2023-08-07 19:45:34 ET
Summary
- There are direct winners of AI technology such as companies that develop generative AI tools, and then there are companies that work on the infrastructure side of AI.
- Vertiv Holdings Co's second-quarter performance showcases the strength of AI-related applications, hinting at a promising sales pipeline for 2023 and beyond.
- The global data center services market is expected to reach $116.43 billion by 2027, driven by increasing digitalization and the adoption of AI technology.
- Investors of critical data infrastructure companies such as Vertiv needs to pay close attention to inflation, especially the pricing environment for metals.
There are direct winners of AI technology such as companies that develop generative AI tools and other customer-facing applications. Then there are companies that work on the infrastructure side of AI, which remain largely hidden from the eyes of consumers. Data center infrastructure companies fall into this second category. In the recent past, investors have been keenly exploring this sector to find companies that would potentially benefit from the increasing adoption of AI technology. Vertiv Holdings Co ( VRT ) is a company worth monitoring in this space.
The Big Picture And Opportunities
Vertiv Holdings is a global provider of critical digital infrastructure and continuity solutions for data centers, communication networks, and commercial and industrial facilities. The company offers products and services such as power management, thermal management, racks and enclosures, monitoring and management, digital infrastructure solutions, and prefabricated modular. Vertiv has acquired a few companies in the same field, such as E&I Engineering Ireland Limited and Powerbar Gulf LLC, to expand its portfolio and market reach.
Vertiv's second-quarter net sales reached an impressive $1.7 billion , a 24% increase from the same period in 2022. The company exceeded expectations with its orders, which were down approximately 3% from the previous year's second quarter but surged 13% compared to the first quarter of 2023. The book-to-bill ratio remained steady at around 1x with improving industry lead times.
Exhibit 1: Q2 performance highlights
The second quarter showcased the strength of AI-related applications, hinting at a promising sales pipeline for 2023 and beyond, potentially leading to increased sales in 2024.
According to Research & Markets, the global data center services market is witnessing robust demand , with revenue increasing from $59.53 billion in 2022 to $67.51 billion in 2023. This market is expected to be valued at $116.43 billion by 2027, growing at a CAGR of 14.6% from 2023. This growth will be fueled by the increasing adoption of digitalization, which would act as a catalyst for the data center services market.
In the United States, according to Statista, the data center market is predicted to experience significant growth, pushing revenue to almost $100 billion in 2023. Network infrastructure is emerging as a dominant force in this market.
Exhibit 2: Data center revenue – United States
Amid an evolving landscape, supply chains are exhibiting promising signs of stability with improving availability and reduced lead times. Nevertheless, the procurement of specific critical electronic components remains a major challenge. The resilience of the U.S. supply chain is noteworthy, recovering from the tumultuous impacts of the pandemic, which triggered soaring shipping costs and constrained supplies throughout 2020. The GEP Global Supply Chain Volatility Index , a gauge derived from a comprehensive monthly survey involving 27,000 businesses, has seen a remarkable shift, registering a value of -0.26 in June, indicating an extended period of excess global supplier capacity. This stands in stark contrast to the situation one year ago, where the index stood at a substantial 3.53. The notable decline in the index value highlights a significant reduction in global supply chain constraints and uncertainties.
Exhibit 3: GEP Global Supply Chain Volatility Index
GEP
Investors of critical data infrastructure companies such as Vertiv need to pay close attention to inflation, especially the pricing environment for metals as different types of metals are used to design critical components.
In June, a significant observation came to light - global demand for raw materials, commodities, and components, especially in Europe and North America, exhibited a concerning downturn. This apprehensive scenario raises alarm bells for manufacturing sectors as escalating borrowing costs amplify the potential for ripple effects on the broader economy. The challenge of procuring essential components, crucial for multiple industries, is foreseen to persist in the long term. Although there has been a decline in metal costs on average when compared to the previous year, overall material expenses remain elevated, particularly electronic components, compared to pre-pandemic levels.
According to the World Bank's projections , metal prices are poised to experience an 8% decrease in 2023, with a further 3% decline anticipated in 2024. Notably, tin and zinc are projected to witness the most substantial price drops, with respective declines of 23% and 20% in 2023. Aluminum and nickel prices are expected to follow suit, with predicted declines of 11% and 15%, while copper, lead, and nickel are foreseen to undergo relatively smaller declines, amounting to less than 5%. As we progress into 2024, this trend is projected to continue, with metal prices expected to undergo further declines, ranging from 3% for zinc to 9% for nickel. This dynamic outlook reflects the fluidity of the global market and the inherent complexities that influence material costs.
Exhibit 4: Metal prices forecast
The data center industry faces its share of challenges, but the rise of AI is a bright spot. AI workloads are expanding the total addressable market, offering new opportunities in the existing landscape. The rapid growth of AI-driven applications is expected to have significant financial implications for the data center industry. With projected costs exceeding $76 billion by 2028, there are concerns about the impact on profitability and business models of emerging services incorporating GenAI, such as search, content creation, and business automation. According to International Data Corp., global spending on AI is expected to surpass $301 billion by 2026. As AI workloads continue to surge, energy usage associated with data center operations is emerging as a major driver of rising bills.
A recent report by WSJ highlights the power consumption challenges faced by data center operators. Datacenter customers, ranging from small businesses to large cloud providers, are consuming power at a rate that surpasses the operators' capacity expansion efforts. A glaring example can be seen in Northern Virginia, the world's largest data center market with more than 275 facilities. Despite an overall inventory growth of 19.5% to 2,132 megawatts, power availability for lease dwindled from 46.6 megawatts to 38.4 megawatts within a year, as revealed by CBRE Group's analysis.
As AI-driven applications become increasingly prevalent, addressing the energy demands of data centers will be a critical challenge. Finding sustainable and efficient ways to power data centers will be vital not only for maintaining profitability but also for supporting the continued growth and success of the data center industry in an environmentally responsible manner.
Vertiv, as a leading thermal management solutions provider, benefits from favorable market trends in the growing data center landscape and high-density applications like AI. The company's strategic advantages also include a broad portfolio and its capacity expansion capabilities to meet the industry's demands. The company expects that AI-related applications will offer a favorable boost to the sales pipeline in 2023 and 2024.
In summary, supply-chain pressures are easing as expected, and the data center infrastructure market is benefiting from the increasing popularity of high-density computing. Although metal costs are expected to trend lower, investors will have to keep a close eye on prices. Vertiv, as a leading data center infrastructure company, is well-positioned to benefit from the growing demand for liquid cooling solutions as companies adapt their existing infrastructure to support AI workloads. The pipeline of opportunities for both cloud hyperscale and colocation segments will grow along with the changing data center landscape today.
Takeaway
The long-term industry landscape is positive for Vertiv Holdings Co, and the company is benefiting from consistently positive earnings revisions as analysts place weight on the improving outlook for the company. Although continued inflation may impact Vertiv's Q3 and Q4 financial performance, the company is likely to show some pricing strength in the future as it establishes itself as a go-to solutions provider in transforming data centers to support the rollout of AI applications.
At a forward P/E of 22, I believe Vertiv is fairly valued, and the positively trending earnings revisions are likely to push VRT stock higher in the foreseeable future. However, given Vertiv's track record, I am not ready to rule out execution risk, and I believe investors will have to closely monitor how recent acquisitions (mainly the acquisition of E+I Engineering Group) impact the financial performance of the company going forward.
For further details see:
Vertiv Holdings Q2: The Big Picture Looks Promising