From Bottlenecks to Breakthroughs

Welcome to The Rundown! Each week we'll identify and break down for you SPACs that are capturing market share and making an impact.

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The evolution of the digital age over the last two decades has seen an uninterrupted growth trajectory for the data center market, with demand being driven by increasing storage and computing requirements, as well as the widespread shift from on-premises infrastructure to cloud solutions. Developments in software applications and IT have reshaped the way clients interact with data, instigating a significant expansion of data center inventory.

As the wheel of progress spins inexorably forward, Fortune 500 companies are turning their gaze toward the vast and uncharted frontier of Artificial Intelligence () and its applications. The surge in AI adoption could propel the data center industry into an entirely new realm of growth and opportunity. 

Following Nvidia's recent earnings announcement, market speculators have been abuzz with anticipation of a potentially exponential increase in data center demand as a result of enterprise demand for AI solutions. However, the full integration of AI solutions will not happen overnight. Analysts predict an investment cycle of at least a decade before enterprises can fully scale up their solutions.

In the meantime, companies like Vertiv Holdings, which provides thermal and power management solutions to data centers, could reap the rewards of this increased demand. The company, which specializes in eliminating thermal bottlenecks – will be a crucial element in servicing the needs of this AI-driven expansion.

But, with an existing extensive order book and the looming challenges of disruptions and pricing pressures, is Vertiv poised to service this demand effectively?

Into The AI Furnace 

Vertiv Holdings Co has steadily built a reputable brand, offering a comprehensive suite of products and services that drive digital infrastructure. Ranging from critical power, thermal management, racks, and enclosures to monitoring and maintenance services, Vertiv has established itself as a dominant player in digital critical infrastructure solutions. Though it offers its expertise to various sectors worldwide, its services find their primary usage within the data center space.

The company's relevance has gained newfound attention in the wake of NVIDIA's Q1 event, where NVIDIA management emphasized the robust performance of its data center business, a success largely attributed to the rising influence of Generative Artificial Intelligence (AI). As a significant portion of Vertiv's business comes from servicing data centers, NVIDIA's hints at exponential growth in AI align promisingly with Vertiv's specialty in data center services, especially in areas like thermal management and control.

Machine learning calls for unique data center needs. Though AI training can be carried out in relatively isolated environments, requiring high computing power but not necessitating proximity to end users or interconnection with other facilities, it poses a new challenge for data center operators. The fierce demand, spurred on by generative AI, means operators cannot increase capacity overnight, leading to a need for maximizing existing facilities via ramped-up computing in tight spaces or increased rack densities.

This spike in computing processing inevitably leads to higher heat levels, necessitating advanced thermal solutions that go beyond just air cooling, but also require a more profound understanding of liquid cooling. Vertiv's proficiency in this area provides them with a significant advantage. The company recently noted the early signs of the AI investment cycle in its pipelines and orders, indicating that it foresees AI applications driving data center demand in late 2023 and beyond, potentially yielding a price realization of ~$105 million (~9%). 

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Charging Forward 

Vertiv's solid performance is evident in its strong order intake, with a book-to-bill ratio of ~1.0x in Q1. However, orders, adjusted for FX, decreased by ~23% from the prior year due to the significant volume in the Americas in last year's Q1 and the return to a normal buying cycle this year. The company anticipates a further decline in Q2 2023 orders compared to Q2 2022, although this is expected to improve relative to Q1.

The backlog remained steady at $4.8 billion at the end of Q1, marking a ~16% increase from the previous year. Despite the economic headwinds, commodities like steel, copper, and aluminum are projected to settle at levels lower than their 2022 peak, even though a slight upward trend has started to emerge. While supply availability improved in Q1, accelerating some sales planned for later in 2023, the supply of power electronic components continues to face constraints.

Despite the tight market, relentless efforts to source alternatives have helped meet these challenges. Similarly, the fan supply landscape remains strained, but the majority of current needs are being met through alternate sources. costs are showing promising signs, with reductions in air and ocean freight rates carrying into Q2 and providing a tailwind. Lead times, although not yet optimal, are improving, with customers returning to historical order patterns.

The thermal business follows a similar trend but faces more extreme patterns due to the supply constraints on fans in 2022. Manufacturing capacity significantly increased in 2023. The three-year order history exhibits a strong growth CAGR(2) of ~12%. This robust demand and sizeable backlog fully underpin Vertiv's growth plans for 2023 and 2024.

Financials and Valuation 

Vertiv Holdings recently experienced a surge after exceeding Q1 expectations and simultaneously improving its Q2 and full-year guidance. Q1 2023 sales rose by 32% compared to the previous year, with revenues reaching $1.521 billion, up from $1.156 billion in Q1 2022. The company's operating profit also experienced a significant boost, moving from $13 million in Q1 2022 to $163 million in Q1 2023, thanks to a 1040 basis points improvement in operating margins.

Further strengthening its financial health, Vertiv reported a positive free cash flow of $25 million in Q1 2023, compared to a negative $150 million during the same period in 2022. Looking forward, Vertiv anticipates Q2 net sales of $1.6 billion, and full-year revenues to be approximately $6.52 billion, representing a 15% increase over previous guidance. 

Operating profit for Q2 is projected at $190 million and $800 million for the full year, marking a $25 million increase from prior guidance. Furthermore, the company expects to generate a positive free cash flow of approximately $350 million, a significant reversal from 2022's negative $260 million. Reflecting these encouraging developments, Vertiv's stock has jumped 48% over the last three months.

The shares are currently trading at nearly $21.2, giving the company a market cap close to $8 billion. This price/sales ratio of 1.22x indicates a relatively cheap valuation. However, investors should consider other factors like the company's considerable debt burden and the recent stock rally resulting from the AI hype. The long-term value will ultimately depend on Vertiv's effective management of its order book and improvements in its unit economics.

Bottom Line 

As Vertiv navigates an evolving landscape marked by AI-driven data center demand, its resilience, and agility underpin an encouraging outlook. Yet, the real long-term value hinges on more than just market opportunities. The company will require careful management of its expansive order book and a strategic approach to improve unit economics. Investors should closely monitor its execution strategy alongside the broader trends shaping the data center market, to see if its stock can continue to surge. 

Source: From Bottlenecks to Breakthroughs