beijing data center going to have a massive deployment, 7,000 cabinets, in six months. So we will see more Beijing cabinet will be sold in Q3 and Q4. If that can be achieved, and we should expect the MRR per cabinet should be increased in Q3 and Q4. That's your first question.

And second question, regarding to the VPN business. The VPN business, besides IBM, the other reason we acquired the DYXnet is traditionally we have management network service. We sell a certain bandwidth for certain company, let's say internet related company. There is a trend, particularly for those big enterprise, including the state-owned company. They have operation in China, in all different location. Due to the security, they rather right now at this moment to run on their [indiscernible] network, instead of to run on [indiscernible] network in all different location.

So the demand are starting on the last year. We saw a lot of demand. For the 21Vianet, we do have the nationwide VPN license, but we don't have [indiscernible] and the team to engage in such business. That's why we acquired this company. So right now we are integrate our small team with the DYXnet. They have a big team over there, into a VPN team in China.

And there is this synergy because for this company we acquired, DYXnet, their revenue actually is quite good. In term of the revenue, right now they are considered as the biggest VPN company in greater China. And if you look at their revenue, 40% of their revenue actually is in Hong Kong [indiscernible] Hong Kong and 20% from Taiwan. They only have 40% of their revenue generate from China.

Their customer, including the T-Mobile, Sprint, [indiscernible] okay, a lot of -- they have more than 2,000 customer. And particularly, they have 30 -- I'm going to try to recapture my numbers -- 30 Global 100 company as their customer, a lot of telco, when they want to take into the China. They just [indiscernible] in the Hong Kong use DYXnet service to get into the China.

So that's a very important company. In fact, the company compete with another carrier on the acquisition. Eventually we won. So the China VPN, because the company in China become bigger and bigger, they operate in all different locations. So this kind of service will -- we expect we are going to have very, very strong demand for the couple years, for this VPN service.

Okay. All right, John.

John Choi – Daiwa

Okay. Thanks, guys.


[Operator Instructions]

Your next question comes from the line of Louie DiPalma of William Blair. Please ask your question.

Louie DiPalma – William Blair

Great. Thanks, guys. My first question is how many of the 7,000 cabinets that are being installed in the second half of the year have already been sold?

Shang Hsiao

Louie, first of all, that 7,000 cabinet, more than 50% of that have been booked. Just give you one example. That including 1,300 cabinet have been booked by Alibaba. And the quantity can be increased from the Alibaba side. Just give you example. 1,300 of that have been booked by Alibaba. So the other one have been booked, like our long-term customer, like Qintong [] and also the China Mobile, also the CCTV.

Actually, CCTV right now become our top-line customer already. So more than 50% of that have been booked. Okay, Louie?

Louie DiPalma – William Blair

Okay. And my next question. Related to the MVNO license that I think you won yesterday, did you have to pay any money for other considerations for that license? And also, are you able to sell that license, if you have no plans to actually offer wireless service?

Shang Hsiao

Okay. First of all, in China, you don't pay anything to get such license. So no payment. So that's why I mentioned this is a valuable asset. If you get it, it's very, very valuable. That's number one.

Number two, that [indiscernible] the license is not for sale. That license is -- go with the name of the Company, 21Vianet. What 21Vianet can do is we could engage a company or do a joint venture with other B2C player, to engage in this MVNO business. We can do the policy for cooperation with the other company. That's [indiscernible] we can do that. We cannot do the -- transfer the title. Okay, Louie?

Louie DiPalma – William Blair

Okay, perfect. Thank you so much.

Shang Hsiao

Thank you.


[Operator Instructions]

Your next question comes from the line of Lingling Hu of Goldman Sachs. Please ask your question.

Lingling Hu – Goldman Sachs

Hi, Shang. Could you help us to understand the current competitive landscape of IDC business because China Telecom just reported earnings last night? And I think that it is also focusing on building up its own IDC and ICT, including the cloud business.

And also, like [indiscernible] cash is also ramping up [indiscernible] Beijing [indiscernible] area. So could you just give us some understanding on the competition? Thanks.

Shang Hsiao

Thank you, Lingling. And I can quote on the IDC report. This is for the year 2013. Based on the IDC report, currently biggest data center service provider in China is China Telecom. It has 39% of the market share. Number two is China Unicom. They have 19% of the market share. Number three is 21Vianet. Our market share already jumped to 12% of the overall market.

And number four, actually right now we mention about it. It's China Net Center. And China Net Center, actually they have 4.9% of the market share. It's only 40% of the 21Vianet size. That's for the year 2013.

And like I mentioned earlier, this year, we will adding 10,000 cabinets. Next year, again, we will add an additional 10,000 cabinets. The company, at this moment, we do have sufficient of cash flow to expand our capacity, IDC capacity. So that's what I can say.

But in terms of the China Telecom/Unicom, they are always -- continue to be their data center. But we need to ask then what's the totals of data center because some of the data center is for the cloud computing service business [ph]. And what we are doing is traditional hosting, for the retail customer. That's exactly what we are doing.

And because China Telecom, they build a huge data center in the Mongolia, something like that. So my guess is their purpose is to build for the cloud computing service, not for traditional hosting.

And you mentioned about China Cache [ph]. Yes, we think that they have also building the data center. At the end of this year, 21Vianet, we are going to have 25,000 cabinets at the end of the next year, 35,000 cabinets, and with more than 2,000 customer from our IDC business, and plus 2,000 customer for our VPN business, and plus more than 10,000 enterprise customer for our last mile customers, and also plus more than -- a lot of customer on our cloud computing service.

So with those customer base, we are doing the cross selling right now. So I think that the customer will more appreciate the 21Vianet. We not only can offer the traditional hosting service. We also can offer the cloud, VPN and last-mile service.

Thank you, Lingling.

Lingling Hu – Goldman Sachs

Okay. I have a follow-up please. Just you mentioned the slight delay in the IBM commercial launch. So is there any change to your revenue guidance, in term of this business?

Shang Hsiao

At this moment, we don’t have a plan to change the guidance, because the customer already are there, waiting on the timeline. Some of the IBM service is fixed cloud. Since the customer over there, we think that we -- if we can commercialize, let's say in the September, we -- at this moment, the management remain confidence we can achieve the number we are talking about for the IBM revenue.

Lingling Hu – Goldman Sachs

Okay, great. Thanks.

Shang Hsiao


Lingling Hu – Goldman Sachs



Your next question comes from the line of Charles Lo [ph] of AGI [ph]. Please ask your question.

Unverified Participant

Hi, Shang. My question is a follow up on this IDC buildup in China. So we see that you are building 7,000 new cabinets in the second half of this year, and maybe another 10,000 next year. Would that -- a lot of it is in Beijing. So would that be a situation that Beijing, at some point, with everyone building data centers, becomes -- data center supply gets too big, and then we are suffering from the low utilization?

And the follow up is that utilization in second half is around 70%. Would that situation continue into 2015? And if that's the case, would that lead to margin pressure for us? Thank you.

Shang Hsiao

Okay. For the data center, for the Q3 and Q4, yes, we are going to deploy a lot of Beijing cabinets. But you say everybody building the data center in Beijing because the demand, because in China, all the internet data center -- no, all the internet company, they are building their -- they are putting their server in Beijing also.

So at this moment, the demand is like this. Anything we build in Beijing area, before the deployment have all been booked. So for example, last month, we put a lot of order on the waiting list in the Beijing. So the Beijing demand is very, very strong. And that strong, it go with the China internet traffic. So we do believe the internet traffic in China continue to grow very, very fast. The demand will continue to be very, very strong in Beijing.

In term of the utilization rate, I just want to mention about it. There's a -- our utilization rate in Q3 and Q4 will be around 70%. But when the company, the base, the number of the cabinet as a base become bigger and bigger, in the future, the new deployment of the cabinet impact, the utilization rate will be smaller and smaller.

Right now impact on utilization rate is so big because our base is still small. But once we have 25,000 cabinet this year -- the next year, another 10,000 is still big. But the impact won't be as bigger as compared to this year.

So I do remember when the company, when we did our IPOs three years ago, and at that time our utilization rate is like 82% to 85%. After the IPO, we starting to build and that impact our utilization rate. So our utilization rate down to 70%. But if you look at the Company revenue, three years ago, in the year 2010, the Company revenue is somewhere around RMB500 million per year. But three years later, our revenue, by the end of this year could just reach RMB3 billion, six times increase.

So my point I just want to make is the company will continue the growth. So utilization rate impact will be less, once the number of the cabinet as a base become bigger and bigger. Okay? Thank you.

Yes. Eric, you want to add something?

Eric Chu

Yes. Actually this is Eric. I'll just really quickly add onto what Shang just said. One thing to look at us is if you look at our business and our offerings in Beijing or some of the other tier one cities, we tend to pride ourselves, in terms offering the mission critical obligations.

So if you look at a lot of the companies, what they do is they spend the top 10%, 15% of their data center spending with us because they like the fact that we offer higher quality services. We offer faster internet transmission. And those kind of service offerings, with a SOA, backed by--financially backed SOA, it's fairly hard to come by in China today.

So that's why it's one thing to have some data center supply coming online in Beijing. But it's another totally different thing to have high-quality data center supply. That's sort of going back to what Shang just said. That's why some customers, they're willing to wait for us to deploy new data centers space, and then put in their service in there. So that's kind of a -- we're not as concerned of the potential oversupply situation.

I guess a similar situation, scenario would be if you look at the U.S. market. People there, they still like to put their servers in Equinet [ph] data center, even though Equinet [ph] data center offer higher premium -- charges premium compared to others. So I guess it's kind of a similar situation here for us.


There are no further questions from the telephone line. I would now like to hand the conference back to the presenters for closing remarks. Thank you and please continue.

Shang Hsiao

Okay. This is Shang. Thank you, everyone. Thank you for your time. Thank you.


Ladies and gentlemen, that does conclude today's conference. Thank you for participating. You may all disconnect.

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