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Operator
Hello, ladies and gentlemen. Thank you for standing by for the GDS Holdings Limited First Quarter's 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded. I would now turn the call over to your host, Ms. Laura Chen, Head of Investor Relations for the company. Please go ahead, Laura.
Laura Chen
Thank you. Hello, everyone. Welcome to the first quarter 2023 earnings conference call of GDS Holdings Limited. The company's results were issued via Newswire Services earlier today and are posted online. A summary presentation, which we will refer to during this earnings call, can be reviewed and downloaded from our IR website at investorsgdsservices.com. Leading today's call is Mr. William Huang, GDS founder, chairman, and CEO, who will provide an overview of our business strategy and performance. Mr. Dan Newman, GDS CFO, will then review the financial and operating results. Ms. Jamie Koo, our COO, is also available to answer questions. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and certainties. As such, the company's results may be materially different from the views expressed today. Further information regarding these and other risks and certainties is included in the company's prospectus as filed with the U.S. SEC. The company does not assume any obligation to update any forward-looking statements except as required under applicable law. Please also note that GDS earnings press release and its conference call include discussions of unaudited gap measure information as well as unaudited non-gap financial measures. GDS press release contains a reconciliation of the unaudited non-gap measures to the unaudited most directly comparable debt measures. I will now turn the call over to GDS founder, chairman, and CEO, William Huang. Please go ahead, William.
William Huang
Okay, thank you. Hello, everyone. This is William. Thank you for joining us on today's call. Before I review the 1Q23 results, I would like to take a few minutes to highlight our strategic priorities for the next few years. What are we focused on? What are we trying to achieve? These priorities will be benchmark for tracking our ongoing performance. The roots of our business are in mainland China, but in the past couple of years, we began to expand overseas. The two regions in which we now operate, mainland China and international, are at different stages of development. Therefore, we have set different priorities for each region in order to achieve the best outcome for our shareholders. In mainland China, we have grown our business over 20 years through several distinct phases to become the leading carrier neutral data center platform. In the most recent phase of growth, as demand from cloud and the internet took off, Our priority was to win new business. We achieved an unprecedented level of new bookings, established the strategic relationships with all the leading customers, and increased our market share. Our resource strategy was a key success factor We invested heavily in building up our asset base in all tier one markets in order to fulfill our customer requirements. Five years ago, we had 20 data centers. Today, we have over 100. We believe it's the largest development program undertaken by any data center company globally. In addition to the existing asset base, We secured the land and energy quota to maintain continuous supply and grow for many years to come. Now the market in mainland China is going through a period of adjustment. We are in a new phase and we have reset our priorities accordingly. Our number one priority now is to deliver this IMB 6 billion backlog. which is a result of our past sales success. It is sufficient to drive our revenue growth by over 60% over the next few years. Number two, as we have already won many years of future business, we will be highly selective in pursuing new orders. We will target opportunities which are strategic, a good fit to our available capacity, a fast-moving schedule, and adapted financial returns. Number three, we will prioritize increasing utilization of existing assets. We have a large asset base, both in service and under construction. which is committed by customers but not yet utilized. As a result, we can deliver the entire backlog with a relatively small amount of incremental capex. This enables us to achieve our growth targets while reducing annual capex to RMB 2 billion to 3 billion RMB. I'm going forward. Number four, we will only initiate new projects if there is committed demand with confirmed moving schedule. We expect most of our new projects will be expansion phases of existing sites. Number five, building our success with passive wave of cloud and internet demand. We will position our products and technology to capture the coming wave of AI applications. For international, our priorities are winning new business and the building market presents. Number one, we aim to develop our international business into a second growth engine, which creates significant additional value for GDS shareholders. Number two, we will anchor and de-risk our projects with orders from our whole market customers as they expand overseas. Number three, we will also win significant business from top global customers. many of which establish the relationships in China. Number four, we will take advantage of our low unit development costs, which comes from our scale product and the supply chain in China. Number five, we will build a standalone business in our international holding company, headquartered in Singapore. while maximizing synergies with GDS Mainland China. In 1Q23, our gross new bookings was around 12,000 square meters, split evenly between Mainland China and international. Market demand in Mainland China over the past few quarters has been a bit soft. This is mainly because large customers who committed to a scalable capacity will need more time to absorb their inventory. In this environment, as I just explained, we are targeting high quality business which meets our criteria. A good example is the 4,600 meter or nine megawatt order which we won for Shanghai 18. The customer is a major Chinese financial institution. The pricing is reasonable and the underlying asset is an expansion place of our existing Pujian campus. On the international side, We won 6,400 square meters or 26 megawatts expansion order from the anchor customer for our campus in Nosa Jaya Tech Park, Johor. You may recall that we are already building three data centers on Site 1 with total IT power capacity of 64 megawatts, which is fully committed by this customer. We started to construction less than one year ago on Greenfield land. We are using our preferred design and the product shifted directly from China. We are incorporating liquid cooling for part of the capacity as required by the customer. Despite the fact that this is our first project in Southeast Asia, We will deliver the first fully powered data center on this site in early 3Q23. We estimate that our unit development cost is 20% lower than the local market. The ability to construct so quickly and as such a low cost give us comparing competitive advantages as we expand in the region. Our growth moving for the first quarter was around 13,000 square meters, which is consistent with the level of the past few quarters. Our customers are sounding more positive about their business outlook. With new business initiatives and the strategic development As their business picks up, it will flow through to us one or two quarters later in terms of faster moving. To adjust to the current environment, we have slowed down our capacity expansion. In 1Q23, we brought 2,700 square meters of new capacity into service. Over the rest of the year, we plan to bring a further 57,000 square meters into service, split between mainland China and international. All of this capacity has solid customer commitments and confirmed moving schedules. As a result of our efforts to adjust the pace of development, our utilization rate has gone up from 67% to 72% over the past year. At the same time, our backlog for area in services has come down from 136,000 square meters to 110,000 square meters. Our Mainline China business is going through a three-year journey to achieve our goals. We are making progress quarter by quarter we have already done the difficult part which is to win high quality new business and secure scarce resource now it's all about execution please stay a little patient and watch us deliver our international business is at a different story there is a great market opportunities on our doorstep and we know how to win. I'm excited about the prospects for us to create second GDS. Before I hand over to Dan, I would like to make a few comments about my personal position. After we published the AGM notice a couple of weeks ago, I acknowledge that investors have a number of concerns. GDS was born out of my vision more than 20 years ago. I have built an exceptional team which has been a major success fact. For me, leading GDS is about much more than just financial gains. It is driven by a passion. to create something extraordinary. This dedication remains unwavering and I assure you that nothing has changed in this regard. I want to take this opportunity to address these concerns and emphasize my commitment to our company. I intend to purchase approximately 1 million ADRs and the possible more. Over the next 12 months, if I am able to do so. In addition, if the AGM proposal is passed, I commit to sustaining my ownership percentage above the new structure. I firmly believe that our current share price does not reflect the true value of our company. I have complete confidence in our ability to enhance our business performance and achieve sustainable growth, thus create significant value for our shareholders. Now I will pass on to Dan for financial and operating review.
William
Thank you, William. I would like to start by talking about our financial objectives, which mirror what William said about our business priorities. For mainland China, number one, we target to grow adjusted EBITDA at a mid-teens percentage CAGR by delivering the backlog. Number two, we will become pre-cash flow positive, by which I mean pre-cash flow before financing, within three years. There's already high visibility as to how we will achieve this goal. Number three, we will cap net debt at around current levels and target deleveraging to below five times net debt to adjusted EBITDA. Number four, we will monetize assets to the extent required to recycle capital and keep within these financial parameters. And number five, we will sustain project level unlevered post-tax IRRs of 10 to 13%. by keeping discipline about new business and resources. For international, one, we will pursue a low-risk investment strategy based on firm pre-commitments. Two, we will target the same investment returns on a portfolio basis as we do for mainland China. Number three, we aim for international to contribute over 10% of our consolidated adjusted EBITDA within three years. Number four, we will take a segregated approach to financing, raising external equity and debt on a dedicated basis and not rely on the capital reserves of GDS holdings. And number five, lastly, we will create additional value for GDS shareholders in a way which is measurable and helps our share price. Now I'll talk through our financial performance for the quarter. Turning to slide 20, where we strip out the contribution from equipment sales and the effect of FX changes. In 1Q23, our service revenue grew by 0.2%, and underlying adjusted EBITDA grew by 6.6% quarter on quarter. Turning to slide 21, net additional area utilized during the quarter was 6,085 square meters. As we disclosed previously, a large customer is redeploying around 17,000 square meters from our data centers in Beijing to two of our campuses in Langfang, Hebei Province. The move out impacts us for the first three quarters of this year. Thereafter, the customer will move into the new locations over about six quarters. In totality, there will be a net increase of area utilized by this customer, but with a timing difference. If we add back the churn in 1Q23, the underlying move-in rate was similar to previous quarters at around 12,600 square meters. We expect gross additional area utilized to continue at these levels in 2Q and 3Q23, and then to step up significantly in 4Q23 as we have contracts with faster move-in. Monthly service revenue per square meter was RMB 2,149 in 1Q23. We expect MSR to decline by around 4%, comparing the final quarter of this year with 4Q22. Turning to slide 22, for 1Q23, our underlying adjusted gross profit margin was up on the prior quarter by 1.4 percentage points. And our underlying adjusted EBITDA margin was up by 2.8 percentage points. At the GP level, this was mainly due to seasonally lower utility costs. At the EBITDA level, there was also some savings in SG&A. Our profit margins are going to fluctuate over the course of this year. Our guidance implied around 45% full-year adjusted EBITDA margin at the midpoint, which has not changed. Turning to slide 23, in 1Q23, our organic CapEx in Mainline China was around 1.4 billion RMB. and international capex was 600 million RMB. Looking at our financing position on slide 24, at the end of 1Q23, our net debt to last quarter annualized adjusted EBITDA ratio was 8.1 times. If we add back the cumulative investment in international of around 5 billion RMB, or 700 million US dollars, the ratio is below seven times. Our effective interest rate for 1Q23 dropped to 4.3%. In January of this year, we issued a 580 million US dollars CB. As a result, our cash balance increased to 10.2 billion RMB or 1.5 billion US dollars at the end of the first quarter. In a few days from now, we expect to repurchase 300 million US dollars of an existing CB when it is put, which will leave our pro forma cash position at around 8.2 billion RMB or 1.2 billion US dollars. Over the remainder of 2023, we have 2.4 billion RMB of project loans to repay. We expect to draw down a similar amount of new project loans. In 2024, we have 3.6 billion RMB of project loans to repay. However, as a result of refinancing, which we are currently working on, we expect to reduce this number to 2.1 billion RMB. Once again, in 2024, the amount of debt repayment will be more or less equal to the amount of new drawdowns. Looking at our capital structure plan for mainland China on slide 25, As I mentioned, we target to cap net debt at around current levels over the next three years. We will, in effect, finance new investment through a combination of operating cash flow and asset monetization to the extent required. Our operating cash flow will strengthen with higher asset utilization and reduced input VAT as a result of lower capex. To give an update on the China Data Center Fund, we have signed a limited partnership agreement with the investor. We're now in the process of refinancing the first project, which we intend to inject into the fund. We expect to receive the net cash proceeds from the fund of 1.45 billion RMB on completion of the first asset injection in the middle of this year. Turning to slide 26 for international, we currently have six data centers under construction, two in Hong Kong and four in Johor. The portfolio totals over 120 megawatts IT power capacity with over 100 megawatts of customer commitments. The cost to date is around 700 million US dollars, which we have financed with around $400 million of paid up capital and shareholder loans, and around $300 million of external debt. We have already put in place long-term term loans for all of these projects. As I mentioned previously, we intend to raise additional equity externally, either at the project, country, or international Holdco level. We will pursue these options over the remainder of the year. Turning to slide 27, we confirm that our guidance for FY23 revenue, adjusted EBITDA, and CAPEX remain unchanged. We'd now like to open the call to questions. Operator, please.
Operator
Thank you. To ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. For the benefit of all participants on today's call, please limit yourself to one question. If you have more questions, please re-enter the queue.
Dan
Our first question comes from Gokul Hariharan
Operator
From JP Morgan, your line is open.
JP Morgan
Hi. Thanks, William and Dan, for the comments. My question is on the new targets in China in terms of delivering the existing backlog. Could you talk a little bit about what is the time horizon? Is it in the three-year period that you expect to deliver this backlog? And what are you hearing from your existing customers in terms of the ability to shorten the kind of time to move in from contract for some of this backlog. And maybe also if you could talk a little bit about what would be kind of, where would you get to EBITDA margins? Are we going to stay at similar levels for EBITDA margins in the China business? Or do you see a higher level as we move into a bit more of a harvest mode for the China capacity? Thank you.
William
Yeah, thank you, Gokul. Let me clarify the financial targets. The base year is 2023. And for most of the financial targets, we're talking about three years, plus or minus a few quarters. So for the mid-teens EBITDA CAGR, for free cash flow positive, deleveraging to below five times, incidentally net net income positive we're talking about three years for the delivery of the backlog we we didn't put a time frame on that because it's a little bit meaningless as we will still have some new booking to be added to that so it's a continuous process of adding adding new bookings and and and and delivery but This year, I think, on a net basis, with the churn that we talked about, the net additional area utilized will be around 50,000 square meters. But next year, we expect that number to be probably 20,000 square meters higher than that. our business plan base case. You want to talk about in the more short term what we're seeing move in, William?
William Huang
Yeah, Google. I think it's too early to say that a lot of positive things will affect today's revenue. But we do see some positive signals from the market. I believe you are aware our largest customer they currently they split they announced that they will split a car business and also will target a goal list to go to the list in any market right so in next 18 months And this is very positive for me. I think this is, and also the cow, China number one, number two, number three cows all cut their price, selling price, which is also means they start to pursue market share. It's not like last year or last two years, just a pause the business plan. That means very clear signal to pursue market share again, So I think it will definitely impact our moving. But so far, I think the whole sentiment has totally changed, but not affect our current. It's too early to say affect our current moving. But I do believe it will affect our next year or next two or three years moving schedule. I wish and maybe it's possible they will bring the moving schedule more early.
William
I just need to finish off and talk about the EBITDA margin expectations. So I think once again, referring to a three-year target, I would say we're looking for at least two percentage points higher EBITDA margin than we achieved in FY23. Got it.
spk12
That's very clear. Thank you. Thanks, Dan.
Dan
Thank you. One moment for our next question.
Operator
We have a question from Jonathan Atkins from RBC. Your line is open.
Jonathan Atkins
Thanks. You talked a little bit about synergies that you'll be getting in your international operations, you know, from China, and I think you talked a little bit about shipping some of the equipment, you know, into Malaysia. Can you talk a little bit more about, whether it's revenue synergies or back office or operating synergies or other types of benefits that you will get between the core Chinese company and then offshore. And then secondly, I was interested in the demand profile that you're seeing internationally, different demand dynamics. I think you've got fairly kind of single-threaded demand, at least currently in Johor. And What does the prospective kind of sales pipeline look like internationally? Is it Asian? Is it Western customers? Maybe a little bit more color on that. Thank you.
William Huang
Hey, John, this is William. I think let me talk about the synergy between the international business and mainly China business. I think it's very obvious we can leverage our current product and supply chain and customer platform. This is quite unique, which I don't think the other player in this region has this kind of advantage. So I think that's why we are very confident based on our current advantage. We will follow up our customer, we will follow up our successful product in China, which I think we still very fully well-developed the product, right? And also the supply chain is very important as well. And I think because it has already reached the point which we always build with largest builder in the world in the last couple of years. I think this gives us a very, very unique position to get a much cheaper supply chain, right? The pipeline, I think, yeah, I think it's now kind of in a situation that everybody talks about in Southeast Asia, which is true. Southeast Asia has a huge demand, right? Because if you look at a Chinese customer or a U.S. customer, they all announced big plan in this region. And so this is not just an announcement based on what's our dialogue between all GDS and all our customers. They do have the real demand in this region. So in terms of pipeline for us, I think we still remain a very strong pipeline from China and also US customers. Again, as I say, we also see some domestic demand.
Jonathan Atkins
Thanks very much.
Dan
Thank you. One moment for our next question.
Operator
We have a question from Frank Laufen from Raymond James. Your line is open.
Frank Laufen
Great. Thank you. As you look forward, what percentage of your installs and sales do you think are going to be AI-related? And can you characterize the AI demand that you're seeing between the mainland China business and the international deployments? Thanks.
William Huang
yeah i think the uh number one i think in china i think we see it's a little bit early stage for uh ai uh driven uh demand right so but it's happening right now i think the uh in china the big platform all announced it already announced their uh ai stuff and but i but we think it will impact our new booking maybe uh one year after or or two years after It's a little bit behind what happened in the US, but I think it will happen, right? So this is in China. In also international business, we have seen some, let's say, new demand configuration is more AI-driven. so let's say we would i already uh uh uh mentioned in our southeast asia uh data center we already implement the liquid cooling stuff this is a mainly driven by the gpu uh uh type of server so i think that this is mainly for the ai stuff it's happening in southeast asia uh uh already
Frank Laufen
All right, great. Thank you very much.
Dan
Thank you.
Operator
We have a question from Peter Milliken from Deutsche Bank. Your line is open.
Peter Milliken
Yeah, hi. Good evening, everybody. My question is about the forward sale. When was that first disclosed? Was it in the 2022-20F or had it been announced previously? Because I hadn't heard of it before.
William
Peter, it was disclosed at the time. Well, it's not one transaction, but they were disclosed at the time when the transactions were done, the counterparty banks, which, incidentally, are amongst the largest banks in the world, were required to make disclosures and duly did so. So that was 100% in line with the legal requirements. At that time, the system employed by the US SEC was that these disclosures were made in so-called paper filings. And some institutional investors, I think, subscribe to services who search paper filings and access that information. But as we know now, many do not. As a result, I think quite a few institutional investors who just kind of like relying on Bloomberg or terminals were not aware of the disclosure. Ironically, in April of this year, the SEC changed their system. So those disclosures would have been made electronically now, and it would have been accessible in the usual way.
Peter Milliken
Right, yes, I'm sure the people who invested in the secondary listing would have liked to have known that. Look, my second question is really about why you wouldn't have prepared the bonds to be ready for this change of control event potentially? You've had a few years where you've been aware of this. Why weren't you talking to them about changing covenants and rolling debt and things like that? Why does it lead to this sudden point where investors have to make a quick decision on agreeing to this change of control event?
William
Peter, we operate in an environment where we make very extensive disclosures. In our articles of association, it states that if William's beneficial ownership falls below 5%, then his Class B shares are automatically converted to Class A shares. I think everyone's known that as the risk factors in our 20F. I think since the completion of our Hong Kong IPO, Williams shareholding has been just above that threshold. And it could have gone below that threshold for any number of reasons. If we'd issued only a relatively small number of shares in a capital raise, for example, his ownership would have gone below that threshold. So, I mean, this should be very clearly understood, right? It's simple to Simple disclosure. We need to make some changes to our articles subsequent to our Hong Kong IPO. It's something that all the companies in our category of US ADR companies with secondary listings had to commit after the Hong Kong IPO to implement certain changes to the articles. And so we felt that it would be convenient or appropriate to package together all the changes to the articles at the same time in our annual general meeting, which is what we're proposing to do. Got it.
Peter Milliken
Okay.
Frank Laufen
Thank you.
Dan
Thank you. We have a question from Edison Lee with Jeffrey's Group.
Operator
Your line is open.
Edison
Thank you for taking my question. Hi, William and Dan. I have two questions. Number one is that one of your objectives at the early part of the PPT says that you are trying to shorten the lead time from investment to move into to less than two years. And so what is the average period right now and what is your strategy to try to shorten that to less than two years. And the second question is about what percentage of your backlog for area and surface is going to hit that completion of the ramp-up period in the next, I would say, let's say within 2023?
Laura Chen
No, I missed the second part of the question.
William
Sorry. How much of the
Edison
The second question is what percentage of your backlog in the area in Syracuse that would actually hit the completion of the round-up in 2002?
William
Sure, thanks Edison. I'll go first. I think it's a characteristic of high-scale business because the order size is very large. Customers need to pre-commit in order for data center companies to develop and they commit for like an entire data center but it's pretty much standard for these contracts to give the customer quite a lot of flexibility over the amount of time that they move in I think the cloud service providers because you know their requirement is for continuous upscale. I think that they, in the past, planned furthest ahead. Maybe their resource plan was three or even more years ahead of time. And they, in our experience, habitually took the longest to move in. So their contracts would give them two years and they would actually move in over a two-year period. Now that has extended to beyond two years. But the internet companies, quite often we would see that they were not placing the orders so far ahead. Very often the requirement was urgent, maybe because their business was so dynamic and their forecasting was not so well established. And so a key selection criteria would be can you deliver in six months time? Can you deliver in nine months time? And then while the contract would typically still have a two-year move-in period, I would say on average the internet companies moved in faster. Maybe they move in more like one year. So as you know, last year the Mix of our business by customer segment changed quite a bit. Cloud, which had been, I think, as high as like 70 or even more percent of our business was 20% in terms of our new business last year. And then internet was 60 and enterprise was 20. I think just that change in itself will lead to faster delivery. But if you look at the totality of our backlog of over 200,000 square meters, I think well over 50% of that backlog is cloud. And so that's why we have to work through the delivery of the backlog. But then for the new, what we're targeting now, expect to see a shorter lead time from when the order is booked until the service delivery starts. and then a shorter move-in period.
Edison
Does it mean that you are going to ask for a shorter move-in period even for the traditional CSP customers, or do you think you will try to expand customers more into the non-CSP customers?
William
Are we going to try to, I guess, as a contractual term, insist on a faster moving period for cloud service provider customers?
spk12
Yeah. I just mentioned that.
Edison
Sorry, go ahead.
William Huang
Yeah, I think the moving parts we expect to be, of course, the new booking last year, the new booking mainly driven by the internal company. I think the more faster moving than a cloud. But a cloud business last year, last two years, I just mentioned, it's paused their business plan, right? But now they boosted their new business plan right now. But I think I wish maybe it will happen, possibly they will move more faster, start from next year. So I think I'm quite positive for this.
Edison
Sorry, I just need to ask this follow-up. So does it mean that for new contracts, for new contracts with cloud service providers to actually ask for less than two-year move-in?
William Huang
New contract? New contract, I think it's much faster than two-year.
William
New contract. As I was asking specifically whether the business we do with cloud service providers, we will insist on a faster move-in period. Is that right?
William Huang
New contract with CSP. Yeah, I think new country, if we have the new country, that means they have the real demand. So definitely they will ask for more ready to move in, right? Otherwise, they still have a lot of the inventory, right? If we have the new country from the cloud, that means their demand is much stronger than they expect.
Edison
So can you tell us whether you are going to ask for one year, one and a half year? Is there any particular target that you have here?
William
As you're asking about the situation that hasn't arisen yet, I mean, we've got more than 50% of our backlog is already, the terms are already agreed. And if you look at the size of our backlog relative to our annual move-in, you see it's at least three plus years of new business there, right? I think we already locked in most of the commercial terms for the next three or four years, new business. And I think we'll probably see not more than 20% of our new bookings will be cloud going forward.
Edison
So I guess that is related to my second question, right? Because I want to know what percentage of your backlog for area and services will actually be completing that ramp-up period. Because I want to get a sense as to whether you are vulnerable to this completion period actually being extended, right, because of the slow movement, and how much would that impact your revenue?
William
You know, Edison, I think it's simple. I mean, I provide some guidance, formal guidance and direction on what is the annual net ad in terms of area utilized. I commented on what we expect to see in 2024 as well. So I'm factoring in what I know bottom up in terms of what's in those contracts and what we understand about our customers' intentions. Probably a simpler approach is to take my direction because I'm amalgamating a lot of different factors.
Edison
Right. But will there be situations where, because it hits a two-year ramp-up period, so even if the capital or the square meter utilizes below the committed rate, you will be able to charge the full price, or that certainly will not happen?
William
Yes, we are able. That's a commercial decision, right? We are able to charge the full price.
spk12
Yeah. Yeah, that's true.
Dan
Thank you. One moment for our next question.
Operator
We have a question from Yang Lu with Morgan Stanley. Your line is open.
Yang Lu
Thanks for the opportunity. I have one question regarding the MSR trend. I think Dan just mentioned that we expect a 4% point drop by the end of this year. I just want to have a better view about how much of that will be driven by the mixed change of a company's new capacity, and how much will be driven by potential contract renew. Because I saw in the back section of the presentation you have around 10% of the contract about to renew this year. So does this MSR change, or what is the assumption of the contract renew here behind the MSR job. Thank you.
William
Yeah, once again, this is a bottom-up number, which is an amalgamation of the contracts and the backlog, which we expect to deliver, and the outcomes that we're expecting in terms of pricing on contract renewals are reflected all in the guidance we gave was direction to give on MSR, which is a 4Q versus 4Q number. And by the way, I'll go further and say in 2024, we think that that MSR decline would be about around 2% to 3%. So it's simpler to take my direction rather than asking to sort of disaggregate it into all the parts, right? You follow what's happening in in the U.S., and we see that pricing is firmer and increasing in some Tier 1 markets in the U.S. and in Europe. We're not in that situation yet in China. We think we may be one or two years behind that. But even at current levels, our projects give us, you think, reasonable returns. to our cost of capital. So I think the business is very sound at current levels and we will wait for the next one or two years, hopefully see the market situation improve somewhat in our favor.
Yang Lu
Thank you.
Operator
Thank you. As there are no further questions, I'd like now to turn the call back over to the company for closing remarks.
Laura Chen
Thank you once again for joining us today. If you have further questions, please feel free to contact GDS Investor Relations through the contact information on our website or the Pearsontic Group's Investor Relations. See you next time. Bye-bye.
Operator
This concludes the conference call. You may now disconnect your line. Thank you.
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