Month: November 2022

CrowdStrike Q3 Earnings: Closer Look at Net New ARR

Posted on by io-fund

The question of “why did Crowdstrike sell-off” doesn’t seem to be satisfied by the $10 million miss on forward revenue and ARR.

Forward Q4 revenue was expected to be $634M and the company guided $619M to $628M for a miss of about $10 million, if we take a midpoint of $624 million (about 1.5% miss). ARR was $2.34 billion compared to analyst expectations of $2.35 billion, for a $10 million miss (less than 1% miss).

Although this likely contributed, I believe the analyst we quoted in our Pre-ER write-up that was modeling for net new ARR of $224M to $230M-plus may be providing a missing link between analyst expectations for this key metric and actual results of $198 million. At the midpoint, this would be more of a miss of 14.6%.

Here is what was said in the Pre-ER write-up:

“An analyst note from Barclays’ Saket Kalia is modeling ARR net addition of $224 million “but thinks upside could be $230M-plus given strong pipeline commentary.” At $230M, it would represent 5% sequential growth and 35% YoY growth. This would be down from 15% sequential growth in the previous quarter and 45% YoY.”

The reason we flagged this is because the net new ARR at high point of $230M would still mark a strong deceleration to 5% sequential growth down from 15% sequential growth last quarter. This means this would have to be met or we would be nearing flat to negative sequential growth on net ARR.

With the actual of $198 million reported, this drops the net new ARR at negative sequential growth of negative (9%) down from $218 million last quarter. This marks a change compared to the comp of 13% in sequential growth from Q2 2022 to Q3 2022.

The market is nervous with cloud becoming the other shoe to drop as enterprise budgets will slow long after consumer slows due to annual billing cycles, annual budget reviews (i.e., likely to produce budget cuts) and due to higher switching costs (or in cloud’s case, slower to switch off than consumer or ad spending, for example).

In my opinion, this is why outsized pressure is being placed on sequential growth. The market does not care about YoY because it’s assuming enterprise spending wasn’t affected yet.

CrowdStrike Q3 Overview:

CrowdStrike beat both top line and bottom line for Q3. In fact, an area where CrowdStrike continues to stand out from its peers is the health of the bottom line and both Q3 actual and Q4 guide was no exception in this regard. For example, the free cash flow margin of 30% is exceptional.

The company reported revenue of $581 million for growth of 53% compared to revenue of $574 million expected for growth of 51%. This is a slight deceleration from 58% last quarter.

For Q4, the company guided for revenue of $619 million to $628 million compared to expectations of $634 million. At the midpoint of $623.5 million, this is a $10.5 million miss.

The GAAP EPS of ($0.24) compares to ($0.22) EPS from the year ago quarter and ($0.25) EPS last quarter.

Adjusted EPS for Q3 came in at $0.40 compared to $0.32 expected. This compares to $0.36 last quarter and $0.17 in the year ago quarter.

Adjusted EPS guide for Q4 also beat at $0.42 to $0.45 compared to $0.34 EPS expected.

GAAP gross margin was 72.7% which was in line with a range of 73% to 74% over the past five quarters. The adjusted gross margin this quarter was at 75% compared to 76%-77% over the past five quarters. Subscription gross margins were also in line.

GAAP operating margin of (9.70%) compares to (9%) last quarter and (10.5%) in the year ago quarter. This resulted in GAAP operating loss of ($56.4) million which is a tad higher than the $48 million losses last quarter and the $40 million losses in the year ago quarter.

The adjusted operating margin was a beat in Q3 and Q4. This was a bright spot in the report with adjusted OM of 15.4% compared to 13% estimated. This compares to 16% Adj OM last quarter and Adj OM of 13% last year. This was essentially flat and it’s important it did not contract.

The guide on adjusted operating income of $87.2M to $93.7M implies an adjusted operating margin of 14.5%.

The GAAP net margin of (9.4%) and adjusted net margin of 16.5% was in line with previous quarters. The guide for adjusted net margin is also in line at 16.6%.

CrowdStrike is very strong on cash flow margins and is one of the top ranking cloud stocks in this regard. This quarter the company reported a free cash flow margin of 30% for FCF of $174 million. The company is guiding for a FCF margin of 28% to 30% next quarter. The operating cash flow was $242.9 million for a margin of 41.8%. There is $2.47 billion in cash on the balance sheet.

The company paid $140 million in stock-based compensation for a margin of 23.7%.

Key Metrics:

As stated in the Intro, the key metrics are likely causing the sell-off.

RPO was up 44% year-over-year for $2.797 billion and was up 11.6% sequentially. However, management reminded analysts that ARR is the leading key metric for their business.

Ending ARR grew 54% year-over-year to $2.34 billion and grew 9.3% sequentially. Therefore, because ending ARR was strong, the net new ARR could be easily underestimated in terms of impact. The net new ARR at $198 million in fiscal Q3 compared to $218 million net new ARR in fiscal Q2 indicates a 9% sequential decline.

The market has the jitters right now so the sequential decline is important to pay attention to especially because management said to expect further weakness in the upcoming Q4 quarter. Here is what the CFO said:

“Even though we entered Q3 with a record pipeline, we are expecting the elongated sales cycles due to macro concerns to continue, and we are not expecting to see the typical Q4 budget flush given the increased scrutiny on budgets. While we do not provide net new ARR guidance given the current macro uncertainty, we believe it is prudent to assume that Q4 net new ARR will be below Q3 by up to 10%.”

If I understand the CFO correctly, then this implies a net new ARR of $178.3 million for Q4 (10% lower than the current quarter at $198.1M) compared to net new ARR of $216 million in the year ago quarter. This is important because it’ll mark not only a sequential decline but a year-over-year decline in net new ARR. The market had already sold off for what I presume was a sequential decline in Crowdstrike’s leading key metric, and management then stated the decline would be steeper for Q4 on the call. Once the comment above was made, we were certainly not going to see a reversal in the stock price from the earnings call.

Customer count was strong at 44% growth. The mix of domestic versus international was slightly lower than usual for North America at 69% with EMEA being slightly higher at 15%.

Deferred revenue grew 56.4% year-over-year and backlog grew 19%.

Additional Commentary:

CrowdStrike was transparent about the importance of ARR even in the face of net new ARR being lower than expected. Here is what was said by the CFO:

“And then finally, just to comment on ARR. You pointed out that's how we run our business. ARR, though, is really an X-ray into the contracts themselves. And as we view that as the most important — or most transparent metric into the outlook for our business, that's the one where we're focused on. So, hopefully, that gives some more clarity on how we think about cRPO and ARR.”

Later on, an analyst did zero-in on the (9%) decline.

“Andrew Nowinski

Great. Thank you for taking the question this afternoon. So total ARR of $2.3 billion, growing 54% is still absolutely amazing, I was – and it's at scale. But I was wondering, were you surprised that the net new logos that you added were down 9% this quarter?

Burt Podbere

Thanks, Andy. So when we think of the net new logos, it really corresponds to what we talked about in terms of what we saw in that SMB space. The SMB space is the one that drives the velocity of our net new logos. And as we talked about, we saw an 11% increase in our sales cycle in the SMB space. And that actually equated into $15 million in terms of deals in that space that could push out. And so when you think about 15 million in that space and what it means in terms of logos, where you can do the math, it's a pretty big number.

So that's how we think about net new logos corresponding to what we saw in net new ARR from the SMB space. So from that perspective, we weren't surprised at the end of the day when we saw that what happened with respect to the increased sales cycles and the amount of money that got pushed out in the SMB space.

My note: Just to be clear, when they say “push out” they are referring to a delayed sales cycle for an impact of $15 million.

The CFO did reiterate the 10% further sequential decline in net new ARR between Q3 and Q4 when he said:

“When we do talk about net new ARR, I did talk about in the prepared remarks about how we think about up to 10% headwinds going into Q4 from Q3, and that's just to coincide with some of the headwind activity that we saw accelerated at the end of this quarter. So that's how we think about that.”

Conclusion:

Given the tough macro, our goal is to fully understand why the market may favor some stocks and deeply discount others after an earnings report. The market is getting nervous on cloud. We talked about this with Microsoft and also saw this following Datadog’s report.

As a reminder, here is a brief overview of Microsoft’s report:

“Microsoft is guiding down for next quarter with analyst expectations for the December quarter at $56.04 billion compared to management guidance on the call for revenue of $52.75 billion, at the midpoint. This represents 2% growth. […] That’s a 11% deceleration over the next few months. Some of this may be coming from Azure as the company is expected Azure to decline 5% next quarter for its current growth rate. This will be 37% growth on a constant currency basis, down from 42% this quarter.”

Here is a snippet from our Datadog ER write-up:

“RPO decelerated and is a concern. The deceleration we noted in our last earnings report and our pre-earnings write-up where we noted the deceleration went from 85% to 51%. This quarter, the deceleration steepened to 31% year-over-year growth for $941 million. RPO is still up on a sequential basis with $858M in RPO in Q1, $881M in RPO in Q2 and $941M in RPO this quarter. If it were to decline on a QoQ basis, the stock would be deeply penalized, so we will monitor this as we go along.”

What we saw today from CrowdStrike sounded very familiar, in my opinion. The market is nervous about cloud and is swiftly discounting these stocks on slowing revenue plus any additional signs revenue may slow in the future. We will need to see more information to draw any conclusions, most especially we will need SentinelOne’s report coming next week.

Most recent coverage on product:

Forum: Crowdstrike’s Pre-Earnings Report

https://io-fund.com/premium/crowdstrike-cybersecurity-is-techs-leading-sector

https://io-fund.com/premium/cybersecurity-stock-faceoff-crowdstrike-vs-zscaler-vs-cloudflare

https://io-fund.com/cloud-software/cybersecurity-continues-to-lead-cloud-stocks

Nvidia Stock: Evidence Gaming Bottomed And Why It’s Important

Posted on by io-fund

This article was originally published on Forbes on Nov 23, 2022,12:52pm ESTForbes on Nov 23, 2022,12:52pm EST

Nvidia has overcome strong headwinds over the past few years, including United States-China tensions, supply chain disruptions spanning many components, tough comps on the data center, tough comps on gaming, and a less-than-rosy macro environment. However, the most impactful of all has been Ethereum’s merge to Proof of Stake (POS), which led to a $2.5 billion cumulative miss in revenue.

In September, we made a prediction in the analysis entitled “Nvidia Stock Is Ready to Rumble with RTX 40 Series and H100 GPUs” that Nvidia’s new gaming release would soften the blow when we said the following:

“First, Nvidia is restricting supply on its current gaming model. Per the CFO: ‘Across those two quarters, the Q2 of ‘23, the Q3 of ‘23, we have likely undershipped gaming to our end demand significantly.’

[…] We estimated for our premium members that the amount undershipped is a minimum of $1 billion. The reason behind this is to help keep prices stable and to increase demand for the RTX 40 Series.

Second, Nvidia announced its GeForce RTX 40 Series at the GTC 2022 Conference this week.

The new Ada Lovelace architecture uses 76 billion transistors and a 4nm production process. In the keynote, the CEO stated: ‘Nvidia engineers worked closely with TSMC to create the 4N process optimized for GPUs. This process let us integrate 76 billion transistors and over 18,000 CUDA cores, 70% more than the Ampere generation.’

The improvement from 8nm to 4nm means more transistors on the GPU, which results in better performance as the 4nm processes data faster.

In the gaming world, this much anticipated release is expected to be 2-4X faster than the RTX 3090 Ti. The flagship AD102 GPU model will have 144 individual streaming multiprocessors (SMs) in one die compared to 84 SMs in the Ampere architecture. As stated, the AD102 will also have a 70% increase in CUDA cores over the RTX 3090 Ti […]

The popularity of this release will help determine if Nvidia can stage a comeback in the gaming segment.” You can read the full analysis here. Fast-forward and not only was the GeForce RTX 40 Series with Ada Lovelace architecture popular, management stated “the Ada launch was a homerun.” Below, we look at the most recent earnings report and then we break out additional details that support Nvidia’s Q3 reaching a gaming bottom.

Sign up for I/O Fund's free newsletter with gains of up to 221% – Click HereSign up for I/O Fund's free newsletter with gains of up to 221% – Click HereClick Here

What Q3 Earnings Results Says About a Gaming Bottom

First, I’ll provide a general overview of Nvidia’s earnings results before I discuss what to expect in the gaming segment specifically.

Nvidia reported as expected for Q3 ending in October with revenue of $5.93 billion for growth of (17%) which matched management guidance of $5.90 billion. Analyst consensus for revenue was $5.85 billion, or (17.7%) growth.

Fiscal Q4 ending in January was a slight miss with guidance of $6 billion compared to analyst consensus of $6.17 billion. This represents growth of (21%).

Nvidia reported adjusted EPS of $0.58 which missed adjusted EPS estimates of $0.71. This compares to the July quarter of $0.51 adjusted EPS.

Management indicated that profitability will increase from here: [GAAP and non-GAAP operating expenses were] primarily due to higher compensation expenses related to headcount growth and salary increases and higher data center infrastructure expenses. Sequentially, both GAAP and non-GAAP operating expense growth was in the single-digit percent, and we plan to keep it relatively flat at these levels over the coming quarters.”

In Q3, the GAAP gross margin was 53.6% and the adjusted gross margin 56.1%. This was a miss from management Q3 guidance of 62.4%. The reason for the miss related to China: “Gross margins reflect $702 million in inventory charges largely related to lower data center demand in China, partially offset by a warranty benefit of approximately $70 million.”

Nvidia is signaling that gross margin will return to normal next quarter with a guide for GM of 63.2%.

For the most part, Nvidia’s bottom line showed signs that last quarter was a bottom for the company with marginal, yet crucial improvement sequentially. As long as the company does not increase operating expenses, which the CFO stated the opex would be flat and not increase, then these margins should improve from here.

  • The company reported GAAP operating profit of $601 million for an operating margin of 10.1%. This compares to an operating margin of 7.44% last quarter. Nvidia’s typical OM is in the 37%-38% range.
  • The adjusted operating profits of $1.56 billion with a margin of 25.9% in Q3 compares to an adjusted operating margin of 19.76% in Q2. This is down from Nvidia’s typical adjusted OM of 47%.
  • The adjusted net margin of 24.5% in Q3 compares to an adjusted net margin of 19.27% last quarter.

The free cash flow margin was (2.6%) for free cash flow of ($156) million compared to a 12% margin last quarter for free cash flow of $824 million. The company has $13.14 billion in cash and $10.95 billion in debt.

The company returned $3.75 billion to shareholders with share repurchases and cash dividends. with $8.3 billion remaining under the share repurchase authorization through December 2023.

The biggest names in tech are reporting their earnings right now, and our premium members are getting updates almost daily. Learn more about about our premium membership here.The biggest names in tech are reporting their earnings right now, and our premium members are getting updates almost daily. Learn more about about our premium membership here.Learn more about about our premium membership here.

Evidence that Gaming Bottomed in Q3

Gaming revenue was down (51%) for revenue of $1.57 billion. Admittedly, even if Q3 is the bottom, there is still quite a ways to go before the company returns to growth in this segment. The reason it’s important to identify a fundamental bottom is because it typically correlates with a bottom in the stock price.

Nvidia Management Points Toward Q3 as the Bottom in the Earnings Callas the Bottom in the Earnings Call

In addition to saying “the Ada launch was a homerun,” management expects gaming to grow sequentially from Q3 to Q4. Management also stated “our new Ada Lovelace GPU architecture had an exceptional launch” and “we sold out quickly in many locations and are working hard to keep up with demand.”

Most importantly, management stated gaming will return to sequential growth in Q4 and that channel inventory will “approach normal levels” as the company exits Q4 to where the company can more adequately match supply with demand.

On the call, Kress discussed that the sell-through rate across two quarters for gaming is $5 billion total, which helps prove the popularity of Nvidia’s RTX 40 series. The CEO also stated: “That 4090 — we shipped a large volume of 4090s because as you know, we were prepared for it. And yet within minutes, they were sold out around the world. And so, the reception of 4090 and the reception of 4080 today has been off the charts.”

The first release date for the RTX4090 models was October 12th with a starting price of $1,599. There was a second release date in November for the RTX4080 models with prices of $1,199 and $899. Notably, the mid-range RTX 40 series outperforms the previous generation’s high-end models, which also helps to drive demand because customers receive an upgrade at the $899 and $1,199 level. This is due to the Ada Lovelace architecture which offers 1,400 Tensor TFLOPs versus 320 Tensor TFLOPs which means the DLSS is superior and the high-end RTX 30 Series cannot compete with the mid-range RTX 40 series.

Deep learning super sampling (DLSS) refers to using AI to predict the next pixel. The new DLSS 3.0 not only predicts pixels but will also use AI to predict frames. This results in “up to four times” better performance over traditional rendering.

In addition to this, Nvidia released a new feature powered by Shader Execution Reordering (SER) which will improve ray-tracing performance by 3X with 25% faster frame rates. Rather than deliver workloads sequentially, the GPUs are able to reorder the workloads to process more workloads at once which results in more power and better performance.

Conclusion:

Despite a historic revenue miss, Nvidia is rising to the occasion with the perfectly timed Ada Lovelace architecture. As we said in our previous analysis, Nvidia is flexing their product muscles by meeting head-on the wave of negative sentiment on the stock. Investors should keep in mind, that despite enormous headwinds, Nvidia has been the best performing mega cap stock over the past few years (reference our analysis here for more details).

The company’s swift and concise answer to the crypto mining selloff helps illustrate why Nvidia stands apart from its peers – primarily, that its products are superior, end-market demand remains strong, and management has many levers it can pull to quickly reverse a bottom.

The I/O Fund targeted NVDA on October 13th for a price of $108. After a 50% gain in less than a month, we trimmed some NVDA around $162 with real-time trade alerts. We did this to raise cash, so that we can buy more at lower levels. Please join us next week, Thursday, 12/1, at 1:30 PST, for our premium webinar. We will discuss NVDA in depth and lay out our targets for adding to this position.

If you would like notifications when my new articles are published, please hit the button below to "Follow" me. You can also sign up for my newsletter here to receive weekly tech stock analysis for free.

Nvidia Q3 Earnings: The H100 will Quickly Overtake its Predecessor the A100

Posted on by io-fund

There were a few key things discussed on the call:

  • Why the H100 will ramp faster than the A100 with Q1 being the estimated time when we should see the H100 driving forward data center growth (we should get an acceleration this quarter in the DC segment).
  • How the H100 helps drive enterprise software revenue as it’s been optimized with Nvidia’s software stack.
  • The strength of Nvidia’s networking business following the acquisition of Mellanox.
  • The CEO believes even if hyperscalers slowdown spending in 2023, that Nvidia is more insulated because their systems are optimized for AI acceleration, which is a top priority within capex spending, and because their systems reduce costs and improve efficiency.

My specific investment thesis is this: “the A100 GPU is what led the company’s gains since Q2 2020 (detailed here) and the Hopper H100 GPU is what will lead the company’s gains for the next two years.”I detail what I think is the most important Q&A from the call below plus other moments that provide a glimpse into what Nvidia investors can expect from here.

Note: I did not cover gaming in this analysis because I am covering Nvidia’s gaming bottom for my free newsletter. I’ll make sure to post this separate analysis on the forum early next week. The H100 will be absent since we are entering an actionable phase with the CEOs discussions about Q1. Actionable analysis, for the most part, is reserved for premium.

Financials:

Note: calendar months are provided to avoid confusion due to Nvidia’s off calendar fiscal year. This upcoming report will be Q3 FY 2023

Nvidia reported as expected for Q3 ending in October with revenue of $5.93 billion for growth of (17%) which matched management guidance of $5.90 billion. Analyst consensus for revenue was $5.85 billion, or (17.7%) growth. 

Fiscal Q4 ending in January was a slight miss with guidance of $6 billion compared to analyst consensus of $6.17 billion. This represents growth of (21%). The guidance has led to slightly lower estimates for Q1 ending in April with revisions from (19.8%) to (22.5%) for revenue of $6.41 billion.

As stated on the forum in the pre-earnings write-up, analysts have Nvidia returning to positive growth by July 2023 and to strong growth of 35%+ by October of 2023. This is helped by the low comps that we are currently experiencing.

Nvidia reported adjusted EPS of $0.58 which missed adjusted EPS estimates of $0.71. This compares to the July quarter of $0.51 adjusted EPS. Management indicated that profitability will increase from here: [GAAP and non-GAAP operating expenses were] primarily due to higher compensation expenses related to headcount growth and salary increases and higher data center infrastructure expenses. Sequentially, both GAAP and non-GAAP operating expense growth was in the single-digit percent, and we plan to keep it relatively flat at these levels over the coming quarters.”

An analyst did bring up that stock based compensation has been increasing each quarter at $700 million in the current quarter, up from $648 million and $578 million in the two previous quarters.

In Q3, the GAAP gross margin was 53.6% and the adjusted gross margin 56.1%. This was a miss from management Q3 guidance of 62.4%. The reason for the miss related to China: “Gross margins reflect $702 million in inventory charges largely related to lower data center demand in China, partially offset by a warranty benefit of approximately $70 million.” Nvidia is signaling the gross margin will return to normal next quarter with a guide for GM of 63.2%.

The company reported operating profit of $601 million for an operating margin of 10.1%.  This compares to management’s guidance for an operating margin of 18.5% with Nvidia’s typical OM at 37% to 38%.

The adjusted operating margin of 25.9% is down from the typical range of 47%.

GAAP net margin of 11.5% for net profit of $680 million was up from a GAAP net margin of 9.8% in the previous quarter. The adjusted net margin of 24.5% for an adjusted profit of $1.46 billion compared to 19.3% in the previous quarter.

For the most part, Nvidia’s bottom line showed signs that last quarter was a bottom for the company with marginal, yet crucial improvement sequentially.

Nvidia had lower cash flow margins than it did last quarter at a 6.61% operating margin for operating cash flow of $392 million compared to a margin of 18.9% last quarter for operating cash flow of $1.27 billion. The free cash flow margin was (2.6%) for free cash flow of ($156) million compared to a 12% margin last quarter for free cash flow of $824 million.

The company had stock-based compensation of $745 million in the quarter, up from $648 million last quarter. There is $13.14 billion in cash and $10.95 billion in debt. The company returned $3.75 billion to shareholders with share repurchases and cash dividends. There is $8.3 billion remaining under the share repurchase authorization through December 2023.

 

Nvidia Discusses Why the H100 Will Ramp Faster than the A100

Since our thesis is that the H100 will drive sales and the stock price over the next couple of years, similar to the A100, we want to make sure we are getting confirmation of how the H100 is performing now that it has been on the market for about a month.

 

Why the H100 is Special

1.     Enterprise Software

The first question from C.J. Muse discussed how the H100 is bundled with Enterprise Software, and the timing of when software monetization will begin to occur. The answer from the CEO was effectively “now.”

Here is what Huang said:

“Every company we’re talking to would like to have the agility and the scale, flexibility of clouds. And so, over the last year or so, we’ve been working on moving all of our software stacks to the cloud – all of our platform and software stacks to the cloud. And so today, we announced that Microsoft and ourselves are going to standardize on the NVIDIA stack, for a very large part of the work that we’re doing together so that we could take a full stack out to the world’s enterprise. That’s all software included.

If they would like to use it in the cloud, it’s per GPU instance hour; if they would like to utilize our software on-prem, they could do it through software license and so — license and subscription. And so, in both cases, we now have software available practically everywhere you would like to engage it.

2.     The CEO stated H100 is going to Ramp faster than the A100

This was the discussion I felt was most important to Nvidia investors on the call. Second place would be the discussion around the Gaming bottom. Enterprise software is certainly important to as the software stack will eclipse hardware at some point. However, today, Nvidia is a hardware company and visibility into the pace of H100 adoption is key for our 2023 position and allocation.

Notably, I believe there will be positive surprises in the data center segment as we go along into 2023. It’s prudent for analysts to be cautious as we don’t have big tech capex numbers yet and the H100 has only been out for a month. Eventually, enthusiasm for Nvidia will return and it’ll the H100 that drives the positive sentiment. 

Here was the question, which is being quoted in full due to its importance to our thesis:

William Stein:

I’m hoping you can discuss the pace of H100 growth as we progress over the next year. We’ve gotten a lot of questions as to whether the ramp in this product should look like a sort of traditional product cycle where there’s quite a bit of pent-up demand for this significant improved performance product and that there’s supply available as well. So, does this rollout sort of look relatively typical from that perspective, or should we expect a more perhaps delayed start of the growth trajectory where we see maybe substantially more growth in, let’s say, second half of ‘23?”

Jensen Huang

H100 ramp is different than the A100 ramp in several ways. The first is that the TCO, the cost benefits, the operational cost benefits because of the energy savings because every data center is now power limited, and because of this incredible transformer engine that’s designed for the latest AI models.

The performance over Ampere is so significant that I — and because of the pent-up demand for Hopper because of these new models that are — that I spoke about earlier, deep recommender systems and large language models and generative AI models. Customers are clamoring to ramp Hopper as quickly as possible, and we are trying to do the same. We are all hands on deck to help the cloud service providers stand up the supercomputers. 

Remember, NVIDIA is the only company in the world that produces and ships semi-custom supercomputers in high volume. It’s a miracle to ship one supercomputer every three years. It’s unheard of to ship supercomputers to every cloud service provider in a quarter. And so, we’re working hand in glove with every one of them, and every one of them are racing to stand up Hoppers. We expect them to have Hopper cloud services stood up in Q1. And so, we are expecting to ship some volume — we’re expecting to ship production in Q4, and then we’re expecting to ship large volumes in Q1. That’s a faster transition than Ampere. And so, it’s because of the dynamics that I described.

My translation: Per the CEO, Q1 should be good to us Nvidia investors!

3.     Grace Hopper and the CPU, GPU, DPU Trifecta

Grace Hopper is Nvidia’s new CPU that is meant to further accelerate and be integrated with Nvidia’s GPUs and DPUs. Notably, AMD is doing the same – where their CPUs are optimized and integrated to further accelerate AMD’s GPUs and DPUs.

Mark Lipacis

Jensen, I think for you, you’ve articulated a vision for the data center where a solution with an integrated solution set of a CPU, GPU and DPU is deployed for all workloads or most workloads, I think. Could you just give us a sense of — or talk about where is this vision in the penetration cycle? And maybe talk about Grace — Grace’s importance for realizing that vision, what will Grace deliver versus an off-the-shelf x86 [CPU], do you have a sense of where Grace will get embraced first or the fastest within that vision? Thank you.

Jensen Huang

Thanks Mark. Grace’s data moving capability is off the charts. Grace also is memory coherent to our GPU, which allows our GPU to expand its effective GPU memory, fast GPU memory by a factor of 10. That’s not possible without special capabilities that are designed between Hopper and Grace and the architecture of Grace […] It all needs to be fast, so that you can make a recommendation within milliseconds to hundreds of millions of people using your service.”

 

Networking is Showing Surprising Strength

According to an analyst on the call, their calculations show networking driving most of the sequential growth. He is referencing Mellanox acquisition which we covered a few years ago in this analysis.

Ambrish Srivastava

I actually had a couple of clarifications. Colette, on the data center side, is it a fair assumption that compute was down Q-over-Q in the reported quarter because the quarter before, Mellanox or the networking business was up as it was called out. And again, you said it grew quarter-over-quarter. So, is that a fair assumption?

Collette Kress

So, looking at our compute for the quarter is about flattish. Yes, we’re seeing also growth, growth in terms of our networking, but you should look at our Q3, compute is about flattish with last quarter.

Additional comments on Networking:

“Your data center networking business, I believe, is driving about $800 million per quarter in sales, very, very strong growth over the past few years” – Harlan Sur

“Jensen, can you help us understand like where your InfiniBand networking sits relative to like traditional data center switching?” – Aaron Rakers

“Yes. Thanks, Aaron. The math is like this. If you’re going to spend $20 billion on an infrastructure and the efficiency of that overall data center is improved by 10%, the numbers are huge. And when we do these large language models and recommender systems, the processing is done across the entire data center. And so, we distribute the workload across multiple GPUs, multiple nodes and it runs for a very long time. And so, the importance of the network can’t be overemphasized.”

For more information on networking, reference our Mellanox analysis here.

 

Will Big Tech Capex Continue to Grow?

We’ve been using Big Tech capex as a proxy for our semiconductor positions. According to one analyst on the call, the presumption is capex from the Big 3 will be flat in 2023. These are still sizable budgets, but the concern is if capex flatlines in 2023, what level of growth will the data center segment be capable of?

Here was the question on the call from Vivek Arya:

“And then, Jensen, the question for you. A lot of concerns about large hyperscalers cutting their spending and pointing to a slowdown. So if, let’s say, U.S. cloud CapEx is flat or slightly down next year, do you think your business can still grow in the data center and why?”

The answer from the CEO focused on Nvidia driving growth from AI acceleration, rather than general purpose compute, which implies that Capex can be flat while Nvidia will be serving the most valuable piece in the stack. AI acceleration, according to the CEO, will not be flat or down.

“Vivek, our data center business is indexed to two fundamental dynamics. The first has to do with general purpose computing no longer scaling. And so, acceleration is necessary to achieve the necessary level of cost efficiency scale and energy efficiency scale, so that we can continue to increase workloads while saving money and saving power. Accelerated computing is recognized generally as the path forward as general purpose computing slows. The second dynamic is AI. And we’re seeing surging demand in some very important sectors of AIs and important breakthroughs in AI.”

The CEO discussed deep recommender systems, large language models driven by Transformers, and generative AI for generating images and videos. He ended the answer with this: “And so, you could see that our company is indexed to two things, both of which are more important than ever, which is power efficiency, cost efficiency and then, of course, productivity. And these things are more important than ever. And my expectation is that we’re seeing all the strong demand and surging demand for AI and for these reasons.” 

My translation: Capex can be flat and the CEO foresees Nvidia will take a higher percentage of this capex because they’re serving demand where few companies can across the three major AI breakthroughs he pointed out. My other comment would be that we won’t have a full picture of capex for next year until we get Q1 reports and 2023 full year guides around end of January. This is when we did a deep dive analysis on capex spending last year, and we will revisit this. So, keep an eye out for that.

 

Note: Nvidia Expected to Change Reporting on Data Center

There was a discussion on the call that Nvidia plans to start breaking out the data center segment to account for internet service companies in addition to hyperscalers. My understanding is internet service providers would mean 5G providers or other internet services related to edge computing. This was not directly stated but it makes the most sense given where edge computing is headed, which could rival the hyperscalers.

Matt Ramsay

I guess, Colette, I heard in your script that you had you talked about maybe a new way of commenting on or reporting hyperscaler revenue in your data center business. And I wondered if you could maybe give us a little bit more detail about what you’re thinking there and what sort of drove the decision? 

Jensen Huang:

[…] And these are internet service companies that offer services, but they’re not public cloud computing companies. The second factor has to do with cloud computing […] [hyperscalers] are two things to us, therefore, a hyperscaler can be a sell to customer; they are also a sell with partner.”

 

Conclusion:

The market has been discouraging this year. The gaming selloff for Nvidia and PC selloff for AMD were brutal. But if you listen to these calls, it is crystal clear something monumental is going on. We want to capture this as fully as possible. Perhaps we will have 40% allocation in two positions (NVDA or AMD) or perhaps we will have to trim to 15% across two positions and layer back up to 30% allocation. We will do this as skillfully as possible.

If 2021 to 2022 taught us anything, it’s that only the strong survive. That goes for stocks/companies and investors. There is no doubt that NVDA and AMD will weather what’s ahead and we want to stay close to our AI bellwethers. Whatever the tide brings us, you can expect us to obsessively cover these companies and to actually increase our coverageincrease our coverage as we go along. There is no limit to the research needed if we are building positions with conviction.

 

AMD Q3 Earnings: Data Center is Resilient

Posted on by io-fund

We covered AMD’s pre-announcement in “The One Critical Reason I’m Still Feeling Zen.” The company has a lot of lost ground to recover and I believe it has enough horse power in its product line up to do so.

This was a stronger report than first glance because by guiding flat from Q3 to Q4 for 14% revenue growth, AMD stated data center and embedded will grow sequentially to absorb PC weakness. One analyst mentioned working with a number between $800M to $900M on Client Revenue for Q4, which would be down from $1 billion in Q3. It was also directly stated gaming revenue would be flat sequentially.

Rough Idea of Q4:

$850M Client Segment, at midpoint (hinted at)
$1,600 Gaming (confirmed)
$1,750 Data Center (rough estimate)
$1,350 Embedded (rough estimate)

This would mean sequential data center growth of 9% from Q3 to Q4 compared to 6.6% sequential growth from Q2 to Q3. Embedded was flat sequentially from Q2 to Q3.

I believe the timing of the Genoa product and the glimpse of Meta’s capex means we are setting up for a strong 2023 with data centers. I believe the analysts fully understood this point on the call as PCs were certainly discussed but was not the main focus. Data center discussions had more air time in the Q&A.

Note: we go into more specs and a great detail on AMD’s products on I/O Fund Advanced. Below is a summary.I/O Fund Advanced. Below is a summary.

Q3 Financials

Most notable from the Q3 report is that the company missed on Q4 revenue guidance with $5.97 billion for growth of 23.8% expected versus $5.5 billion reported for actual growth of 14%. The market shrugged this off as AMD stated data center and embedded would grow year-over-year and sequentially. I believe this was a solid reaction as AMD is becoming a leading AI company and holding the stock hostage to cyclical PC sales is missing the larger picture.

This brought the full year estimates down by $300 million from $23.8 billion to $23.5 billion. This will represent growth of 43% down from 44.9% expected. We can see that PCs will have a $2.8 billion drag on revenue this year as originally revenue was expected to be $26.3 billion.

Adjusted EPS of $0.67 missed estimates of $0.76 adjusted EPS. GAAP EPS was $0.04.

Where AMD had some positive surprises was in the adjusted margins and cash flow. The adjusted GM of 50% is higher than the year ago quarter at 48%. This is also true for Q4’s guide of 51% adjusted GM, which is higher than the year ago quarter at 50%.

The adjusted operating margin was also higher than what we had for expectations. It came in at 23% versus 13% expected and is flat from the year ago quarter. This led to adjusted operating income of $1.3 billion for 20% growth YoY and adjusted net income of $1.1 billion compared to $893 million a year ago for 23% growth YoY. Notably, this is down from $1.7 billion in Q2.

The GAAP GM was at 42% and GAAP OM was at ($64) million and both are lower than usual due to PCs/Client Segment.

The operating cash flow of $916 million is up from $849 million in the year ago quarter and free cash flow of $842 million helped maintain a steady FCF margin of 15%.

Apples-to-apples, I think this was a stronger report than Microsoft’s – a tech titan exposed similarly to PCs – because AMD’s other segments are so strong the company is able to maintain double digit growth of 14% next quarter compared to Microsoft’s low guide of 2%.

Data Center Strength:

This was an important comment regarding cloud spending specifically within the data center segment:

“Cloud revenue more than doubled year-over-year and increased sequentially as multiple hyperscalers expanded deployments of EPYC processors to power their internal properties and more than 70 new AMD instances were launched by Microsoft Azure and Amazon, Tencent, Baidu and others in the quarter.”

Analysts pressed AMD on if they expect 20% to 30% growth in the data center next year but management declined to comment “precisely” this early. Instead, AMD went on to call out North America hyperscale spending as a key driver for next year and mentioned China will not see a significant recovery (similar to 2022).

“Now it varies by segment, and so if I go through each of the segments, what we are seeing is I think North America cloud is, probably, the most resilient out of the segments within the Data Center market and this is where AMD is the strongest […] As we go into 2023, we expect growth in that market, particularly customers moving more workloads to AMD, just given the strength of our product portfolio, and overall, Genoa coming forward.

“Moving more workloads to AMD” = That’s a comment on Intel losing market share. Woohoo! Let’s gooooo!

Below is a notable conversation about how analysts are viewing Big Tech capex and cloud infrastructure growth as a leading indicator for AMD:

Harlan Sur

Great. Thank you. And despite the macro concerns, and as you mentioned, some near-term workload optimization, your North American cloud customers, I mean, they are still growing their cloud services business at a strong 30%, 40% year-over-year growth rate and I assume that these types of growth rates like the consumption of compute networking, storage workloads and therefore, installed utilization, like, this is all quite strong in driving the need to build out more compute capacity. Is this what’s driving the team’s sort of strong mid-term outlook for this segment or is it more a function of your strong product lineup with Genoa and continuing to capture greater compute share or both?

Dr. Lisa Su

Yeah. Right. Harlan, I would say, it’s a little bit of both and I think you said it well. In the very near-term, there is a little bit of optimization that each cloud vendor is doing. But in the medium-term, what our customers are telling us is they need more compute.

And the more compute is for additional workloads building out. It’s also for upgrade of, let’s call it, older compute, given our new products have very strong TCO, power efficiency, given the cost of power and energy around the world. We are actually seeing that also be a driver for some of the conversion to AMD in the cloud as we go into 2023.

Notably, one analyst stated the company missed their model and estimate for data center revenue. The CEO replied this is due to GPUs having a tough comp from last year due to the timing of a high-performance computing release – Frontier Exascale Supercomputer. She also pointed toward lower enterprise revenue.

In addition to Data Center, Embedded was strong and AMD called out 5G infrastructure specifically. I’m hoping this translates well for Marvell.

Information on PC Market for 2023

The data center may be resilient but certainly PCs are weighing on this company. I think this question and answer was important for AMD investors to hear so I’m quoting the conversation.

“Vivek Arya

[…] what does client recovery look like, do you get back to the $2 billion quarterly rate, do you get to $1.5 billion? And I asked that because your competitor was suggesting that next year the PC TAM would only be down 4% or 5%, which seems a little bit optimistic. What do you think AMD is kind of — what kind of PC TAM does AMD have in mind for next year so that we get a sense for how this de-risk the model is from a PC perspective?

Dr. Lisa Su

Yeah. So, a couple of different points, Vivek. Let me just answer the sort of the expectations around Q4. I would say, we are guiding, let’s call it, modestly down for Client and Gaming, and obviously, we are coming off of what is already a low base in Q3. We want to do that to correct the sort of the inventory situation as quickly as possible, and as a result, we are going to under ship consumption again in the fourth quarter to do that.

As it relates to next year, I think, there are a lot of factors. I mean this year PCs will be down quite a bit, let’s call it, high-teens, close to 20%. As we go into next year, I think, the industry is calling mid-single digits. I think that would be a good case. I think we should model down to minus 10%.

And again, within our PC business, we expect as we get through this inventory correction, I mean, we have very good products, and I feel very good about our product portfolio and very good about our platforms overall. So I do think the PC business will recover as we go into 2023, but we will have to work through these dynamics over the next quarter or so.

My translation: Perhaps I am being optimistic but I believe AMD is saying the recovery will happen earlier in 2023 (H1) rather than later in 2023 (H2) per the language chosen and that AMD plans to be on the earlier side within H1 by under shipping in Q4.

Conclusion:

AMD had a better earnings report than Microsoft and a better report than Nvidia is expected to have. These companies are comparable because of the one-time event hitting a non-thesis segment. Where they are not comparable is that AMD’s strongest segments are keeping the company in double digit growth territory.

I like Microsoft and Nvidia very much but it is uncanny how AMD continually finds a way to unexpectedly have a good report. I get to call this stock The Dark Horse for a little longer until it surpasses Intel on the data center; which means the name will likely be retired by 2024.

There's a lot to look forward to. If you’re looking for more than I/O Fund Essentials is providing, learn more about becoming an advanced member today.

Magnite Q3 Earnings: Improving Bottom Line

Posted on by io-fund

Magnite provided a stark reminder that the bottom line is more important than the top line in current market conditions as the stock moved 80% off the earnings report with low revenue growth yet the small cap has rare strength with its improving bottom line and 20% cash flow margin.

Low Growth; Strong Bottom Line

The company reported Q3 revenue of $127 million, which grew 12%, and beat estimates by 2.8%. This is down from 23% last quarter.

For Q4, management is expecting revenue to be $154 million for growth of 8.3%. Perhaps Magnite also benefited by being the last to report as many ad-tech companies guided lower than 8.37%. Analysts were expecting growth of 8.25% for Q4.

CTV ad revenue grew 29% year-over-year to $55.8 million, and represents 44% of revenue. Management is guiding for 10% CTV ad revenue growth next quarter for $64 million in revenue, at the midpoint.

Mobile weighs on the company’s growth with 7% this quarter for $44 million, compared to 14% last quarter for $44 million. The segment was flat sequentially. Mobile represents 35% of revenue. 

Desktop is the weakest segment at (7%) growth this quarter for revenue of $27 million compared to 1% drop last quarter for revenue of $27 million. This segment was also flat sequentially. Desktop represents 21% of revenue.

Magnite breaks down United States and International growth with both regions growing YoY. The United States represents 78% of GAAP revenue.

The United States region GAAP revenue grew 9% YoY to $114 million, up from $106 million last quarter. International grew 18% YoY to $32 million, and was flat sequentially, with $31.2 million last quarter.

The company reported GAAP EPS of ($0.18) and Non-GAAP EPS of $0.18. This is an improvement from Q2 and also an improvement from the year ago quarter. In fact, this was the strongest EPS on GAAP and Non-GAAP basis over the past five quarters excluding the holiday quarter.

Analyst estimates for adjusted EPS next quarter are $0.32. Assuming the company reports this EPS, it will exceed last year’s holiday season with adjusted EPS of $0.26 and it will also beat Q4 2020 with adjusted EPS of $0.19.

This improvement is important to note and to continue to track as few companies are able to improve bottom lines right now let alone a small cap. 

Pictured Above: Magnite stands out for its improving bottom line.

The GAAP gross margin was down from 53% in Q2 to 51%. However, the GAAP operating margin has improved to (15%) in Q3 from (17%) in Q2. The improvement is more evident when you compare to Q1 at (34%) and the year ago quarter at (18%). Excluding the holiday period, Q3 2022 had the strongest GAAP operating margin from the past five quarters.

Down the income statement, the GAAP net margin of (17%) mirrored the operating margin with a 1 point improvement sequentially and YoY. This resulted in $24.4 million in net losses.

On an adjusted basis, the company reported a profit of $25.6 million, up from $20 million last quarter and up from $20 million in the year ago quarter.

Where Magnite shines is the cash flow margins. Operating cash flow of $28.6 million represents a margin of 20% on GAAP revenue. The company stated that it will have free cash flow of “over $105 million” which is up from the previous guide of $100 million. This will represent a FCF margin of 20.5%

Please note the following I/O Fund internal note on Magnite’s FCF calculations which deduct cash interest payments from operating cash flow. 

“Some companies calculate FCF in a different manner. If the company does not provide FCF, we can calculate using operating cash flows minus capex from the cash flow statement. In this case, the operating cash flow calculation itself is different which is a rare case. The operating cash flow is adjusted EBITDA less Capex. The FCF involved the deduction of cash interest payments which is available in the supplemental disclosures of other cash flow information as the recent earnings call provided the interest payments for this quarter, however, they did not provide cash interest separately.” 

The company has $253 million on the balance sheet and $725 million in debt. The debt is less of a concern as long as the company is FCF positiveas long as the company is FCF positive and doesn’t pursue anymore acquisitions. The debt includes $400 million in convertible senior notes and a term loan of $355 million due to the SpotX acquisition.

The company’s net leverage has greatly improved from 6.2X in Q2 2021 to 2.6X in Q3 2022. This also improved from 3.1X in Q1 to 2.8X in Q2.

Magnite reported stock based compensation of $17.4 million, or 13.7% of revenue. 

Magnite Proves the Valuation Trade is Alive and Well

Despite Magnite being comfortably profitable on an adjusted basis and free cash flow positive with a 20% margin, the stock was priced for bankruptcy or another fatal risk at 1.5 forward P/S going into earnings. I believe the stock rallied because the risk/reward didn’t reflect the valuation, rather reflected the broader “small cap” bucket where most small caps have serious profitability issues. 

The low valuation coupled with clear evidence Magnite is unlikely to go out of business anytime led to the stock rallying.

Magnite helps to illustrate that 2022 market conditions continue to be more favorable for stocks with strong bottom lines. This is a critical adjustment for growth investors as Magnite’s top line does not fall into a growth definition at 12% this quarter and 8% next quarter.

Note: All numbers quoted ex-TAC unless otherwise stated. GAAP margin is calculated on the GAAP revenue of $145.8 million. Please note, we do not own Magnite at time of writing but plan to enter if we can find the right technical setup.

 

November 2022 Stock Pick – AMD

Posted on by io-fund

At I/O Fund, we provided deep dive research and two 1-hour webinars that predicted AMD would take away a huge chunk of Intel’s market share to have double-digit market share in the data center. At the time, AMD had only 4% market share. The prediction was bold as Intel is the 800 lb. gorilla — yet the prediction fully materialized and AMD today has “low 20 percent” market share in the data center.

AMD’s comeback is nearly unheard of, with only Apple posting a comeback of this proportion in the history of the tech industry.

 If you’re interested in hearing more beyond this write-up, I recommend our exclusive webinar provided to I/O Fund Members where we discussed in great detail AMD’s “EPYC” improbable comeback: AMD Webinar

The abbreviated version is that AMD plans to take even more market share from Intel — and then will take this new lead over Intel to help fill the role of duopoly in AI accelerator chips.  

Note: by the time you’re reading this, AMD comeback over Intel is more evident than when we first discussed it as we began discussing this and built a leading position with real-time alerts when AMD had 4% share in the CPU-data center and the company has grown this market share over 5X since our original prediction. In fact, the strategic comeback was so little recognized by industry analysts that we nicknamed AMD “the Dark Horse” which means an unexpected competitor who secures victory.

How Did “The Dark Horse” Get Here?

AMD’s Zen architecture was introduced in 2017. The company proved it wasn’t down for the count by offering a chipset-free design, resulting in energy-efficient processors capable of executing more tasks per cycle and more cores than Intel.

AMD’s first-gen Zen architecture helped prove AMD had a pulse and a heartbeat— however faint it may have been with a tiny 2% CPU market share— but it was circa 2020 when the company found its wings again. In that phase, it grew by 400%, catapulting to 8% of the CPU market. Today, its share stands at an estimated 20%-24% and while the company is unlikely to increase six times over again, with continued excellent management, market dominance of 50% market share or greater is very much in the real realm of possibilities. This is the move we want to capture in 2023/2024.

Second Gen

Note: we go into more specs and a great detail on AMD’s products on I/O Fund Advanced. Below is a summary.I/O Fund Advanced. Below is a summary.

When the company released the second generation of its Zen architecture, AMD showed it was outpacing Intel in terms of computing power, memory and energy use. More importantly, it was doing all this at a lower cost, thanks to multi-chip modules that combine a 7nm with a 14nm to use the most advanced technology when and where it’s needed most by leveraging the more mature process node. 

At the time, Intel was still producing a 14nm chip, although it promised that a 10nm was on the way. Essentially, AMD leapfrogged their competitor with a more power-efficient product, and one that allows for more cores per chip. 

 Interestingly enough, Intel was expected to catch-up with a comparable 10nm release planned for Q2 or Q3 2020 called the Ice Lake Xeon Scalable. Then, at the height of the pandemic, just four months before Intel’s expected release, the I/O Fund covered AMD, calling it “the one that got away” in 2019. “It’s estimated that for every $1.00 in Rome chip sales, Intel loses $2.25 on average in Intel Xeon SP sales,” we noted. "The savings are then deployed to buy more Rome chips, which can further depress Intel’s revenue.”

The Milan EPYC Series announced in August of 2020 was officially launched in March of 2021. The Milan is built on 7nm technology and has up to 64 cores and 128 threads with increased clocks compared to the Rome series. At the time of launch, Milan had a 100% advantage over Intel’s Sky Lake on server processor scores, according to Geekbench.

This was the momentthe moment Intel was expected to go gangbusters but instead Intel drove into a brick wall. Ice Lake’s release was delayed for two years, finally launching with 40 cores, up from 28 cores, versus a whopping 68 cores for AMD.

When it was finally released, an unbiased analyst had this to say:

“We won’t rehash the delay, denial, and begrudging admittance cycle that is Ice-SP’s gestation, just be aware that it was a 2019 CPU and is now a mid-2021 CPU. We know it launches today and Intel is officially claiming, ‘We have shipped over 200,000 Ice Lake CPUs for revenue’ and the shipping parts are the D-2 stepping […] let’s do the math and assume those 200K Ice-SPs shipped in three months or about 66K CPUs/month. If the server market is about 30M CPUs/year, let's call it 32M for the sake of round numbers, that would be 8M/quarter for normal production. = or about 2.28 days worth of production. This is not a figure I would be mentioning in public if I was aiming to boost confidence.”just be aware that it was a 2019 CPU and is now a mid-2021 CPU. We know it launches today and Intel is officially claiming, ‘We have shipped over 200,000 Ice Lake CPUs for revenue’ and the shipping parts are the D-2 stepping […] let’s do the math and assume those 200K Ice-SPs shipped in three months or about 66K CPUs/month. If the server market is about 30M CPUs/year, let's call it 32M for the sake of round numbers, that would be 8M/quarter for normal production. = or about 2.28 days worth of production. This is not a figure I would be mentioning in public if I was aiming to boost confidence.”

In my world, that’s the equivalent of a good Comedy Central Hollywood roast!

Why 2023 will be AMD’s Year

When we first covered AMD, it had a 4% share of the data center; now, it sits at roughly mid-20% of the CPU data center over Intel, a spectacular comeback.

However, the move we want to capture is when AMD goes from owning “mid-20%” of the CPU data center to owning 40% to 50% of the market— and this is entirely possible due to Intel’s most recent stumble.

AMD has the 5-nanometer line scheduled for release in Q4, which includes Zen-4 architecture, and Zen-5 architecture planned for 2024 (reference our AMD Q3 2022 earnings update provided for you in the Blog updates). 

The company also stated that the Zen-3 Milan Series is still outstripping supply with visibility six quarters out, implying for full year 2023. Zen-2 was CEO Dr. Lisa Su’s comeback, while Zen-3 is responsible for the current move in data center market share.

Source: Tom’s Hardware’s Hardware

Pictured Above: AMD has grown from 2% market share to “mid 20-percent market share”

 

AMD’s Dominance Over Intel Has Never Been More Obvious

 

AMD reported an 83% year-over-year increase in data center revenue for Q2 2022. Meanwhile, Intel dropped 16%. AMD appears to have gained 6% market share, which, one analyst noted, is “the highest share gain in the data center business that [AMD] has reported even going back to 2005.”

We began covering AMD when it had 4% total market share versus 96% Intel and the recent gains places AMD now in the “mid 20%” total market share for the data center against Intel. When asked if this was the correct math, Su stated to the analyst: “I think your math is in the ZIP code from our point of view.”

We have been quite thrilled to see the team at AMD led by Lisa Su and Forrest Norrod overtake Intel at times. However, what happened last quarter with Intel’s stumble is an exponentially greater mistake than the last stumble that we prepared for in March of 2020, which later materialized that July.

 

Meta: You say Capex, I think AMD

You may have seen tech commentators poking fun at Meta’s recent keynote. Zuckerberg demonstrated adding legs to Metaverse avatars, “progress” that doesn’t quite match up with the company’s mammoth investment. Most investors look at Facebook’s cash and think “this will make a great stock,”— yes, the FCF margin has been impressive. Many of Meta’s newfound critics are wondering: “Will the Metaverse succeed?”

What we want as investors is second-level thinking. Where is Big Tech capex going? Regardless of whether or not Meta succeeds, AMD stands to greatly benefit.

 

Other Factors

Meanwhile, we have to consider that outside of cybersecurity, there are going to be very few growth markets in tech in 2023, and of the growth markets we are tracking, very few will hit double digits.

Note: for more information on cybersecurity stocks and growth trends, please upgrade to I/O Fund’s full service where we also provide real-time trade alerts.upgrade to I/O Fund’s full service where we also provide real-time trade alerts.

 Big Tech capex is important as it’s the one catalyst that can raise revenue estimates for next year for AMD, which subsequently raises bottom line estimates. We covered this in a free analysis going into earnings here:

“The news has been in an uproar about crypto mining and the consumer-related PC markets. However, it has been our stance for some time that Big Tech capex is the true leading indicator for AI semiconductor companies. Despite an enormous increase in Big Tech capex primarily driven by data centers, this line item does not get the attention it deserves in terms of follow-through to the semiconductor industry. Below, we look at FY2022 budgets to draw the conclusion that H2 spending on data center chips is equal if not greater than the first half of 2022 […] The Data Center Systems segment, however, is expected to grow fastest among all the segments. It is expected to grow 11% YoY to $212 billion, higher than the 6.4% growth in 2021.”

Where AMD Is Headed

Artificial Intelligence and Machine Learning Will Exceed the Mobile Economy

Smartphones had a 10-year cycle of maturation beginning with the iPhone in 2008 and the app economy proved to have a similar maturation for digital advertising. Following a decade-long run. 

·       The smartphone market was valued at $720 billion in 2019 and the global mobile application size was $155 billion.

·       The mobile advertising market was valued at $60 billion — Facebook

·       The total global ad spend worldwide is valued at $560 billion — Google

 

The mobile market is worth roughly $2 trillion yet the combined market cap of these companies is $4 trillion. Meanwhile, PricewaterhouseCoopers is predicting the AI market will reach $15.7 trillion, which some experts believe will put its impact on par with the advent of electricity. 

Semiconductors will not comprise the entire $15.7 trillion but according to McKinsey, they will “capture 40 to 50 percent of the total value from the technology stack. 

“These diverse solutions, as well as other emerging AI applications, share one common feature: a reliance on hardware as a core enabler of innovation, especially for logic and memory functions.”

The artificial intelligence economy will be four times larger than the mobile economy. Picture this: if mobile gave us companies with $2 trillion market caps, it makes sense that AI will give us businesses with $8-$10 trillion market caps.

Breakdown

There’s also a lot to look forward to. Should you choose to upgrade to become a I/O Fund Premium member, you’ll receive AMD’s next five-year thesis, which will include Xilinx, long before anyone else know what they’re up to. This acquisition is more offensive for growth rather than defensive (along the lines of how YouTube impacted Google or Instagram impacted Facebook).

Our premium site owns two lesser-known semiconductor names. The first is centered in an important shift for electric vehicles and is up 58% in our portfolio this year. The second is an up-and-coming AI stock that doubles as a 5G infrastructure stock. There is something very big on the horizon for the AI/5G semi company in H2 2023 and we believe now is the time to look more closely as this company. We reserve these stock picks for our Premium I/O Fund Members, which you can learn more about here.

The Stock Market Could Go Higher — Here’s Why

Posted on by io-fund

On October 13th, within the first 30 minutes of the trading day, we removed half of our hedge and went on a buying spry at the I/O Fund, notifying our advanced premium members of our every move. Our broad market work was suggesting a buyable low was likely, and since then, the patterns we are seeing off this bounce is suggesting that it could be more than another bear market bounce.

The below clip is the first part of our weekly webinar from last week. We dive into what various markets are suggesting about the bear market potentially being over. Each week we look at new information so that we can stay on the right side of the trend. We then go into various tech stocks that we are either buying or looking to buy.

Summary: for well over a month we have been pointing out the complex bottoming process that has been unfolding. Global markets like the Australian XJO, Canadian TSX, and Japanese Nikkei appear to have bottomed before the U.S. markets, and are also suggesting that they want to make one more push to new highs in the coming months. Also, the German Dax and French CAC 40 have broken out of their bear market trend lines, which further suggests that a bigger move higher is underway. 

These are markets from different regions of the world all suggesting a meaningful low could be in place. This is accompanied by many of the boring value names in the U.S., like JP Morgan and Caterpillar who are nearly between 30-45% off their lows. These stocks, like many we track, are also suggesting that they could make a run to new highs in the coming months. This is clearly showing up in The Dow Jones Industrial Average. It is actually closer to making a new high than new low, while comfortably above its 200 day moving average.

The reason I am pointing this out is because big trends, like the ones we saw in January and September of 2022, only occurs when all markets are working together and pointing in the same direction. This is simply not happening right now. Instead, we seem to have more markets and stocks pointing higher, with new leadership taking hold.

While some tech names could make new lows, we believe many stocks will make higher lows. Furthermore, there are some tech names that we have identified that are +40% off their lows, and bottomed in May of 2022. We believe choice tech names will continue to lead but it will not be like the stocks we have become so accustomed to in the past.

On the I/O Fund premium siteI/O Fund premium site, we provide weekly one-hour webinars weekly one-hour webinars that discuss what the I/O Fund is buying and selling. We also have a proprietary hedging signal that we monitor in real-time, a fully transparent portfolio of 20+ positions, real-time trade notifications, and more. To get access to all of this, learn more about our Pro and Advanced plans here.

dLocal Q3 Earnings Update

Posted on by io-fund

dLocal delivered yet another strong quarter. However, the analysts concern on the Argentina crisis and the rise in company’s operating expenses in Q3 seem to dampen the upside to the stock. The company’s revenue grew by 63% YoY and up 11% QoQ to $111.9 million. The company beat the analysts revenue estimates by 1.6% and the revenue growth is good in spite of the high comps of last year. The total payment volume (TPV) grew by 51% YoY and 12% QoQ to $2.7 billion.

The company’s net revenue retention rate came at 152% compared to 157% in the Q2 2022 and 185% in the same period last year. The NRR has decelerated, however it is within the management guidance of above 150% for the year 2022.

The company’s revenue from top 10 merchants accounted for 53% of the revenue. This is down from 51% in Q2 2022 and 57% in Q3 2021.

The company’s LatAm revenue grew by 39% and flat QoQ to $87.3 million. The LatAm revenue accounted for 78% of the total revenue. Excluding the Argentina’s cross border business, it grew 43% YoY and 7% QoQ in LatAm. Argentina’s central bank has imposed some limitations to access the foreign exchange market for the payment of certain imports of goods and services as the country faced a fall in foreign currency reserves. The management mentioned in the call that the situation has improved during the quarter. However, the analysts were not too impressed as they had concerns that these issues in Argentina could be recurring unless the situation in Argentina improves.

The company’s revenue in Asia and Africa grew by 312% YoY and 80% QoQ to $24.5 million. It accounted for 22% of the total revenue compared to 9% in the same period last year. The management is positive on the growth in these regions. The company’s single API has helped it to quickly ramp up in these regions.

The company’s President, Jacobo Singer said in the earnings call, “So I think, overall, it's taking what was saying, the fact that we have a single API we call — and we have. There are a lot of analogies between the services we have been providing Latin America and opportunities that are in Africa and in Asia, and we have been able to replicate our playbook in LatAm in those two continents. And the merchants, they value a lot the fact that, that playbook is constant on the same API and on the same agreement, allow them to test our service or in the region faster than doing any other solution before.”

The company’s gross profit grew by 56% YoY and 9% QoQ to $53.9 million with a gross profit margin of 48% compared to 49% in Q2 2022 and 50% in the same period last year. The management mentioned that the slight decrease was due to the country and product mix. Diego Canay, CFO of the company said in the earnings call, “Our cost of processing for the quarter represented 2.0% of our TPV, stable quarter-over-quarter and compared to 1.8% a year ago. The increase versus Q3 2021 was driven by business mix, particularly an increase in pay-ins, which have higher processing costs than payouts.”

The operating profit was $37.2 million compared to $21.6 million in the same period last year. The operating margin was 33% compared to 31% in the same period last year. There was a rise of operating expenses that was primarily due to the increase of headcount, marketing, and travel expenses.

Diego Canay said in the earnings call, “If we look at operating expenses for the quarter, we see that they have grown 26% year-over-year, as we saw an increase in salaries as we continued expanding our team with focus on sales, expansion and technology. In addition, we increased our travel and marketing expenses. We operate in a hyper growth business and want to keep investing in building the infrastructure and harvesting long term sustainable growth with a very disciplined and lean approach.”

The company’s net profit came at $32.5 million compared to $19.7 million in the same period last year with the net profit margin of 29% during both the periods. The company’s EPS came at $0.10 compared to $0.06 for the same period last year. The company missed the analysts EPS estimates by $0.01. The profits for the current quarter include net financial losses of $2.5 million which was mainly driven by higher cost of hedges due to the changes in FX regulations and higher interest rates. The management expects these financial costs to get normalized in the coming quarters.

Jacobo Singer said, “So regarding financial expenses and related to this particular change in regulation, yes, part of Q3, we have incurred into high cost of hedges because of the change in regulation. We see these being temporary changes, which we need to incur extraordinary in order to cover our position. As we have always been saying, we take a very conservative approach towards FX. We have never been in the business of taking corrective risk — so that's why we hedge non-dollar amount. If anything, we expect in the coming quarters this cost to get again normalized going forward.”

The adjusted EBITDA increased by 58% YoY and 9% QoQ to $42 million. The adjusted EBITDA margin was 37% compared to 38% in the last four quarters. The management has a given a guidance of 35% plus for the year 2022. To an analysts question for the guidance for Q4, Diego Canay replied, “Sure. So we give you annual guidance, so we're not giving guidance per quarter. As we mentioned, all the strengths continue in terms of growth. As I mentioned, we have an increase in OpEx in the third quarter, but we don't expect that type of increase in the coming quarter. So we expect operating leverage going forward. We will guide for a new EBITDA margin level in the next year, but these are the trends that we are seeing right now.”

The company has a cash and marketable securities of $542.3 million which includes $320 million of own funds and $222 million of merchant funds. The company has debt of $14.8 million. The company generated a free cash flow of $121 million in the past year.

The Low is in for Bonds, As Well As Most Stocks (For Now)

Posted on by io-fund

Last week, the market went through one of the largest intraday swings since the bear market began in 2022. Since then, we have reclaimed that high. The question is: what does this mean for the market in the long term?

How the Chaos Began

It started with the FED. They indicated they are now more open to pausing interest rate hikes, which sent markets soaring. The Federal Open Market Committee (FOMC) announced that, instead of reacting to only the latest inflation numbers, they will take in the “cumulative effect” of all their rate hikes.

They further acknowledged that the aggressive actions they’ve taken to combat inflation need time to play out. In other words, it remains to be seen whether they will they be seriously damaging, ineffective, or somewhere in-between. This startling self-awareness implied that the FOMC may not need to aggressively raise rates until the effects of their rate changes are truly obvious.

The market jumped 1.5% on this announcement, as pundits began to suggest a pause was insight.

However, in the speech that followed, Jerome Powell halted bullish emotions. He acknowledged that inflation has not come down as expected, even though supply chain issues that plagued most of 2021/2022 have been resolved. But he called a pause “very premature”— there’s still so much further to go, both in how high the rate could go and in the duration that they need to stay in the stratosphere.

And so, the press conference led to a plunge in the S&P 500, which closed down -3.4% from its high earlier in the day. It became the worst sell off on a FED-day since January, which has led to a retrace of most of the bounce from the October 13th low.

What Happens Next

You might assume we should brace ourselves for a new low in the S&P 500. That would be the prevailing trend preceding every FED meeting this year, but the market isn’t operating in a vacuum, and when you look outside of the S&P 500, a different story continues to emerge.

While some FAANGs and tech darlings, like TSLA, continued lower, many sectors and global markets continued higher. We’ve been trained for over a decade to follow tech, as it will lead the market. However, a seismic shift is occurring in real-time, as new leaders are being minted. The bond market was signaling to anyone listening that this FOMC meeting was different, as the complex bottoming process we have been discussing for weeks continues to build.

This shouldn’t be a surprise to our regular readers on Seeking Alpha. Here’s what we’ve been saying:

“…more and more signs are pointing to a bigger trend reversal underway.”

“…global markets did not follow the S&P 500 to new lows last week. Instead, they are signaling that a new push higher is likely to follow.” new push higher is likely to follow.”

“…the last time we saw these patterns was in mid-June, just before the market moved up 18% in less than 2 months…”

Those predictions, by the way, were all within the past month.

Value is a Major Indicator of the Next Upward Swing

The Big Five tech companies, also known by the acronym the FAANG, are having a rough time, especially Facebook (where thousands are being laid off), and Amazon and Google, which hit new lows, most people ignored what the rest of the market was saying.

Last week we discussed how boring Caterpillar and JPM Morgan have made their first higher high, as they are closer to making all-time highs than lows. This week, we will continue with theme from a broader perspective.

The DOW

The oft-ignored Dow Jones Industrial Average (DJI) has just given us a clean and clear 5 wave pattern off its late September low, while also reclaiming the 200 day-moving average. Not only did it bottom before the NASDAQ and S&P 500, but this 5 wave pattern suggests a much larger trend is developing. Translation: If the next pullback holds the low, and we can breakout to new highs, I see the Dow Jones powering to new all-time highs in the coming months.

Dow Jones Industrial Average Index Chart

This is not only limited to U.S. value stocks. Global markets are also setting up for a bigger push higher. The French CAC-40 and German DAX have recently broken out of their bear market down trends. This is in light of Europe facing all the problems the U.S. is facing currently facing with inflation, on top of a serious energy crisis.

The Canadian TSX as well as the Australian XJO have broken out of their bear market trend lines. Interestingly, these too markets appear to be setting up for a run the higher highs like the Dow Jones.

CAC 40 Index TradingView Chart

The reason I am mentioning this is because really big trends occur when all markets are moving in the same direction. While tech and some FAANGs have a setup to go lower, the rest of the market looks like it is setting up to go higher. It’s important to track these markets in order to get clues on when bottoms (and tops) are developing. A bottom never happens when everyone is expecting it, and it almost always happens when sentiment has reached a bearish extreme.

Transportation Is Having a Bonanza

The transportation sector has historically been a leading indicator of America’s economic growth, and therefore it often leads the stock market.

The Dow Jones Transportation ETF (DJT) is also exhibiting relative strength compared to the broad market. While the Tech heavy NASDAQ-100 is about 9% off its lows, and the S&P 500 is 12% off its lows, DJT is over 16 % off its lows.

Dow Jones Transportation Average Index Chart

Also, like the Dow Jones, it has just completed a 5 wave pattern off the low, suggesting that a bigger rally is likely.

If the next pullback can hold the low, and then turn back above to make a fresh high, it will be signaling that a major low was put in as we move into the heart of a new rally.

The Bond Market Called the FED’s Bluff

The FOMC announcement triggered an odd reaction in a sector few were paying attention to: bonds. The further one gets on the curve, in our experience, the less of an effect FED decisions has on rates; instead, growth and inflation expectations affect them more. After every hawkish policy decision this year, we have seen rates go higher, as long duration bonds hit a fresh low.

Last week, we discussed how bonds were setting up for a multi-month rally. This week we will acknowledge the very important fact that bonds not only failed to make a new low after the last FED speech, but they have since reclaimed the high on FED-day. This is significant, as the bond market is pricing in inflation and rate hikes, and signaling a low in bonds.

Ishares 20+ Year Treasury Bond ETF Chart

As bonds catch a long-term bid, rates will only go lower. This will force many beaten down tech stocks, which are simply long duration assets, to get repriced. This will be a tailwind for tech, and we believe today was the beginning of this repricing.

In anticipation of favorable repricing, coupled with tech’s beaten down valuations, we have been building key positions with real-time trade alerts sent to our premium subscribers.

Sign up for I/O Fund's free newsletter with gains of up to 221% – Click hereSign up for I/O Fund's free newsletter with gains of up to 221% – Click hereClick here

Market Levels

Reminder: the market rallied about ~12% just on a rumor of a potential pivot by the FED. Regardless of whether you believe we had it, the market definitely sold the news, and failed to make a new low. Not only that, but the S&P 500 reclaimed the 3912 level which was the high going into the FED speech. This is significant, as it is the first FED high the market has taken back in 2022.

With the divergences we have been talking about for weeks, if we do see continued volatility, it will likely be setting up a buyable low as we setup for a larger rally in the coming weeks.

The S&P 500 is not as clear as the Dow Jones. Like DJT, it completed 5 waves off its October 13th low, but it did so in a messy fashion. There are two primary probabilities: either the S&P 500 will make a new high in 2023 OR will instead play out a larger degree bear rally. If the next pullback can hold the low, then turn back and make a new high, I will be leaning towards the S&P 500 seeing new highs into 2023.

This would occur in large swings and likely take us back to 4300 SPX. It would be the scenario where some stocks and markets make new highs, while others do not. However, what is important to understand is that when you combine what rates, the dollar, global markets and many value stocks are telling us, it is that a large rally of some kind is under way.

S&P 500 Index TradingView Chart

What’s Coming— And When

The potential for some stocks to make a new low is present. However, the larger setup is for stocks to keep pushing higher. Short of a black swan event, we think most of the risk over the intermediate to long-term time frame is up — but the FAANGs do not appear to be leading, as we have been accustomed to expect. However, weakness in these companies does not seem to be signaling weakness across the market. As long as rates hold their high, and many of the value stocks that are well off their highs hold, I see any additional volatility as a buying opportunity.

Regarding tech, not all companies are equal. One of the strongest companies in the market, is a well-known tech name, bottomed in May and is nearly 40% off its lows. While we will likely not see an all-encompassing tech rally, we do believe some names are setting up to be new leaders. The prices we are seeing, we believe, will pay off handsomely in the coming years.

Who’s ready for it?

Every Thursday at 4:30 pm Eastern we provide our Premium Members with a weekly market webinar where we discuss the stocks we’ve entered and exited throughout the week, plus stocks that are about to break out and our buy plan. The information from our weekly webinars have been used to successfully hedge our portfolio multiple times in 2022, as well as build positions at key levels. When we buy positions, sell positions or hedge the market, real-time trade alerts are sent to our Premium Members plus we offer a fully managed portfolio including details on allocations.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

Meta Stock: The rising expenses and Capex are worrying

Posted on by io-fund

Meta shares nosedived 25% after the company's recent Q3 results. Meta's expenses are rising and the company is seeing softer revenue growth and softer margins. The slowing advertisement revenue has forced the company to look for new investments and the market is doubting when or if these investments will pay off.

Perhaps most importantly, the increase in expenses and Capex has plummeted Meta's cash flow margin in the most recent quarter. This is a material change to Meta’s story as the company was the leading FAANG stock on free cash flow yet reported a sudden, drastic reversal in Q3.

Below, I discuss the company's recent results in a detailed analysis below.

Meta’s Revenue is Slowing

The company’s revenue in Q3 fell by 4% YoY to $27.71 billion and was up 2% on a constant currency basis. The company managed to beat the consensus estimates by 1.2%. This is the company's second consecutive quarter of declining revenue.

CEO Mark Zuckerberg attempted to address concerns in his opening remarks yet the market was not buying it, “We now reach more than 3.7 billion people monthly across our Family of Apps. And while we continue to navigate some challenging dynamics of volatile macro economy, increasing competition, ad signal loss and growing costs from our long-term investments, I have to say that our product trends look better from what I see than some of the commentary I have seen suggests.”I have to say that our product trends look better from what I see than some of the commentary I have seen suggests.”

While the company does not fully acknowledge the change in business model that we discuss in our analysis “Facebook Stock: A Permanent Change To The Business Model” results show that the company is struggling with growth. The management expects growth to return next year as Mark Zuckerberg said, “We are still behind where I think we should be, but we believe that we will return to healthier revenue growth trends next year. That said it’s not clear that the economy has stabilized yet.”

Management’s guide for next quarter is $31.25 billion at the mid-point of the guidance, representing a YoY decline of 7.2% and the guide includes 7% foreign exchange headwinds. Analysts expect revenue to decline by 6.1% in Q4 and 1.6% in Q1 2023. The consensus estimates suggest that revenue growth is expected to return in Q2 2023.

Softer Operating Margins

In addition to revenue declining, the sell-off was also fuelled by a declining operating margin. Operating income fell 46% YoY to $5.66 billion. The Family of Apps segment operating income was $9.3 billion and Reality Labs operating loss was $3.7 billion. Total costs and expenses rose 19% YoY to $22.1 billion.

The company has seen a significant drop in the operating margin. Operating margin was 20% compared to 29% in Q2 2022 and 36% in the same period last year. It is significantly lower than the company’s historical period as seen in the chart below.

Chart: Meta Platforms Operating Margin

Source: YCharts

The management expects total expenses to be $86 billion at the mid-point of the guidance for the full year 2022, which represents YoY growth of 21%. This includes $900 million in additional charges for consolidating the office facilities that the company expects to record in the fourth quarter. I estimate the operating margin for Q4 to be 23% which would be significantly lower than the 37% in the same period last year.

Sign up for I/O Fund's free newsletter with gains of up to 403% – Click hereSign up for I/O Fund's free newsletter with gains of up to 403% – Click hereClick here

Meta Capex

For Q3, Meta had capital expenditures, including principal payments of financial leases of $9.52 billion, up 109% YoY.

YTD 2022, the Capex is $22.8 billion, and the management guidance for the full year 2022 has been revised to $32-$33 billion from the previous range of $30-$34 billion.

This represents YoY growth of 69% at the mid-point of the guidance. Doing the math suggests Q4 Capex will be about $9.7 billion, up 75% YoY and up 1.9% QoQ.

Chart: Meta Capex in $B

Source: Company Investor Relations

Dave Wehner, CFO of the company said in the earnings call, “Turning now to the specific CapEx outlook for ’22 and ’23. We expect 2022 capital expenditures, including principal payments on finance leases, to be in the range of $32 billion to $33 billion updated from our prior range of $30 billion to $34 billion. For 2023, we expect capital expenditures to be in the range of $34 billion to $39 billion driven by our investments in data center servers and network infrastructure. An increase in AI capacity is driving substantially all of our capital expenditure growth in 2023.”For 2023, we expect capital expenditures to be in the range of $34 billion to $39 billion driven by our investments in data center servers and network infrastructure. An increase in AI capacity is driving substantially all of our capital expenditure growth in 2023.”

Turning now to the specific expense outlook for ’22 and ’23, we expect 2022 total expenses to be in the range of $85 billion to $87 billion updated from our prior outlook of $85 billion to $88 billion. This includes an estimated $900 million in additional charges in Q4 related to consolidating our office facilities footprint that we expect to record in the fourth quarter of 2022. We anticipate our full year 2023 total expenses will be in the range of $96 billion to $101 billion. This includes an estimated $2 billion in charges related to consolidating our office facilities footprint.”

Chart: Meta Platforms Operating Margin Quarterly

Source: YCharts

It's earnings season and our premium members have been getting deep dive analysis on the top tech stocks each week, on top of real-time trade notifications, technical analysis from our portfolio manager, weekly webinars, and more. Learn more about becoming a premium member here. It's earnings season and our premium members have been getting deep dive analysis on the top tech stocks each week, on top of real-time trade notifications, technical analysis from our portfolio manager, weekly webinars, and more. Learn more about becoming a premium member here. Learn more about becoming a premium member here.

The Bottom Line

The increasing expenses, particularly in the reality labs segment, have weighed on the company’s profits. The management expects the reality labs segment losses to continue in the next year and investors don’t seem confident the company’s spend on the metaverse will materialize into growth or profits for some time.

On the other hand, the company has been investing heavily in cloud infrastructure and artificial intelligence. The increase in Capex reduces the company’s free cash flows. This is a concern since Meta led Big Tech on a strong free cash flow margin in the past. The free cash flow margin was 1% in the recent quarter and down significantly from 37% in the December quarter.

The company’s net income fell 52% YoY to $4.4 billion. EPS of $1.64 compared to $3.22 for the same period last year. The company’s net profit margin was 16% compared to 23% in Q2 2022 and 32% in Q3 2021.

The company has cash and marketable securities of $41.78 billion at the end of Q3 2022. The debt was $9.92 billion.

The operating cash flow was $9.69 billion (35% of revenue) and free cash flow was a meagre $173 million (1% of revenue) in the recent quarter. The difference between operating cash flow and free cash flow is the high Capex.

Chart: Meta Platforms Profit Margin Quarterly

Source: YCharts

Conclusion:

Meta Platforms was once a stock market darling for its solid revenue growth, strong profits and cash flow. Times have changed, and the company is now struggling with slowing ad revenue. It’s not only the increased expenses and capex that are an issue, rather a clear path to monetization that goes with it.

If you’d like more information regarding how the business model has changed, please reference the articles below.

Facebook Stock: A Permanent Change to the Business Model

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.