CRDO - Credo Technology: The Future Is Bright

Summary

• The market opportunity for Credo in the data infrastructure and high speed connectivity products markets continue to grow, driven by secular industry tailwinds.
• Credo has a promising customer base, having 5 out of the top 7 hyperscalers talking to it as well as having Microsoft and Amazon as customers.
• The main competitive advantage Credo has is its patented SerDes technology, which brings proven advantage to its products relative to incumbents.
• While competition may be tough, the company is able to leverage on its technology and nimbleness to gain market share.
• My 1-year target price for Credo is $19.50, representing 64% upside from current levels.

Investment thesis

I think that Credo ( CRDO ) could be the next AMD ( AMD ) as it looks to disrupt large incumbents and gain market share as a small player. Credo's competitive advantage comes from its patented SerDes technology that enables its products to have better performance and lower costs compared to incumbents. Furthermore, as a small company competing against larger competitors, it can leverage on its nimbleness as well as the increasing need for more resiliency and diversification in supply chains to gain market share. The market opportunity for Credo remains huge as it looks set to gain market share from incumbents. In addition, Credo's customer base looks promising as it has engaged with 5 out of the top 7 hyperscalers, most of which are large technology companies.

Overview

Credo was founded by ex-Marvell ( MRVL ) engineering directors in 2008, focused on providing solutions that address the increasing data rates and greater requirements for bandwidth in the data infrastructure market. As a result, the value proposition for Credo's technology is the easing of problems with system bandwidth as the need for more data and bandwidth increases exponentially, while ensuring higher performance in terms of reliability, security and power than its competitors.

The crown jewel of Credo is the patented Serialize/Deserialize ("SerDes") intellectual property. This IP can be licensed out as part of its solutions. The company also has its own line of high-speed connectivity products that targets data centres. Currently, its portfolio of products includes optical digital signal processors ("DSP"), HiWire Active Electrical Cables ("AEC"), as well as SerDes chiplets .

Growing market opportunity

Credo looks to disrupt the incumbents in the market due to the drastic increase in data generation over the last decade that has posed different challenges to traditional market players. As such, Credo is able to use its proprietary SerDes as well as its DSP technology to bring innovation in the data infrastructure market and gain market share as Credo's products are better able to meet customers need for ever increasing energy efficiency as well as performance requirements.

Credo serves the data infrastructure market, driven by infrastructure for 5G, high performance computing, as well as hyperscalers. As end consumers lead more digitalised lives and education and work shifts online, this has resulted in higher requirements for bandwidth, power and security as well as better cost efficiency.

Gartner forecasts that the wired connectivity market within the data infrastructure ecosystem will grow to $17 billion by 2025, up from the $12 billion in 2020, and 650 Group expects that hyperscalers will have the fastest growth rates within the market.

Credo expects that the market for high-speed connectivity products will grow to $5 billion in 2025, up from $2 million in 2022. As such, with the growing need for faster speed continues, this brings a competitive advantage to Credo over its incumbent competitors as it is ready to disrupt the market in need of innovation.

Promising customer base

One more prominent customer is Microsoft ( MSFT ) which has worked with Credo on the AEC business, and Amazon ( AMZN ) is also said to have bought Credo's AEC. Credo has also previously disclosed that they have worked with 5 of the top 7 hyperscalers. For reference, the largest hyperscalers in the United States are Microsoft, Amazon, Meta Platforms ( META ) and Google ( GOOG ). While Credo may be small in the industry relative to incumbents, the fact that these large hyperscaler companies, that are large technology companies, are talking to Credo and even buying its products gives incredible amount of credibility to the company and its offerings. Other customers it works with are companies like Arista ( ANET ) and for its licensing business, it has had more than 30 licensing engagements since inception.

The big question with regards to Credo is the concentration of customers. The company definitely has a concentrated customer base, but should this be a cause for concern? As can be seen below, 69% of its revenues in FY2022 came from just 4 customers, while 54% of revenues in FY2021 came from 3 customers and 44% of revenues in FY2020 came from just 2 customers.

The way I think about the concentration of revenues in a small number of customers is that this is a function of Credo's small size and the nature of the business. I think we will continue to see concentration in its large customer base due to the continued design wins Credo is getting from hyperscalers and other large technology companies. Since the company is still currently small, these large design wins will continue to be a large portion of its revenues in the near term. I think that as time goes by, we will see Credo's customer base start to diversify and become less concentrated. As a result, there may be some risk pertaining to high customer concentration that investors need to be aware of. That said, I still think it is highly favourable for Credo to be getting these wins from these large technology companies and hyperscalers that gives credibility to Credo's offerings.

Competitive advantage

In my view, Credo has a competitive advantage as its product offers better power efficiency, with competitive performances while at a lower cost and smaller than other players. The key technology to highlight here is the patented Serialize/Deserialize ("SerDes") intellectual property. While competitors do have their own SerDes architectures, the patented IP enables Credo's products to have architectural advantages that leads to cheaper manufacturing process, best-in-class power efficiency and smaller chips. I think that all these are important for Credo's customers, especially so for hyperscalers as they require a lower power budget. As such, I think that this patented technology will help Credo to continue to gain market share in fast growing segments like optical DSP.

Rising to the competition

However, it is important to note the current industry dynamics in which Credo operates in. With regards to the wired communications connectivity market, Broadcom ( AVGO ) is the leading player with almost 50% market share. In the Ethernet semiconductor space, both Broadcom and Marvell takes up almost 90% of market share. As a result, we have to be very mindful of the 2 large competitors that are currently the industry incumbents. While incumbents may fall one day if they lose their competitive advantage, I think that both Broadcom and Marvell are tough competitors for Credo given their track record, economies of scale that can be reaped from their scale and their larger variety of network products offered. These competitors are also continuing to spend almost $6 billion in research and development spending that can help them to maintain their competitive advantage and meet the demands of the industry.

Given this industry dynamic context, I think that it further proves my point that Credo brings a value add as a new player in an industry dominated by a 2 large players.

Firstly, I think that the heavy concentration of market share in these 2 players signals the need for increasing supply chain resilience and thus, diversifying supply away from these 2 dominant players. As a result of this renewed focus on supply chain resilience, Credo stands to benefit as a new entrant and an alternative supplier.

Second, I think that the fact that Credo has been engaging with 5 of the top 7 hyperscalers and with more than 20 blue chip clients underscores the fact that these large companies see the value that Credo brings. This gives further credibility to the company's patented technology which helps customer perform better and at lower costs, as highlighted above.

Lastly, size may not matter, especially when Marvell and Broadcom are significantly larger than Credo. I am of the view that the Credo advantage, apart from its patented technology, is also a more flexible and nimble business model that is able to meet customer's needs and demands. By moving faster than its larger peers, this helps Credo have a first mover advantage in emerging areas and demonstrate its credibility and reliability to customers.

Valuation

I assume an EV/Revenue multiple of 7x for Credo, which is in line with its competitors, Marvell and Broadcom, both of which are currently trading at 7x NTM EV/Revenue. I think that a similar multiple is warranted given the higher growth profile of Credo. Applying this 7x EV/Revenue multiple on Credo's FY2025 sales and discounting it back at a WACC of 10%, my 1-year target price for Credo is $19.50, representing 64% upside from current levels.

Risks

Customer concentration risk

As highlighted above, 69% of its revenues for FY2022 came from just 4 customers. I take the view that it is inevitable at this early stage in Credo's stage as a company to have this kind of concentration risk given that the company is targeting hyperscalers and these are the top 7 hyperscalers in the market. That said, I am cautious that this might lead to some volatility in revenues in the near term. Given that the near-term business model will give rise to some uncertainty, this might also affect the type of multiples that the market is willing to give Credo.

Competition

One of the biggest challenges that Credo has faced and will continue to face is the fact that the current incumbents in the industry, Broadcom and Marvel do control a large portion of the market. As a result, they do have some track records with their current customers, benefit from economies of scale. As such, Credo will need to show that its offerings can integrate well with the existing data centre ecosystems and show interoperability with incumbent vendor solutions. Although I do think that Credo will succeed in this David versus Goliath fight, the risks remain that competition from these two large players may be stronger than expected.

Technology risks

While Credo may have some competitive advantage with its SerDes IP, if its competitors are able to create a better technology or product that can compete against Credo's offerings, this could then diminish Credo's competitive advantage in the market. If so, this will erode the investment case for Credo as it will not have credibility to gain market share in the long run.

Supply-side issues

As others in the industry has seen limited growth due to limited availability of the needed substrates, this could also be the case for Credo if they are unable to have adequate wafer supply. There is the risk that Credo may experience supply side disruptions that could limit the growth of the company.

Conclusion

While it's still early days for Credo, I think that the future is bright for the company. The promising customer base includes hyperscalers and large technology companies, giving huge credibility to the technology and product offerings of Credo. Furthermore, while Credo is a small company fighting two large incumbents, by leveraging on its technology, being more nimble, it can compete against these incumbents and gain market share. Also, the market opportunity for Credo is huge and its patented technology brings innovations to an industry that is seeing an evolving need for faster speeds and more data. My 1-year target price for Credo is $19.50, representing 64% upside from current levels.

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