Malaysia has attracted global tech companies pledging to pour in billions of investment to set up data centre facilities in the Klang Valley and Johor. This trend is driven by digital revolution with the world rapidly gravitating to cloud services, generative artificial intelligence (AI) and machine learning. With a planned IT load of around 1,400MW coming on line by 2029, Malaysia will become one of the largest data centre hubs in Asia. We believe the number of investments could continue to expand beyond 2030 as our largest utility group, Tenaga Nasional Berhad (TNB), has already received applications for potential energy demand of 2,000MW from 10 data centres. Given the country’s unique position to capture the explosive growth in data centre, we see the key players in the telecommunication, power and construction sectors as the prime beneficiaries. Outperform on Telekom Malaysia (TP: RM8.80), TNB (TP: RM16.00), Gamuda (TP: RM9.20) and IJM (TP: RM4.20).

Widespread adoption of technologies. In our technology-driven world today, data centres have become a crucial component of modern IT infrastructure, responsible for centralising the management and processing of vast amount of data that drive businesses and our day-to-day life. In the past decade, data centre industry experienced explosive growth following the increasing demand for cloud services and the growing adoption of web-enabled devices globally. Now in 2024, a fundamental shift in data centre design, site location and investment is taking place. As more ordinary devices and electronic appliances of daily essentials are equipped with sensors, processing power and network capabilities, the Internet of Thing (IoT) will further introduce a mind-boggling and unprecedented state of data creation. In 2018, the size of the global data centre market was estimated at around USD200bn but this is projected to grow at a CAGR of 7-10% to USD400-560bn by 2032, based on various projections.

What makes Malaysia an attractive destination? When comes to data centre hubs in the region, Singapore, Japan, Taiwan and Hong Kong have been dominating the scene as the leading Tier 1 markets. However, as resources became scarce while development cost escalated, data centre operators, who often look at 1) business and customer proximity 2) political stability and 3) infrastructure, began to scout for the next destination. Tier 2 markets like Malaysia, are now showing the growth potential. Propelled by a combination of factors such as favourable government support, abundance of resources (land, power and water) and advanced infrastructure, Malaysia’s fortune as an untapped potential is fast-changing. Coupled with its proximity to Singapore, a new symbiotic relationship between Malaysia and Singapore is likely to turn Malaysia into the next epicentre of data centres in this region.

Who are the beneficiaries? We expect more infrastructure development such as power connectivity, internet exchange point, cable landing station and fibre optic cables to be laid to cater for the expanding IT workloads. TM is seen as the prime beneficiary in the telco space. We estimate that its partnership with Singtel to establish a greenfield data centre in Iskandar Puteri could potentially result in an earnings uplift of ~24% beyond FY26F. We value TM at RM8.80. The thirst for more energy should lead to an unprecedented surge in TNB’s power demand. To cater for this, we expect TNB to increase its capex and hence, a higher tariff will be justifiable to capture adequate return on investment. We raise our TP on TNB to RM16.00. For exposure in the construction sector, we favour Gamuda and IJM for its track record in securing more data centre jobs. Their nextgeneration industrial building system would help shorten construction period as speed of deployment is crucial to these data centre operators.

Key risks. Competition from regional data centres, power and water scarcity, oversupply condition in the domestic market, environmental impact due to overconsumption of natural resources as well as heat and waste water generation.

Global Landscape

The birth of mainframe computers to the housing of server rooms. In our technology-driven world today, data centres have become a crucial component of modern IT infrastructure, responsible for centralising the management and processing of vast amount of data that drive businesses and our day-to-day life. The idea behind data centres have come a long way and it was hardly a new innovation. Since the arrival of computers, data centres have been in existence and evolved from on-premises to cloud and edge computing. This can be traced back to the 1960s with the introduction of mainframe computers, creating a demand for space to secure, centralise and store these machines. As IT continued to transform at a rapid rate, the demand for data processing and the housing of huge computer rooms increased. Given the cost to maintain these facilities, organizations began to outsource their needs, paving the way for modern-day data centres.

Exponential growth driven by cloud services and proliferation of webenabled devices. In the past decade, the data centre industry experienced explosive growth following the increasing demand for cloud services and the growing adoption of web-enabled devices globally. As smartphone adoption evolves and rapidly gives way to a new generation of wearable computing devices, big data demand exploded with the needs for real-time data access, storage and processing. In 2010, IDC has estimated that 1.2 trillion gigabytes of new data had been created globally, a 50% jump from the previous year. Simultaneously, it projected data produced would expand to 35 trillion gigabytes by 2020 but this was achieved sooner-than-expected in 2018. In 2020, the actual data creation was approximately 59 trillion gigabytes, a whopping CAGR of 48%. The growing need for data processing and storage translates to growing demand for data centre space. Most data centres built 10 years ago had a critical IT load capacity of <10MW but today, it is not uncommon to develop 100MW or more. Many of the large-scale data centres built were located in the US and Europe while in Asia, Singapore, Tokyo, Sydney and Hong Kong were the preferred choices (Figure 1 & 2).

Generative AI will be the next driver. Now in 2024, with the world rapidly gravitating to 5G connectivity, generative AI and machine learning, a fundamental shift in data centre design, site location and investment is taking place. As more ordinary devices and electronic appliances of daily essentials are equipped with sensors, processing power and network capabilities, IoT will further introduce a mind-boggling and unprecedented state of data creation. Hence, the processing requirements that come along with this trend would dictate the demand for data centres as well as the locations on the basis of cost optimisation and fulfilling the need for real-time processing closer to the end users. In 2018, the size of the data centre market was estimated at around USD200bn but based on various sources, global data centre market is projected to grow at a CAGR of 7-10% to USD400-560bn by 2032.

Demand from major cloud service providers. The major global cloud service providers are Amazon Web Services (AWS), Microsoft Azure and Google Cloud. Generative AI is expected to significantly disrupt the data centre industry. As a large chunk of AI models are running on the cloud platform, demand for cloud services and hence, data centres are expected to accelerate. The newer AI systems are more powerful than the older models, as much as 10 to 100 times. We understand that major cloud providers are already seeing high demand from corporates and enterprises across financial to manufacturing industries to run large language models on their platforms. On top of that, internet and OTT companies such as Netflix, Disney+, ByteDance and Sea Limited should also be seeking for more IT load capacity. Bloomberg Intelligence is predicting the generative AI market to expand to USD1.3 trillion over the next 10 years from only USD40bn in 2022.

More power, more heat. Generative AI requires more densely clustered and performance-intensive IT infrastructure than the standard frameworks found in conventional data centres, thereby consuming more power as well as generating more heat. For instance, the workload of an AI image generator application requires more power than a text generation application. Large language models such as ChatGPT consumes 2.9 watt-hours per request, about 10x the electricity of traditional Google query. The average rack density (refers to amount of computing equipment installed within a single server rack) has been slowly climbing over the past years and this trend is expected to continue given the adoption of generative AI. A conventional data centre would have 5-20kW per rack but high-performance computing for generative AI would require >20kW per rack (projected to hit 80-100kW per rack in the future). Also, power consumption by generative AI workloads fluctuate more than traditional IT workloads, making it more crucial to obtain a reliable and consistent power supply.

This could also post challenges to achieving an optimal power usage effectiveness (PUE), a measure that defines the efficiency of a data centre (data centre with a PUE of 1.2-1.5 is considered efficient while >2 is considered inefficient). In 2022, the average annual PUE ratio achieved by the large-scale data centres was 1.55. Going forward, operators are aiming to achieve PUE ratio as close to 1 as possible.

Cooling system to consume more power and water resources. The increase in rack density would also exacerbate the cooling demand because of the highperformance equipment also generates substantial heat. Traditional facilities that rely on air-based cooling method may struggle to dissipate the heat generated. To achieve an efficient use of water, measured by a metric called water usage effectiveness (WUE), new data centres may have to adopt advanced cooling technologies such as liquid cooling or rear-door heating exchangers. Cooling system may account for roughly 40% of an average data centre’s electricity use. Hence, an efficient cooling system may reduce the overall power consumption.

We note that there were pilot projects done with regards to underwater data centre to harness natural cooling method. China has deployed a 1,300-tonne commercial facility submerged 35 metres underwater in December 2023. This module is reported to be able to process 4m high-definition images within 30 seconds, equivalent to 60,000 traditional computers’ processing capability. Despite the benefit, we believe underwater data centre is not likely to take off in large scale in the near future, as more conventional alternatives are still available (i.e new locations with access to treated water, floating data centre). Moreover, there are potential side effects with underwater data centre such as the unpredictable rising temperature of seawater and implications on marine ecosystem.

Malaysia’s Booming Data Centre Industry

Symbiotic relationship with Singapore. The Malaysia Digital Economy Blueprint (MyDigital Blueprint) was launched in February 2021, aiming to accelerate the country’s transformation into a high-income nation and technologically-advanced economy by 2030. As part of the strategy under the MyDigital Blueprint, the government has given approvals for Microsoft, Google, AWS and TM to build and manage hyperscale data centres as well as the provision of hybrid cloud services. Coincidentally, our neighbouring country, Singapore, announced a moratorium on new data centres between 2019 and 2022 as the proliferation of these energy-guzzling facilities were draining a sizeable amount of Singapore’s resources i.e. land, electricity and water. Along with these, Malaysia (particularly Johor) is benefitting from the spillover effect of insatiable global demand for IT load capacity, given its proximity to Singapore, which is a leading network hub connecting economies of Southeast Asia and beyond. Being the most connected country in Asean, Singapore is a landing destination for 25 operating subsea cables and has 14 more projects in the pipeline. The city-state has also announced its plan to double the number of cable landings within the next decade. Comparatively, Malaysia has 25 cables connected through six landing stations (Table 1).

Data centre construction cost has increased by up to 8% YoY across region while demand is showing no sign of pausing. Japan has the highest construction cost in Asia Pacific while Singapore is at the top of the rank in terms of land cost (~USD11,573/sqm). Malaysia looks appealing given its relatively cheaper development cost. In addition, operational cost would also be attractive given the access to reliable and relatively cheaper electricity and water supply. Currently, the total IT load in Malaysia is estimated at ~900MW in 2024 but this is expected to balloon to ~1,400MW by 2029, translating to a CAGR of 8%. Thus far, the top 3 tech giants have collectively committed to invest USD10.2bn in new data centres in Malaysia.

Modernisation of vintage data centres. Apart from greenfield data centres, we also believe that there is room for modernisation of vintage data centres that are under Tier 1 and 2 classifications, which are still in operations using the less efficient power and cooling systems. Given the increasingly scarce energy resources as well as sustainability concerns, existing data centre facilities should be modernised and upgraded to contain rising operational costs. Nevertheless, we believe Tier 1 and 2’s market share in Malaysia is relatively small compared to Tier 3. New data centres that are currently under construction are predominantly Tier 3.

Who are the beneficiaries in Malaysia?

More infrastructure development to support the booming data centre industry. So far, Cyberjaya, Kuala Lumpur and Johor are the preferred locations in Malaysia with over 70% concentrated in Cyberjaya. For the coming years, most capacity expansion will be located in Johor. Johor data centre boom is largely driven by investments from multinational corporations with global presence, whereas existing data centres in other parts of the country are catered for domestic market. Presently, the nearest cable landing station is located in Mersing (northeast of Johor), which is further away from the locations of new data centres (Kulai, Sedenak and Pulai). As these data centres are likely to ride on its proximity to Singapore, we expect new infrastructure such as internet exchange point and more fibre optic cables will be laid to cater for the expanding IT load. We believe TM and Maxis would benefit from this as the major cloud companies would require more than one internet service provider connecting the data centres with terrestrial networks.

TM will be the prime beneficiary in the telco space. As there is no cable landing station in southern Johor, we believe TM could possibly add a new station to its existing coffer of 4 stations, as well as participating in consortium to lay more subsea cables to connect Malaysia to the rest of the world. Although we believe TM’s joint venture (JV) with Singtel is not likely to be earnings accretive within the next 3 years but beyond FY26F, we believe its 51% stake in the greenfield data centre could result in ~24% earnings uplift. While earnings impact is limited in the immediate years, we are bullish on the value of the upcoming hyperscale data centre JV. Based on our estimate, a steady-state valuation of the 64MW data centre could be between RM12-20bn, depending on the margin that it could achieve (Table 5 & 6). In our opinion, EBITDA margin of 45% and a PER of 20x are reasonable. Hence, we peg the new data centre at RM16bn and revise our TP to RM8.80.

Powering up TNB. In its latest quarterly results, TNB posted a surge in electricity demand by ~10% YoY to 31,899 GWh, led by the commercial segment (+11.2%). We believe this was primarily driven by higher demand from data centres with two projects (~535MW) completed under the Green Lane Pathway in March 2024. The current energy loads for the projects are about 115MW and expected to increase gradually as more tenants signing up the data centres. This has resulted in a new peak demand of 20,045MW, recorded on 29 May 2024, which exceeded Peninsular Malaysia Generation Development Plan 2020 demand projection of 19,365MW in 2025 and approaching 20,755MW in 2030. Currently, the Single Buyer stated that installed capacity in Peninsular is about 27,385MW, which translates to a reserve margin of 27% (7,340MW) against the new peak. From 2025 onwards, data centre industry is expected to create some 2,000MW of new demand, which we reckon that our national grid would be able to cope given its high reserve margin.

Nevertheless, the growth momentum of the electricity demand could pose the risk of reserve margin falling below the approved levels of 23-28% set by Energy Commission (EC). Thus, we believe the regulator could mitigate the situation by extending the retiring plant to maintain the adequate margin until a new stable capacity is installed on the grid. Out of the total installed capacity, about 9,720MW (~36%) power plants are set to expire between 2024 and 2030, which is to be replaced by 9,372MW of newly-commission capacity for the similar period according to the development plan. Meanwhile, various accelerated renewable energy programmes including 623MW of existing Large Scale Solar programme (yet to commission), 800MW Corporate Green Power programme (CGPP) and newly launched tender 2,000MW LSS5 will contribute to new installed capacity to replace the retiring plants.

Given the robust demand outlook, TNB is expected to increase its capital expenditure particularly in Transmission and Distribution division to upgrade and maintain system resiliency. About RM90bn capex is expected to be rolled out for 6 years until 2030 to support energy transition initiative and systems upgrades. On this basis we adjust our capex assumptions beyond 2030 higher by another RM1b-RM2bn, slightly increasing the tariff of Transmission and Distribution for the respective Regulatory Period to capture more adequate return for increasing future capex. As a result, we upgrade our call on TNB to Outperform with TP RM16.00.

Building jobs to keep contractors busy. Another key beneficiary is the construction sector, enjoying a strong flow of data centre building jobs. Gamuda secured contracts worth a combined value of RM1.74bn of hyperscale data centre jobs in Elmina Business Park (Klang Valley) in May 2024. Sunway Construction secured a RM748m contract at Cyberjaya in March 2024 and an additional RM1.5bn for Yellowwood Properties at Sedenak Tech Park, Johor in Jun 2024. On a smaller scale, IJM secured a RM331m contract for TM Technology Services SB at Iskandar Puteri Data Centre in Jun 2024. In view of TNB locking in electricity supply agreement (ESA) with ten data centre developers with a total electricity requirement of 2,000MW, our back-of-theenvelope calculation is suggesting a total estimated construction value of ~RM80bn. This is based on an average construction cost of USD7.5m per MW. Given such strong pipeline, we expect data centre projects to continue to drive orderbook replenishments for the construction sector. However, we generally believe that global hyperscalers would be more inclined to appoint larger construction companies as their main contractors given that strong working capital funding is crucial to ensure adequate machineries and material supplies are in place without compromising the speed of construction, which is also a critical consideration.

Pre-fabricated method to shorten construction period. For construction exposure, our top pick is Gamuda for its solid track record and next-generation industrial building system (IBS) that could help shorten construction period while maintaining quality of work. For instance, Gamuda has managed to complete AIMS Cyberjaya Block 2 faster-than-expected i.e. in 8 months versus a projected 13 months. Gamuda is ramping up production capacity of data centre construction material with the construction of two next-generation IBS factories. We re-rate the construction segment to 22x PER in view of a stronger job replenishment pipeline. Our TP is adjusted to RM9.20.

We also believe that IJM could secure more projects in Johor after clinching a smaller-scale job in Iskandar Puteri from TM, which is its first data centre job. We do not rule out the possibility of IJM securing contract to build the 64MW facility for TM in the near future. We raise our FY25-27F earnings forecasts by an average of 21% to account for encouraging orderbook replenishment prospect for both construction and industry segments. As such, our TP is revised to RM4.20. Benefits should also spillover to building contractors (prefabrication & modular), mechanical and electrical (M&E) contractors, building materials (cement), power-related industries (cables, generator set, power supply and installation), water treatment (water supply services and piping system) and renewable energy (solar). Note that M&E accounts for the bulk of the construction cost of approximately 70-80%.

Meanwhile, several land owners are already benefiting from one-off property disposal gains in recent months and we believe there will be more to come given the insatiable demand for data centre in Malaysia. Developers with land in Johor include UEM Sunrise and EcoWorld while Sime Darby Property should benefit from future development in the Klang Valley region.

What are the risks and concerns?

Regional competition. Apart from Malaysia, other countries in the Southeast Asia region are also adding data centre capacity to capture the growing global demand. Indonesia’s data centre market capacity is projected to grow to ~ 580MW in 2026 (and 1,400MW by 2029). Collectively, Google, Microsoft and AWS have committed over USD7bn in Indonesia by 2030. In response to the considerable land and energy consumption associated with data centre, Singapore enacted a 3-year moratorium in 2019 but this was lifted in January 2022. Having underestimated the potential growth for data centre from AI, Singapore made a surprised announcement in May 2024 that it would free up more power for data centre expansion. This came after Nvidia and the other tech giants swung to Malaysia and Indonesia seeking additional data centre capacities. Nevertheless, Singapore is planning to unlock only 300MW of additional capacity through more efficient use of energy at existing facilities, achieving PUE of 1.3 or less over the next 10 years. We believe Singapore has little to offer given limited land and power, and therefore, it is more likely to work with Malaysia by providing complementary financial resources as well as technical know-how in order to participate in this growth trajectory. Note that the Johor-Singapore Special Economic Zone (JS-SEZ) agreement is expected to be finalised in September.

Power and water scarcity. With more power and water being channelled into the data centre industry, this could put enormous strain on the national grid and water supplies, particularly in Johor. TNB’s reserve margin currently stands at a comfortable level of 27% but this may fall below 20% should the additional requirement of 2,000MW from data centre industry come on stream without further increase in the total installed capacity. We believe the overall application for electricity supply received by TNB may well be more the guided 2,000MW. Data centre would take 1.5-2 years to build while adding new power to the grid would take over 4 years. We note that there are various plans in place to boost renewable energy supply, especially solar-powered, this remains an unstable alternative as Malaysia has high cloud cover with an optimal light of only 5-6 hours each day. This could also lead to high intermittency of solar output. Therefore, support from conventional power will still be required to cater for energy usage during intermittency, as well as at night. Industry experts believe our traditional energy reserves may not be able to support data centre growth in the next decade, with some suggesting more sustainable alternative such as nuclear power.

Meanwhile, water supply should also be a concern. A 100MW data centre could use around 4.2m litre of water per day, equivalent to a daily usage of 10,000 people in a city. Although there are concerns that domestic needs may be compromised, we note that there is sufficient water supply in Johor as a 2,000MW data centre capacity would consume some 84m litre per day, which is only ~3% of Ranhill Utilities’ targeted capacity of 3,000m litre per day (by 2027). Currently, Johor has a reserve margin of ~17%. In Singapore, floating data centres have been built to take advantage of natural cooling system but we do not expect this to be commercially available in Malaysia in the near future.

Imminent oversupply but selected players having the edge over others. While we reckon Johor has benefited from the spillover effect from Singapore’s data centre bottleneck, attracting interest from both global and domestic investors pledging billions of investment, we believe only those with the access to the required infrastructure and professional talent would succeed. Being the country’s leading communications solution provider with extensive terrestrial connectivity as well as global subsea cable network, TM is in a sweet spot to leverage on the booming data centre market. Also, given that TM is a government-linked entity, insufficient power and water supply issue may well be an over-rated concern. Moreover, its partnership with Singtel, Singapore’s leading communications group, should also provide TM the competitive edge over competitors who have expertise in other unrelated industries such as property, textile etc.

Sustainability and environmental impact. The growth of this energy-guzzling industry would result in a surge in demand for power, which is still mainly generated using coal and gas. Although TNB has plans to increase the capacity of renewable energy, we believe fossil fuel power plants will continue to generate the bulk of energy supply in the country. However, we note that contaminated water generated from the liquid cooling system can be minimized through advanced technology that could recirculate and evaporate used water.

Source: PublicInvest Research - 19 Jul 2024