Micron will release its results on March 20th. The company reported 15.7% revenue growth in the last quarter, breaking the string of five quarters of negative growth. Management expects revenue to grow 43.5% YoY to $5.3 billion.
Higher prices and better utilization rates are also expected to improve the company’s margin profile in 2024, along with contribution from higher margin high-bandwidth memory (HBM).
The company will be in focus as HBM3e emerges as a significant enabler of generative AI applications and a significant growth driver over the next few years. Micron has recently started volume production of HBM3e, and more details will likely be revealed during the earnings call.
Revenue
Micron reported 15.7% YoY growth to $4.73 billion in the recent quarter after five quarters of negative growth.
DRAM revenue grew by 24% QoQ to $3.4 billion, primarily helped by increased bit-shipments in the low 20% and improved prices by a low single-digit percentage. DRAM revenue constituted 73% of total revenue.
NAND revenue grew by 2% QoQ to $1.2 billion, primarily helped by 20% price growth.
Revenue guidance for the next quarter is $5.3 billion at the midpoint, representing YoY growth of 43.5%. The company’s CFO, Mark Murphy, said in the earnings call, “Now turning to our outlook for the fiscal second quarter. While we remain mindful of macroeconomic risks, the memory and storage market environment is improving. We expect supply-demand balance to tighten in both DRAM and NAND throughout 2024. Our leading-edge DRAM and NAND nodes are oversubscribed for the full year. Consequently, we expect prices to increase through calendar 2024, driving improvements in our financial performance.”Our leading-edge DRAM and NAND nodes are oversubscribed for the full year.Consequently, we expect prices to increase through calendar 2024, driving improvements in our financial performance.”
The analysts expect revenue to grow 44.6% YoY to $5.34 billion in the next quarter and accelerate to 59.5% in Q3 and 70.6% in Q4.
Margins
Margins have gone through a steep cyclical low and have been showing signs of improvement. The GAAP gross margin was (0.7%) in Q1, compared to 21.9% in the year ago quarter. It marked a 1010 bps QoQ improvement from (10.8%) in Q4. The decline in gross margin compared to the previous year was due to the lower average selling price for DRAM and NAND and $165 million of underutilization costs in Q1.
The sequential rise in gross margin was due to improved prices and higher DRAM revenue mix, and it benefitted from $600 million from the sale of inventory written down in the prior periods. Mgmt expects around $400 million from a similar inventory benefit in the next quarter. The management guide for the next quarter is 12% at the mid-point. The adjusted gross margin was 0.8% compared to 22.9% in the same period last year. The management guide for the next quarter is 13%, helped primarily due to the improvement in prices, lower utilization charges, and the benefit from the sale of inventory.
The operating margin was (23.9%) compared to (5.1%) in the same period last year. The management guide for the next quarter is (8.2%). The adjusted operating margin was (20.2%) compared to (1.6%) in the same period last year. The lower operating margin was due to the factors discussed in the earlier paragraphs, higher R&D expenses, and the reinstatement of certain compensation programs that were suspended in the prior fiscal year. Management expects operating expenses to be lower in the next quarter due to lower R&D expenses and an asset sale previously anticipated in Q1. The management guide for Q2 is (4.9%) and expects to return to positive adjusted operating income in the third quarter.
Due to the various factors discussed above, the company reported EPS of ($1.12) in the recent quarter compared to ($0.18) in the same period last year. The adjusted EPS came at ($0.95) compared to ($0.04) in the same period last year.
The management guide for the GAAP EPS is ($0.45) at the mid-point for Q2 and adjusted EPS of ($0.28) at the mid-point. The analysts expect adjusted EPS of ($0.26) in the next quarter and a return of profitability in Q3 with adjusted EPS of $0.19.
Cash Flow and Balance Sheet
The operating cash flow grew by 48.6% YoY to $1.4 billion. The operating cash flow in Q1 benefitted from $600 million of customer prepayment “to secure supply for leading-edge memory products.” The operating cash flow margin was 29.6% compared to 23.1% in the same period last year. The adjusted free cash flow came in at negative ($333 million) and included capital expenditures of $1.7 billion compared to capital expenditures of $2.5 billion in the same period last year. The adjusted free cash flow margin was (7%) compared to (37.4%) in the same period last year. The company’s CFO said in the earnings call, “We see operating cash flows improving substantially in the second-half of the fiscal year and are now forecasting positive free cash flow in the fiscal fourth quarter.”positive free cash flow in the fiscal fourth quarter.”
The company had cash and investments of $9.8 billion and debt of $13.5 billion in Q1 compared to $10.5 billion and $13.3 billion in Q4. The short-term debt is $908 million and the weighted average maturity of the company’s debt is 2030.
Key Metrics from Business Units
Compute and Networking Business Unit (CNBU) revenue declined by (1%) YoY and is up 45% sequentially to $1.74 billion, as data center and client shipments strengthened in Q1 primarily helped by AI demand and normalized inventory at client customers. We want to see more recovery in compute and networking, as the segment was as high as $3.8B in Q4 of FY2021 and $3.9B in Q3 of FY2022.
The Mobile Business Unit shows signs of recovery, growing by 7% QoQ and by 97% YoY to $1.29 billion. The company’s CFO, Mark Murphy, said in the earnings call, “Mobile revenue continued to show strength as customer inventories normalized and smartphone units and average memory and storage capacity growth at customers drove demand.” We would also like see the recovery continue, as the mobile segment was at $1.89 billion in Q4 of FY2021 and $1.97 billion in Q3 of FY2022.
Embedded Business Unit (EBU) grew by 21% sequentially and by 4% YoY to $1.04 billion helped by growth in most of the end markets.
Storage Business Unit (SBU) revenue declined by (4%) YoY and (12%) sequentially to $653 million due to lower consumer component sales and partially offset by strong growth in SSD revenue.
Other noteworthy points to watch
In the earnings call, CEO Sanjay Mehrotra talked about the AI tailwinds, “We expect 2024 to be a year of recovery and can see the path towards a healthy supply-demand environment along with strong growth in critical new technologies like HBM3E. From the data center to the edge, AI has emerged as a significant secular driver that will further bolster the industry towards record revenue TAM in 2025 and drive growth for years to come. Micron's broad and growing suite of leading-edge products positions us well to capitalize on the immense opportunities ahead.” strong growth in critical new technologies like HBM3E. From the data center to the edge, AI has emerged as a significant secular driver that will further bolster the industry towards record revenue TAM in 2025 and drive growth for years to come. Micron's broad and growing suite of leading-edge products positions us well to capitalize on the immense opportunities ahead.” Any key insights on the 2024 trends are to be watched.
Management comments on HBM3E are to be closely watched in the upcoming earnings. The company’s CEO Sanjay Mehrotra said in the last earnings call. “Micron is addressing these exciting opportunities brought on by the proliferation of AI with an industry-leading portfolio of data center solutions, including HBM3E, D5, several types of high-capacity server memory modules, LPDRAM, and data center SSDs. We have received very positive customer feedback on our HBM3E, which has approximately 10% better performance and about 30% lower power consumption compared to competitive offerings of HBM3E.”We have received very positive customer feedback on our HBM3E, which has approximately 10% better performance and about 30% lower power consumption compared to competitive offerings of HBM3E.”
In fiscal Q1, we shipped samples of HBM3E to a number of key partners and are making good progress in our qualifications. Micron is in the final stages of qualifying our industry-leading HBM3E to be used in NVIDIA's next-generation Grace Hopper GH200 and H200 platforms. In addition, our LP5x is being used for the Grace CPU, driving a new use case for LP memory in the data center for accelerated computing.
We are on track to begin our HBM3E volume production ramp in early calendar 2024 and to generate several hundred millions of dollars of HBM revenue in fiscal 2024. We expect continued HBM revenue growth in 2025, and we continue to expect that our HBM market share will match our overall DRAM bit share some time in calendar 2025.”
The company has confirmed recently that they have begun volume production of HBM3E. TD Cowen Analyst Krish Sankar pointed out that they expect Micron to increase its market share in the HBM market significantly to over 25% in the next year from the current 10-15%.
Margin improvement and management comments on the margins are key items to watch in the earnings call. The company’s CFO answered the analyst’s question on gross margin improvement. “We are seeing some cost declines occurring with the increase of leading node production, and then again with the lower wafer starts and the higher utilization. What we've talked about before, we start to see idle charges dropping, as we've discussed. So again, principally price in the second quarter, but then beginning to see some cost benefits, even though we're losing the benefit of that lower cost inventory.We are seeing some cost declines occurring with the increase of leading node production, and then again with the lower wafer starts and the higher utilization. What we've talked about before, we start to see idle charges dropping, as we've discussed. So again, principally price in the second quarter, but then beginning to see some cost benefits, even though we're losing the benefit of that lower cost inventory.
We will see price appreciation through the year. We're going to — we don't expect there to be volume growth in the third quarter either, but good price appreciation, which will drive gross margins up. And then in the fourth quarter, we would expect to see volume and price, and again some lower utilization charges. So again, we would expect to see margin expansion second quarter to third quarter, and then again third quarter to fourth quarter.”
We will see price appreciation through the year. We're going to — we don't expect there to be volume growth in the third quarter either, but good price appreciation, which will drive gross margins up.And then in the fourth quarter, we would expect to see volume and price, and again some lower utilization charges. So again, we would expect to see margin expansion second quarter to third quarter, and then again third quarter to fourth quarter.”
Conclusion
The company’s Q1 FY2024 results showed that Micron’s recovery is underway. We would like to see this positive trend continue in Q2 with margin expansion in the coming quarters and a commitment to positive free cash flow by the end of the fiscal year 2024.
This article was originally published on Forbes on Forbes Forbes on Mar 14, 2024,07:01pm EDT
Ad spending growth is widely forecast to accelerate in 2024, after a challenging macro environment significantly dented budgets and growth in 2023. The US advertising market is already showing positive signs of growth, starting off 2024 with a 4.3% YoY increase in January, the strongest January on record and a tenth straight monthly increase.
We’re tracking ad-tech at the moment for three key reasons: a robust ad market backdrop with multiple major event tailwinds, strong cash flow generation, and improvements in operating leverage. We’ve previously covered the 2024 outlook for four major digital advertising verticals in our analysis “Ad Spending Growth to Accelerate In 2024” at the end of December; now, we take a look at three of the advertising industry’s top stocks: Meta, The Trade Desk, and Alphabet.
Meta: The Juggernaut Has Returned
The Juggernaut is back — Meta has been the second-best performing stock of the Magnificent 7, with its 44% return since the end of 2021 and a 301% return since the end of 2022 beaten only by Nvidia. This rally has been supported by significant improvements in operating leverage as revenue growth has reaccelerated to the mid-20% range.
Meta has stood out amongst social media peers for its strong growth in ad impressions, a recovery in ad pricing, and its ability to generate strong cash flows while still spending tens of billions on R&D. We’ve tracked Meta’s strong ARPU acceleration, but the more impressive (and arguably more important) story for Meta is how this translates into a substantial degree of operating leverage.
Meta’s operating margin expanded over twenty percentage points YoY to 40.8% in Q4, returning to a margin not seen since Q1 and Q2 2021. FY23 operating margin improved 990 bp YoY to 34.7%, with room for improvement in FY24. This is helping drive a strong improvement in the bottom line, with Meta reporting a net margin of 34.9%, a second straight quarter above 33% and a strong 2040 bp YoY expansion. Improvement from the 2022 bottom in fundamentals is easily visible in the chart below.
The rebound in leverage comes despite Meta pouring tens of billions into Reality Labs – operating loss for Reality Labs totaled ($16.1) billion for FY23, or a massive ~1195 bp headwind to operating margin.
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Meta’s Momentum to Continue in 2024
Meta’s momentum with strong revenue growth is expected to continue in 2024, supported by ARPU trends. In addition, the implementation of AI features, a favorable ad market backdrop, and improving operating leverage supports substantial EPS growth this year.
Meta guided for a very strong Q1, calling for 24.8% YoY growth, a third straight quarter with growth >20%, though it comes against a weak 2.6% YoY comp. Accelerating ARPU in Facebook’s two core geographies, the US/Canada and Europe, supports this revenue growth story.
Source: Meta
Also supporting the growth story is a favorable social media ad spend backdrop, as well as major political and sporting events, namely the US presidential election in November and the Summer Olympics. Globally, social media ad spend has one of the fastest projected growth rates in the ad industry at +13.8%.
In the US, growth is expected at a similar rate, with Insider Intelligence projecting 13.5% YoY growth to $82.9 billion. This represents a $7.8 billion increase from their Q1 2023 forecast, with the market benefiting from “higher ad loads, a focus on lower-funnel ads, and an improved advertising economy,” driven by both Meta and TikTok.
For 2024, key metrics are supporting a return to >40% operating margin for the full year and a possible >33% net margin, driven by increasing ad pricing, strong engagement trends and impressions growth, aided by the release of numerous AI features. Reaching those margins for the full year would imply EPS growth of nearly 38% to $20.50 on $160B in revenue. Meta would be trading at a 24x forward PE ratio under that EPS growth assumption, 15% cheaper than its 5-year average PE of 27x; however, this is the peak multiple we’ve seen so far in Meta’s rally.
The Trade Desk: CTV Tailwinds Offer Growth Outlet
The Trade Desk, which offers a cloud-based digital advertising purchasing and optimization platform for advertisers across many mediums, from CTV to display, audio, digital out-of-home, and more, continues to be one of the fastest growing ad-tech stocks in the industry. Revenue grew 23% in FY23 to $1.95 billion, outpacing a tepid ad market but representing a 9 percentage point deceleration from 32% revenue growth in FY22.
Though revenue has decelerated, profitability has remained solid, and GAAP net income more than tripled YoY to a nearly 10% margin this year, though that is much lower than historical levels. Operating income is showing signs of stability and improvement on a TTM basis, after periods of volatility in 2021 and 2022.
The Trade Desk's operating income has quadrupled from $50 million in early 2017 to $200 million in2023 despite a deterioration in operating margin. Source: YCharts
Despite a steady deterioration in TTM operating margin over the past six years, from the 30% range to the 10% range in FY23 (after briefly dipping negative), operating income has grown, in fact it has quadrupled from $50 million in early 2017 to $200 million in 2023.
The challenge now for The Trade Desk is maintaining this more rapid trajectory in operating income growth through 2024 and into 2025 given that revenue growth is expected to decelerate. This will be critical in driving expansion in GAAP net margin, which hovers just below 10% currently, compared to above 15% as it had maintained for more than three years.
The Trade Desk's net profit margin hovers just below 10% currently, compared to above 15% as it had maintained for more than three years. Source: YCharts
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CTV, Kokai Provide Growth Opportunities in 2024
CTV ad spend and the ramp of The Trade Desk’s new AI-powered buying platform Kokai offer two potential growth outlets for 2024.
CTV ad spend is forecast to be digital advertising’s fastest growing channel this year, with Dentsu placing growth at 30.8%, while BIA is expecting growth as high as 39.5%. CTV ad spend in total has surged 400% since 2019, as use of streaming services soared through 2020 and 2021; now, rising adoption for major streamers’ ad-supported tiers beckons to bring more spend through CTV. This trend bodes well for The Trade Desk, as CTV “continues to be the fastest-growing channel at scale” for the company, as it sees that “ad supported streaming is going to be an essential strategy for any successful TV provider moving forward.”
Kokai, which launched in June 2023 as The Trade Desk’s AI-powered buying platform, has been labeled by CEO Jeff Green as the “largest platform overhaul” in its entire history. Kokai will be scaling throughout the year, and promises a new degree of optimization for ad buyers while providing KPIs throughout the entire funnel, instead of simply at the last click. In essence, The Trade Desk sees Kokai as an “upgrade in almost every way” to its existing platform.
Though determining the growth trajectory of Kokai over the next few quarters may be challenging, tracking gross spend and The Trade Desk’s take rate provides insights into revenue acceleration trends, and if Kokai and a strong CTV ad market are driving an acceleration in spend and improvements in take rate.
Source: The Trade Desk
The Trade Desk’s take rate has fluctuated between 19% and 21%, hovering around 20.3% in FY23. While it may seem obsolete to track a metric that fluctuates within a tight 200 bp range, the impact of a 100 bp change in take rate is actually quite large. Take FY21 as an example, when The Trade Desk recorded its lowest take rate at 19.4% — had this been 100 bp higher at 20.4%, revenue growth in the year would have been 700 bp higher, at 50% versus the 43% reported growth.
If gross spend can accelerate via a robust CTV market and Kokai’s improvements and efficiency gains for buyers, maintaining a take rate above 20% or driving growth to above 20.5% can help revenue growth accelerate to the high-20% range. However, the upcoming phase-out of cookies provides a significant risk to take rate, in that if The Trade Desk fails to get significant adoption of UID 2.0, which is the second most-used cookie replacement, it may struggle to command such a high take rate due to a loss of targeting ability in a cookie less digital environment.
Alphabet: Beneficiary of Search, CTV Ad Spend
Alphabet is a beneficiary of both search and CTV ad spend, and has seen growth accelerate this year as it works to integrate generative AI features and AI-based tools to drive improved ROI for advertisers – Alphabet recently reorganized its digital ad business to place more emphasis on generative AI and AI automated ads.
Alphabet reported $65.5 billion in advertising revenue, up 11% YoY, its first double-digit growth rate in six quarters, driven by strength in Search and YouTube. Alphabet has nearly doubled its quarterly run rate in just four years.
Source: Alphabet
Search and YouTube ad revenue growth accelerated in each quarter this year, from the low single-digits to 12.7% and 15.5% in Q4 respectively. What Alphabet is demonstrating is that AI-powered ad solutions are helping drive resilient Search ad revenue growth, at the same time that strong engagement metrics for YouTube Shorts (>2B MAUs, 70B daily views) and increasing watch times for YouTube TV are boosting YouTube’s ad revenue growth.
Source: Alphabet
AI Integrations Provide Opportunity for Growth
Alphabet is steadily making progress in integrating AI features in Search via Search Generative Experience (SGE) and in advertising campaigns via Performance Max (PMax). Executives have previously mentioned how these “AI-powered solutions like Search and PMax are helping retailers drive reliable, strong ROI and meet customers wherever they are across the funnel.” This is the value-add of SGE and PMax – driving CPM higher from via higher ROIs from improved targeting and optimization, while letting Alphabet toy with new ad placements and formats in Search pages. Alphabet sees “significant opportunities” to “actually deliver incredible ROI at scale” from these AI-powered features.
Alphabet’s Demand Gen is instrumental in driving long-term growth momentum across its more than 3 billion monthly active YouTube and Gmail users. Alphabet explains it as its “big bet to help social advertisers find and convert consumers via immersive, relevant, visual creatives” across these channels. Alphabet shared some color on Demand Gen in Q4, saying that “tens of thousands of advertisers are testing and, on average, seeing 6% more conversions per dollar versus image-only ads in Discovery campaigns.”
Gemini is also playing a more forward facing role in advertising products, powering Alphabet’s new conversational features in Google Ads. While it is still in beta in the US and UK, early tests have shown “advertisers are building higher-quality Search campaigns with less effort,” streamlining the campaign building process.
Cash is King
As the saying goes, cash is king, and Meta, Alphabet, and The Trade Desk stand out for strong cash flow generation metrics. Meta leads the Magnificent 7 with a nearly 53% operating cash flow margin, while The Trade Desk and Alphabet command OCF margins in the low-30% range.
To put how strong this cash flow generation is in perspective, Meta and Alphabet have grown operating cash flow 1,400% and 425% respectively. This is incredibly impressive given the scale of the duo’s cash flows, with Meta generating $71 billion and Alphabet $101 billion.
Conclusion
Ad-tech stocks are on 2024’s watchlist for a few reasons: strong cash flow generation and growth, a positive ad-market backdrop buoyed by major political and sporting events, and implementation and integration of AI features to help drive improved ROI for advertisers. Meta, Alphabet and The Trade Desk look best positioned to capture and capitalize on the ad industry’s acceleration this year.
My firm is not buying these stocks at the moment as we believe we can get them lower than where they’re currently trading. Though Meta is trading lower than its 5-year average PE ratio, it’s at the peak level sustained so far during 2023’s rally, leaving less room for upside. On the top line, it trades at a 9.6 with 11 being the highest its traded since 2019 (the stock was valued at 11 during Covid when ad-tech was surging from high social media use). The 3-year median is 6.4 and the 5-year median is 8.3.
Alphabet is the cheapest of the Mag 7, trading at a 20x forward PE although EPS growth is expected to be more tepid at just 17% this year, versus 38% for Meta. The company is trading right at its 3-year median and 5-year median on a PS ratio. Some of the softer price action could be due to the anti-trust lawsuit which has closing arguments set for May.
The Trade Desk is more expensive than the two on the bottom line, trading at 123x forward earnings, although it is expected to deliver 82% growth to $0.66 in GAAP EPS. Its trading at it’s 3-year median and 5-year median with a PS ratio of 20.6.
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I/O Fund Equity Analyst Damien Robbins contributed to this report.
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.
Edge AI will be an important trend with AI-powered PCs allowing more people to access the full benefit of AI-powered applications. This, in turn, will help AI developers build a bigger ecosystem. There is a bottleneck right now for AI applications to where client devices are not powerful enough or energy efficient enough to leverage AI capabilities. We’ve discussed this previously in our Memory and PC analysis with details on the upcoming Windows 12 upgrade, and also in the Memory and PC stocks write-up
Inference is also pushing forward the need for AI Edge devices and networks to be more powerful, but also more energy efficient. Inference takes batches of real-world data and quickly comes back with an answer or prediction. This is best done at the edge, which includes the edge network that a company like Cloudflare provides, and edge devices, such as smartphones and laptops. In the inference stage, the compute intensive neural networks are modified for speed and to improve latency. In order to do this, inference is optimized for runtime performance. This allows the computation tasks to be as close to the data source as possible. In many cases, data is produced at the edge, and it’s more efficient and faster to run inferencing at the edge. We’ve covered this in the past in our Cloudflare analysis.
Arm-based PCs are sparking competition, and this will be more evident this time next year (Q1 2025). The analysis below expands on the topic of Edge AI devices to discuss what 2024 will bring, and how we want to be positioned for 2025.
x86 versus Arm versus RISC-V
If Arm-based PCs stick this time, it will mark a massive shift in edge devices. X86 dominates PCs as it stands today, yet AI leaders have their roadmaps loaded with Arm-based releases over the next year. This will be Qualcomm in 2024, followed by Nvidia and AMD in 2025.
x86 and x64 Computer and Laptop Processors:
x86 is a set of design instructions and the architecture for nearly every desktop and laptop computer except MacBooks. The x86 architecture has been around for decades and is considered the standard in personal computers and servers due to its high clock speed and ability to execute multiple instructions per clock cycle. When it comes to performance, the x86 architecture is superior with additional features such as hyper-threading and turbo boost, which assists with tasks that require high computational power. In the early 2000s, x64 was built on top of x86 and is the dominant complex architecture.
Arm-Based Architecture:
A few years ago, MacBooks switched from Intel’s x86-64 processors to Apple’s system on a chip (SoC) based on Arm 64 architecture. Arm offers much lower power consumption and generates less heat due to being a Reduced Instruction Set. The M2 is built on Taiwan Semi’s 5nm process with 100GB/s memory bandwidth and 24 GB of unified memory. When the M2 was released in 2022, Apple claimed 1.9X CPU performance at the same power. At the same performance level, Apple claims the M2 uses ¼ the power as x86.
Source: Apple
The M3 MacBook Air is hitting stores this month with Apple stating it’s 13X faster than an x86 Intel powered MacBook. The Arm-based system on a chip (SoC) combines a CPU and a GPU with a 16-core Neural Engine for what Apple is calling the “World’s Best Consumer Laptop for AI.”
To understand why Apple chose to go with Arm-based architecture and why Microsoft Windows has to play catch up in 2024, it’s important to understand what Arm offers.
The name Arm stands for “Acorn RISC Machine” with RISC standing for reduced instruction set computer. Reduced instruction set leads to lower power consumption and less heat. Decades ago, in the early 1980s, founders Sophie Wilson and Steve Furber discovered that a CPU can run faster on a small set of instructions. This means the operating system breaks down tasks rather than add more instructions to the processor. While most CPU designs were adding more instructions to chips, Arm patented the technique of using fewer instructions that run more quickly and efficiently.
CPUs require instruction sets that tell the processor to move data between registers and memory or to perform calculations with a specific execution unit. Architecture is defined by providing the link between instructions and processor hardware designs. Here’s what Arm’s instruction set looks like.
However, a major difference is that Intel maintains its IP in-house and sells chips while Arm licenses its IP. Revenue is generated from licenses for Arm’s technology and royalties that come from the sale of a licensees’ chips that contain Arm’s technology.
Arm Dominates Mobile, and AI May be the Catalyst for Arm to Dominate PCs:
Around 2012, mobile phones began using the 64-bit architecture that PCs had been using for some time. Arm introduced the ARMv8 64-bit architecture for mobile in 2011. This architecture has two execution states to run 32-bit code and 64-bit code. To run on both Arm and Intel architectures, a developer might compile native code for both or run code emulation, although it is more common to choose one and stick with that choice. This is why we see near ubiquity with Arm on mobile whereas Intel and AMD have done quite well in the data center. Due to power constraints of the mobile device, which was introduced much later, Arm found a massive market where it dominates at 99% market share of smartphones.
Today, Arm offers the most popular CPU architecture in the world with 250 billion chips shipped since inception, of which 30.6 billion were shipped in FY2023. As stated, Arm is most dominant in mobile CPUs with 99% market share, and is at 40.8% in automotive. The overall share of Arm’s related markets is 48%. The company’s dominant market share is achieved through its developer ecosystem.
For mobile, Arm’s design known as “heterogenous compute” has helped facilitate lower power requirements as the architecture allows different CPU parts to work together for improved efficiency. This enables workloads to work across both high-performance and low-performance CPU cores to lower energy by balancing performance.
Arm’s architecture is the best choice for mobile and Intel’s x86-64 is the best choice for the data center and PCs. However, we are on the precipice of going through a major shift to where Arm architecture will compete with x86 architecture for PCs. This has been promised many times in the past, yet starting with Qualcomm’s Snapdragon Elite X, there is a chance that a viable Arm-based Windows PC finally happens. To improve the chances an Arm-based PC finally sticks, both AMD and Nvidia are preparing to release Arm-based PC systems in 2025.
Arm’s different licensing models are the following:
Arm Total Access Agreements: It is a type of licensing model wherein the company provides a package of CPU designs and related technologies for an annual fee. The agreement has a fixed term and Arm reserves the right to modify the package by adding or removing specific products.
Arm Flexible Access Agreements: This model provides a selection of CPU designs and related technologies for an annual fee. However, the latest products are not included. In comparison, the total access agreement is a comprehensive package. Another key difference is that the customers need to pay a single-use license fee for specific products if they are included in the final chip design. Like total access agreements, the company reserves the right to modify the package.
Technology Licensing Agreements: It involves licensing a specific CPU design or technology to the customer for a fixed fee. The license can be used for a fixed term or the number of uses.
Architecture License Agreements: Under this agreement the customers design their own customized CPU designs using the Arm’s Instruction Set Architecture (ISA).
RISC-V
For the fiscal year ending March 2023, more than 260 companies have reported shipping Arm-based chips, including Amazon, Alphabet, AMD, Nvidia, Qualcomm, and Samsung.
Arm is based on lower power instruction sets and hardware, which is also known as a RISC architecture or Reduced Instruction Set Computing. As stated, this contributes to Arm’s approach to power efficiency by reducing the number of instruction sets required. Intel and AMD’s x86 CISC, or Complex Instruction Set Computing, offers more complex instructions that execute multiple operations. This leads to better performance but more power consumption due to the need to decode the complex instructions.
There is a third competitor to Arm and x86 which belongs in the RISC architecture category, called RISC-V. The instruction sets for RISC-V are similar to Arm’s yet RISC-V is open source and is also very new with an official launch in 2019. Compare this to Arm, which was founded forty years ago. RISC-V emphasizes register access over direct memory access, which may be more suitable for parallel processing.
It’s unlikely that RISC-V overtakes Arm in the near-term but it could become a serious contender in future years. Companies like SiFive and Imagination Technologies are designing RISC-V processors. Think Silicon released a RISC-V GPU in 2022. As of last year, AMD’s Radeon RX 6700 works with the RISC-V platform from SiFive.
According to Ars Technica, Qualcomm is also starting a joint venture with NXP, Nordic, Bosch and Infineon “aimed at advancing the adoption of RISC-V” with a focus on automotive use cases. With that said, there are not many games that support RISC-V and it has a long way to go to become a true competitor to Arm.
Arm Holdings Financials:
Arm Holdings is positioned to capitalize on the growing adoption of artificial intelligence (AI) technologies, leveraging its established licensing model and extensive ecosystem to drive future growth. Arm's established licensing model offers a recurring and relatively stable income source.
However, despite Arm dominating the smartphone market at 99%, the company has made very little on licensing compared to its partners. For example, mobile handsets created a $200+ billion segment for Apple, which relies on Arm technology for the iPhone, yet only resulted in (roughly) $3 billion for Arm. In this case, it was far better to own Apple.
The market is excited about the fact that AI will drive double the licensing fees for Arm. My contention is that, similar to mobile, it’s better to own the AI leaders who license Arm’s technology rather than Arm. Analyst estimates have Arm growing to $6.5 billion by 2028. For our purposes, this isn’t high enough growth to ensure insiders won’t take their exit following the IPO lock-up expiration – and frankly, the valuation on Arm is absurd at 41.9 Forward PS and 108 Forward PE Ratio. There is no riskier proposition than an IPO that is richly valued.
In the event the valuation comes down drastically (which it likely will, given IPOs tend to selloff sharply in the year following lockup expiration), we’ve done a thorough analysis on Arm as it’s a central player to Edge AI and is key to the next phase for AI.
Armv9 Architecture
The latest Armv9 architecture offers significant improvements in performance and efficiency, particularly for artificial intelligence (AI) applications. This has led to increased adoption by its partners, particularly in the premium smartphone segment.
Compared to the previous Armv8 architecture, Armv9 chips command double the royalty rate. This means Arm receives a higher percentage of the chip's selling price when a manufacturer uses Armv9 designs.
The rapid growth in Armv9 adoption and its higher royalty rates have already contributed to a significant increase in Arm's royalty revenue. Armv9 constituted 10% of royalty revenue in the September quarter and accelerated to 15% in the recent quarter. By doing the math, Armv9 revenue grew 69% QoQ to $70.5 million. As adoption continues to rise, the Armv9 architecture is expected to be a major driver of future royalty income growth for Arm.
Addressable Market
The company’s total addressable market was $203 billion in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 6.8% to $247 billion in CY2025. The company has maintained a market share of over 99% in the mobile applications processor market. It expects this market to grow at a CAGR of 6.4%, from $29.9 billion in 2022 to about $36 billion in 2025. The company estimates that the aggregate value of chips that contain Arm technology was $98.9 billion (48.9% market share) for the CY ending December 2022, up from 38.7% in 2014. Notably, the 6.8% CAGR is a low CAGR for an AI trend with AI chips expected to grow at a 38.2% CAGR.
Arm also has strong market share of 40.8% in the automotive chip market. Management expects the automotive chip market to grow from $18.8 billion in 2022 to $29.1 billion in 2025, growing at a CAGR of 15.7%.
The cloud compute chip market is expected to grow at a CAGR of 16.6% from $17.9 billion in CY2022 to $28.4 billion in CY2025. Arm’s market share in the cloud computing chip market has increased from 7.2% in CY2020 to 10.1% in CY2022. Since Arm-based chips are increasingly used in data centers, its market share is expected to increase significantly in the future. Per the prospectus, “Arm-based chips have been gaining market share as CSPs, such as Amazon AWS and Alibaba, have started to deploy Arm products in their own in-house designed chips used in their data centers, and as other CSPs, such as Microsoft and Oracle, start to deploy chips designed by Arm licensees, such as Ampere. As a result, we expect our market share of cloud compute to grow significantly faster than the overall cloud compute market.”
Financials
Arm’s recent Q3 FY2024 revenue ending December grew by 13.8% YoY to $824 million, helped by the recovery in the smartphone market and demand for AI technology. This marks the second consecutive quarter of positive revenue growth, following declines of (2.5%) in the June quarter and (3.7%) in the March quarter, due to the cyclical downturn from smartphones.
License and other revenue grew 18% YoY to $354 million. The company has seen strong growth in license revenue as they are signing long-term and high value agreements with its customers due to demand for Arm’s advanced CPUs to run AI workloads. The trend was strongest in the Sept quarter as license revenue grew by 106%.
The company’s CEO, Rene Haas, said in the earnings call, “And that has seen growth in not only the smartphone sector but also in infrastructure and other markets, which drives growth. We are also seeing strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm.”strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm.”
They expect another record quarter for the licensing revenue. The company’s CFO, Jason Child said in the earnings call. “We are expecting another strong quarter for licensing with revenue up sequentially to near record levels. As with recent quarters, we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems.”we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems.”
The company also reported record royalty revenue due to its higher value Armv9 technology and also market share gains in cloud server and automotive markets. Royalty revenue rebounded to 11% YoY growth to $470 million from a decline of (5%) and (8%) in the previous two quarters. Management’s guide for the next quarter is to grow over 30% YoY and mid-single digits sequentially.
The company’s CFO, Jason Child said in the earnings call, “Within Q4 total revenue, we expect royalty revenues to grow mid-single digits sequentially and to be up over 30% year-over-year as we compare against the bottom of the industry wide inventory correction that occurred in prior year Q4. Royalty revenue sequential growth is mainly coming from increasing penetration of Armv9, where royalty rates are on average, at least double the rates on equivalent Armv8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate.”increasing penetration of Armv9, where royalty rates are on average, at least double the rates on equivalent Armv8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate.”
The management has increased its revenue guidance for the next quarter by $95 million to a range of $850 million to $900 million, representing YoY growth of 38.2% at the midpoint. The strong upward revision was due to the points discussed earlier, like the rebound in royalty revenue and the higher revenue opportunity from AI.
Analysts expect revenue to grow 37.4% YoY to $869.88 million in the next quarter and 27.9% in the June quarter.
FY2023 revenue ending March declined by (0.9%) YoY to $2.679 billion. Analysts expect FY2024 revenue to grow 18.7% YoY to $3.18 billion and 23.9% YoY to $3.94 billion for FY2025.
Annualized Contract Value
Annualized Contract Value (ACV) grew by 15% YoY and by 5% QoQ to $1.16 billion. The sequential increase was due to an increase in high-value license agreements and also the increase of total access agreements.
RPO
Remaining performance obligations (RPO) grew by 38% YoY to $2.43 billion, helped primarily by high-value license agreements and renewal of long-term customer agreement. As per the shareholder letter, “We expect to recognize approximately 28% of RPO as revenue over the next 12 months, 26% over the subsequent 13-to-24-month period, and the remainder thereafter.”
Margins
Gross margin was 95.6% in the recent quarter compared to 96% in the same quarter last year. Adjusted gross margin improved 50 basis points YoY to 96.8%.
Operating margin was 16.3% compared to 33.7% in the same period last year. The operating margin was lower due to the increase of R&D expenses from an increase in engineering headcount and SG&A expenses from increase of non-engineering headcount.
In the Sept quarter, the operating margin was low at (19.4%) due to increased R&D expenses, stock-based compensation, and IPO-related expenses. Stock-based compensation was higher than it’s expected to be in future quarters as the IPO triggered a one-time expense for previously granted shares. As per the September quarter shareholder letter, “Total share-based compensation cost (equity-settled) was $509 million with $19 million in cost of sales, $343 million in R&D and $147 million in SG&A. Share-based compensation costs were higher in Q2 than is expected in future quarters as the IPO triggered a one-time expense for previously granted shares. The future run-rate of share based compensation cost will depend on a number of factors, including the share price, but is currently expected to be between $150 million to $200 million per quarter.” At the midpoint, this will be about 20% of revenue.
Adjusted operating margin was 43.8% compared to 39.9% in the same period last year and 47.6% in the Sept quarter.
Net margin was 10.6% compared to 25.1% in the same period last year and (13.7%) in the Sept quarter. The adjusted net margin was 39.3% compared to 31.1% in the same period last year and 46.9% in the Sept quarter.
Cash Flow and Balance Sheet
The operating cash flow margin was 37.6% compared to 56.8% in the same period last year and 28.2% in the Sept quarter. The free cash flow margin was 30.5% compared to 53.5% in the same period last year and 21% in the Sept quarter.
The company has cash and short-term investments of $2.4 billion compared to $2.2 billion in the Sept quarter, and no debt.
Key Metrics
The company reports the actual chips shipped in the subsequent quarter. For the quarter that ended September, Arm’s customers shipped 7.7 billion chips, down (3%) YoY and up 8% QoQ, showing a sequential improvement for the second consecutive quarter on account of smartphone market recovery and demand for AI chips.
Total Access Licenses
Total Access Licenses grew by 80% YoY to 27, with the company signing five new licenses in the quarter. Notably, this included three companies upgrading from Flexible Access Licenses, marking the first time such a transition had occurred. This also caught the attention of the analyst, who asked“Did that take you by surprise or were these customers that were getting to be particularly large for an AFA and so it was natural for them to upgrade?”
The company’s CEO, Rene Haas replied, “Yeah. Thank you for the question. We didn’t bring it up in our comments. We had a lot of good stuff to talk about this quarter, and I was trying to keep it as concise. But the AFA transition to ATA, thank you for calling that out. That’s a great trend for us. When we designed the program a number of years ago, that was absolutely the intent is that customers that launched into an AFA would ultimately go on to a total access license.When we designed the program a number of years ago, that was absolutely the intent is that customers that launched into an AFA would ultimately go on to a total access license.
What largely drives that, quite frankly, is the company that AFA start to get commercial traction in their business. Some of the AFA customers are early-stage companies. They may have an early exit or get acquired. But as they get larger and mature, we expect them to embrace Arm technology in a broader way. So I wouldn’t call it a surprise. I would actually call it an expected outcome that we have, and we’re really happy to see it. It’s great.”
Flexible Access Licenses
The Flexible Access Licenses grew by 6% YoY to 218. These agreements are renewed annually and over 50 were renewed in the quarter and 14 new agreements were signed with 6 net additions in the quarter.
Risks
The company also highlighted the risk in its prospectus that some of its customers support open-source RISC-V. This may not be a potential immediate risk to the business. However, it might be difficult for Arm to raise prices.
Arm China accounted for about 24% of revenue for the FY ending March 2023. The company said in its prospectus, “Neither we nor SoftBank Group control the operations of Arm China, which operates independently of us.” So, this is a potential political risk to consider if the US-China tensions escalate.
The company’s IPO lock-up period expired on March 12th, so volatility is likely in the coming months. The risk that Arm cannot hold the exuberant valuation it currently trades at post-lockup is very high.
Arm was previously listed from 1998 to 2016 when it was taken private by SoftBank Group, and it holds about 90% of the outstanding shares. The high ownership of SoftBank is a significant risk to consider since SoftBank could slowly start to book profits on Arm Holdings once the IPO lock-up expiry is now over. Arm’s current valuation of $135 billion (90% is $122 billion) is significantly higher than SoftBank’s current market valuation of $85 billion.
Arm’s shares have doubled since its IPO in September 2023. Arm is currently trading at a forward P/S ratio of 41.9. As seen in the chart below, this is trading far higher than the other AI semiconductor companies. The 1-year forward for fiscal year ending in March 2025 is a PS ratio of 33.8, which still exceeds other AI-related semi companies – including Nvidia.
Qualcomm
As we look into Arm-based PCs, it’s worth noting that Qualcomm will be the first to release an Arm-based PC this summer with ETA of June. Qualcomm is a tough stock to own because it’s subject to licensing and IP lawsuits that the company most recently won, and anti-trust lawsuits that the company has lost. China adds complexity, as similar to Samsung and Apple, the OEMs use Qualcomm but ultimately seek to compete with Qualcomm where possible. This leads to IP battles and creates risk not present in other stocks. Interesting enough, Qualcomm is being sued by Arm following the acquisition of Nuvia as Arm alleges the IP deal it had with Nuvia should have been terminated at acquisition. What goes around, comes around.
For the most part, Qualcomm’s customers are frenemies. This is true for all of tech but especially Qualcomm. The tug-o-war between partners/competitors was noted in the most recent earnings call when an analyst asked the following:
“Tal Liani:
Thanks. I have two follow-ups on answers or questions you had before. The first one is Samsung. On one hand, there is a new contract. On the other hand, Samsung is going to use their own more in '24 versus '23. So net-net, are you expecting revenues of Samsung to go up or down in '24 versus '23? What are your expectations of share losses within — can you frame it for us?”
Management didn’t directly answer the question so I’m not going to quote their answer here other than to note the material concern to Qualcomm’s business model. Even as the company innovates on chips, chipsets and SoCs, the older products typically get replaced (where possible).
Qualcomm is not of interest for our portfolio right now as we would want to see more top line growth. Handsets have been in a decline, IoT is in a deep trough, yet automotive is surprisingly strong – which is all detailed below. However, Qualcomm is an important company to cover for AI edge devices and can be instrumental in helping us time our other investments.
From the most recent earnings call, the major takeaways for our purposes are timing for the Windows upgrade, Android’s roll-out for AI features, and China’s ramp in mobile that favors domestic OEMs like Huawei instead of Apple. Most importantly, as stated, the company is working with Microsoft on an Arm-based PC due out mid-2024. Details around this help to inform our thesis on AI-powered PCs, which was detailed here and here.
Brief Overview of the Financials:
In 2023, Qualcomm entered a trough similar to many other semiconductor companies. This was driven by mobile handsets and internet of things (IoT). Qualcomm’s IoT segment includes consumer virtual headsets and edge networking such as WiFi 7 broadband devices. In the most recent quarter, Qualcomm returned to positive growth of 5% after four quarters of negative growth, some as steep as (-24%) and (-23%).
The rebound will be strongest in the second half of CY2024 when Qualcomm returns to growth with an estimated 12.5% in the September quarter. Notably this estimate has come down since the last earnings report, when it was estimated to be 14.3%. The December quarter estimate is for 5.90%.
According to the earnings call, the September quarter will be seasonally stronger due to the anticipated Windows upgrade that is due to be released around the school season.
Here is what was said on the earnings call:
“We're tracking to the launch of products with this chipset tied with the next version of Microsoft Windows that has a lot of the Windows AI capabilities. We're still maintaining the same date, which is driven by Windows, which is mid-2024, getting ready for back-to-school, what we're excited about it is since we announced that Tech Summit showing the performance of the product and the AI capabilities, design traction continues to increase.”
On the bottom line, Qualcomm reported $2.75 non-GAAP EPS, beating estimates for $2.37. The company is returning to growth on the bottom line with the September quarter being the peak at 22% growth for EPS of $2.46. Last quarter, Qualcomm “returned $1.7 billion to stockholders during the quarter, including $784 million in stock repurchases and $895 million in dividends.”
Margins:
Gross margin of 56.6% is in line with previous quarters
Operating margin of 29.5% is higher than previous quarters. Discussion from Q&A is noted below.
Net margin of 28% is higher than previous quarters.
More on Mid-2024 Timing
As mentioned above, the Windows upgrade is expected to hit mid-2024. There were some additional notes on timing:
Tom O'Malley:
Thanks for taking the question. Just passing on my congratulations to Akash as well. I just wanted to ask on the ASP side for Android. You're obviously kind of characterizing the market that's flattish into March, kind of the bottom in June and then improving from there. But you benefited from some good mix in the beginning of the fiscal year here. Could you talk about what you would expect from a mix perspective as you go to the back half? Would you see the same kind of strength on the ASP side that you've kind of seen over the past year? That would be really helpful to understand. Thank you.
Akash Palkhiwala:
Yeah. So if you think about premium flagship launches for our OEMs, a lot of the launches happen in the holiday time frame just before the holidays going into Chinese New Year as well. And so you've seen a lot of those happen. We do have some significant launches through the middle of the year, but obviously, the next big launch goes into the holiday season, starting with Apple and then going into the Android launches. So that's a typical cadence.”
China is a Problem for Apple
We outlined how BYD was becoming a problem for Tesla. According to commentary on Apple’s earnings call and Qualcomm’s earnings call this quarter, China’s preference for domestic OEMs is becoming a problem for the iPhone. In particular, Huawei is making a comeback. Below is mention that Huawei is performing well in the premium tier.
“Samik Chatterjee
[…] So just wondering if you can give us an update in terms of what you’re seeing from those customers? And if at all, Huawei and their reemerges in the market is starting to have an impact in terms of volume or market share for these customers as well in the context of your flat guide for them for quarter-over-quarter? Thank you.
Akash Palkhiwala
In terms of your comment on Huawei, really what we’ve seen since Huawei 5G launch is that the premium tier TAM in China has expanded. And so we’re continuing to see strong demand from our customers post that launch.”
There’s additional evidence that a Chinese OEM is gaining market share as a new customer emerged at 14% of revenue for Qualcomm compared to an estimated 20% from Apple.
“Ross Seymore
Great. And I guess for my follow-up, I noticed in the 10-Q, you had a new 10% customer, I think it was a 14% customer. I don't expect you to name who that is. But is that a reflection of the strong China demand that you talked about in the continuation of good future growth opportunities or was there any onetime aspect of that customer, whoever it may be popping up in the quarter?
Akash Palkhiwala
I think the you framed it in your first theory is a reasonable way of thinking about it.”
Per our write-up on Big Tech earnings, “Apple is facing competition from other smartphone companies in China due to foldable designs and advanced AI features. The company’s total revenue from China in the recent quarter was $20.8 billion, which missed estimates of $23.8 billion.”
Some of Qualcomm’s commentary is useful for if/when we build a position in Apple in anticipation of AI mobile devices. As of now, Apple faces a serious headwind with Huawei and Chinese OEMs. We saw the technicals flashing a few months back in a free analysis here and again here.
Snapdragon AI Platform Roll-Out:
Qualcomm’s Snapdragon 8 Gen 3 mobile platform is helping to bring generative AI to the edge with an AI engine that can run LLMs up to 20 tokens per second. It offers on-device AI such as live translate, interpreter and chat assist. Per management: “This marks the beginning of how gen AI will evolve the overall smartphone experience and highlights the significant opportunity for Snapdragon platforms.”
The Samsung Galaxy S24 Ultra, GalaxS24 and S24 Plus is using the Snapdragon 8 Gen 3 mobile platform. Per management: “The Snapdragon 8 Gen 3 mobile platform is setting a new standard for on-device gen AI experiences for premium smartphones and powers all through flagship Android devices launched and launching this fiscal year.”
In addition, the Snapdragon X Elite will offer on-device gen AI and copilot for the upcoming Windows upgrade. There was a second mention of “mid-2024” for this release.
The Snapdragon X35 will also serve 5G-enabled industrial IoT devices equipped with generative AI, such as enterprise workflow, inventory management and warehouse applications (there are dozens or use cases). According to Qualcomm: “We continue to believe that industrial edge devices with connectivity, high-performance computing and on device AI will become one of our largest addressable opportunities fueled by the secular trends of digital transformation.”
Custom Oryon CPU Cores:
Qualcomm’s Snapdragon AI platform is powered by a new Arm-based CPU called Oryon. This effort began with the acquisition of Nuvia, a company that specializes in custom Arm silicon. This was important for Qualcomm to compete with Apple’s M1 chip, released in 2020 with more iterations since, such as M1 Pro, M1 Max, M2 and M3.
Prior to Nuvia, Qualcomm used Arm designs off-the-shelf with Cortex cores designed by Arm. The Oryon CPU will be the first 64-bit that Qualcomm has designed itself using an architectural license. Legally, only ARM themselves or companies Arm has sold a license to are allowed to design Arm CPUs. When Qualcomm bought Nuvia for its CPU design, Arm is asserting the license is no longer valid and is not transferrable since the company with the license no longer exits.
The importance of this is that Arm architecture on PCs is expected to help Windows PCs compete on performance and power efficiency with MacBooks. It could also spell trouble for Intel. Here are current benchmarks (benchmarks tend to be skewed in favor of one performance measurement rather than overall performance). This is also benchmarked against the M2 whereas the M3 on 3nm technology came out last Fall. According to Apple, the M3 is 15% faster than the M2 with efficiency cores that are 30% faster than what was benchmarked against the upcoming Qualcomm release.
With that said, Oryon is rumored to have power efficiency issues due to Qualcomm using cell phone PMICs. The power management integrated circuits (PMICs) are what manage and regulate the power in electronic components. By using cell phone PMICs, the CPU cores won’t run in the optimal efficiency range. In order to handle the needs of a laptop, Qualcomm is bundling together PMICs. In the very near-term, this means selling more Qualcomm PMICs, but in the medium-term, it means a competitor like AMD or Intel (or Nvidia) could crush Qualcomm on price and performance. The full write-up from SemiAccurate is worth a read. Here is what the independent analyst stated:
“Laptops have a large multiple of the board area of a cell phone, think more than 10x rather than a percentage. So a very expensive cell phone spec board just blew out costs for Oryon laptops. Whoops. Some OEMs SemiAccurate talked to were a tad peeved by this because it is entirely unnecessary, it is mandated solely by the force bundled PMICs. Allowing a suitable PMIC would also allow for a much cheaper PCB too but as you might guess, Qualcomm took a different path.”
Although we will have to wait until 2025 for AMD and Nvidia’s Arm-based laptops, the stage is being set for Qualcomm to stumble and this is something we track for portfolio purposes. To translate, Qualcomm could do well in 2024 given it will be the first to launch Arm-based Windows PCs for AI purposes but whatever lead Qualcomm gains in roughly 6 months time will be harder to maintain in 2025 and beyond as Qualcomm’s exclusive deal expires and more competition arrives.
Qualcomm will release its first smartphone processor with the Oryon CPU in late 2024. The Snapdragon 8 Gen 4 will feature custom CPU cores for the first time since 2016.
Note on Automotive:
The handset segment reported +16% growth and IoT reported (-32%) growth whereas the Automotive segment reported +31% growth.
It’s the smallest segment by revenue size at $598 million compared to handsets at $6.7 billion and IoT at $1.1 billion. However, what’s important to note is that Qualcomm’s automotive segment is growing when other pockets of Automotive are weak on an industry-wide basis.
According to the Auto Investor Day, Qualcomm expects to have “greater than $4 billion in revenue in fiscal '26 and greater than $9 billion in revenue in fiscal '31.”
Here is what was stated on the call:
“And we already have some revenue from ADAS processing. You see a lot of cars for example, in China with both ADAS and autonomy with our processor, you see some of our customers in the United States of our processor. And I think that continues to grow as we get towards our 2026 revenue target, you’re probably going to see very healthy components of all of those elements.”
Regarding the disconnect between Qualcomm’s growth in automotive versus the industry declining, the following was stated:
“Switching over to your second question on automotive. You should really think — the way to think about our automotive business is we're tied to the launch of new cars. Clearly, the industry is going through a transformation, digitization of cars, and we are right at the intersection of that transformation. We are we're benefiting our cars put in more infotainment content for experience within the car. More ADAS content comes into the car as well.
And really, we get to benefit from all those intersection points in the car, and we're increasing the content as new cars launch. So that's the maybe a disconnect between some of our peers what they're seeing and what we're seeing. Stepping back, I mean, clearly, this is an industry that's going through some shorter-term dynamics, so we'll be closely monitoring it. But when you step back, our technology, our position, our products look really good, and we're excited about where we're going.”
Nvidia and AMD could strong ARM Qualcomm
The efficiency shown by the M1 and M2 chips from Apple has resulted in a long battery life and high performance per watt. Apple’s laptops like the M2 Max Macbook Pro can compete with discrete graphics and is better suited for AI processing than laptops with x86 processors. This has led to Apple doubling its market share since the M1, and has caught the attention of Nvidia and AMD. Qualcomm has an exclusive through 2024, which leaves 2025 as the year the world’s top design companies can release an Arm-based PC. According to Reuters, this is exactly what they plan to do.
In addition to Qualcomm’s controversial use of mobile PMICs, which could alter the benefits of an Arm-based PC in terms of power requirements, Nvidia and AMD are more equipped to build advanced AI features into CPUs and devote on-chip resources for AI-enhanced software (need I go further into how Nvidia and AMD will potentially beat Qualcomm on advanced AI features? This one is a tad obvious)
Where the rubber meets the road is that x86 applications have a mature ecosystem and is ubiquitous whereas code for Arm-based Windows is far less supported. If Nvidia and AMD are getting involved, then they must be envisioning the power requirements for AI will be enough of a motivating factor to push forward efforts for Windows Arm-based code.
Conclusion:
We are not interested in Qualcomm or Arm as a portfolio position at this time, rather we are tracking these companies more closely as they will help to bring AI to the edge with Arm-based PCs. This will be timed to an AI-focused release for Windows in mid-2024. There is also quite a bit of excitement around Arm at the moment. For the most part, our firm does not participate in IPOs as the vast majority trade below their opening price after the lockup expires. Arm’s valuation is particularly shocking as it exceeds even Nvidia. We find it advantageous to take our time and buy post-lockup, especially given Arm CPUs dominate 99% of mobile and it’s procured very little revenue compared to mobile heavy hitters in hardware and software. What’s also of interest to our portfolio is that Qualcomm may stumble given the mobile PMICs being used, and in that case, our favorites AMD and Nvidia could have an opening to dominate come 2025.
The overarching theme is that Edge AI is approaching and we want our positions to be aligned as closely as possible given client revenue has been weak for semis across the board. It will be the perfect recipe when client revenue segments return to growth, combined with ongoing data center strength. We want to be positioned when this happens for otherwise strong semiconductor companies that are currently a “tale of two cities” – weak PC and mobile segments detracting from strong data center/AI segments.
Microsoft topped on February 13th, making a series of lower highs while the S&P 500 (SPX) continued higher. We now have Tesla, Apple, Google and Microsoft not participating in the current push higher, which is a big warning for the bulls. Not only were these stocks market leaders in 2023, but they account for ~18% of the total weighting within the S&P 500. This is a large weight around the broad market, and a divergence that should not be ignored.
Regarding MSFT, we have logged significant gains, moving it from a 8% position back to a 2% position. The valuations are at extremes, and the technical picture is concerning. Note below how we have two degrees of 5 wave patterns that started off the 2022 low. This is a mature pattern, and likely setting up for a pullback. Below $397 will be the first warning that a downtrend has started. Once we go below $365, the top will most likely be confirmed and we will set up downside targets to buy.
Nvidia (NVDA)
Nvidia started Friday up over 6% and ended the day down -5.5%. This is called a bearish engulfing candle, and can be visually seen in the below chart (the red arrow). This type of candle pattern tends to show up around trend reversals. What makes this one more notable is the fact that it happened on such heightened volume. In fact, this was the most trades shared in a day since the August, 2023 top, which started 2 month correction.
We have been patiently waiting for a prolonged reversal of this market leader. We believe that if it does not happen here, it should happen after we push towards the $1000-$1100 region on one more push higher. As long as we hold $784, the potential for another swing higher is possible. Below this level and we will start setting up downward targets to buy.
Bitcoin (BTCUSD)
We have been waiting for Bitcoin to go vertical, and it appears to have done so over the last few weeks. The vertical move tends to mark the halfway point of the uptrend, which puts our targets over the $100,000 region. However, we should see a pullback before continuing higher.
Note the weekly chart below. The Detrend Oscillator is in the same position as the 2021 peak. This oscillator loves the reverse at prior peaks and troughs. It’s at this position while the Composite Indicator is making a lower high. In other words, price is pushing higher with less momentum. These are warnings that a breather is likely to happen.
If we do pullback, we will be targeting the $57,000 region to add to our position. In order to continue higher, we must hold $40,000. Below this level and the uptrend we have been tracking will likely be over.
This article was originally published on Forbes on Mar 7, 2024,08:19pm ESTForbes Forbes on Mar 7, 2024,08:19pm EST
This year has led to a split landscape for cybersecurity stocks, with two of cybersecurity leaders up more than 20% YTD while others are negative YTD. In the past, we’ve discussed the resiliency of the cybersecurity trend being that it’s one of the highest costs that enterprises face at 12% of IT budgets on average. The cost of cybercrime continues to rise, and is estimated to reach $10.3 trillion by 2025 and $13.8 trillion by 2028. AI and automation are playing an increasingly large role in the industry, with 560,000 new pieces of malware detected every day. Software systems cannot keep up with this, and AI is already assisting human teams in identifying which threats require more analysis.
Despite the strength of the trend, we are seeing mixed results across cybersecurity leaders. Palo Alto cut its billings and revenue forecast in a shift to a “platformization” approach. Zscaler fell despite beating on the top and bottom line as it pointed to a rather sharp deceleration in calculated billings. In contrast, CrowdStrike rose nearly 11% after it beat estimates with another record in net new ARR, and guided fiscal Q1 marginally ahead of consensus. Adding to CrowdStrike’s strength, Fortinet has rallied double-digits year-to-date despite signaling that growth is slowing, with revenue and billings set to decelerate sharply this year.
However, if we zoom out, it’s quite clear what the strongest cybersecurity stock has been with CrowdStrike’s 1-year returns of 162% well ahead of its peers. The analysis below looks at why some are starting the year exceptionally strong, while others are not in the leading cloud vertical of cybersecurity.
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Fortinet: Growth Is Slowing
Although Fortinet reported solid improvement in operating income and EPS for fiscal 2024, revenue growth and billings growth is slowing considerably. Revenue increased 10.2% YoY to $1.42 billion in the quarter, a 570 bp deceleration from 16% growth in Q4. Fortinet had initially guided for billings to decline YoY to $1.63 billion at midpoint, but it handily beat its guide as it reported 8.5% growth with billings of $1.89 billion. This was a 280 bps acceleration from 5.7% billings growth in Q3, but a far cry from the 30% range seen through 2021 and 2022, with growth decelerating swiftly through 2023.
Source: I/O Fund
Q4’s billings were driven by signing 13 deals above >$10M generating $232M in billings (up 177% YoY). However, the Q4 beat was short lived with Q1’s guide pointing to a (5%) YoY decline in billings to $1.43 billion at the midpoint. Growth is expected to be minimal for the full year, with Fortinet pointing to $6.4 billion to $6.6 billion in billings, or growth of 0% to 3%.
This would represent a significant slowdown in billings growth over the past two years, from 33.8% in 2022 to 14.4% in 2023 to the low-single digit range for 2024. Revenue growth is decelerating rather rapidly as a result, with Fortinet’s $5.76 billion guide for the full year pointing to growth in the high single digit range from $5.31 billion in 2023. Consensus estimates were at $5.94 billion for 11.9% growth, but that has since been revised lower to $5.79 billion for 9.1% growth.
Product revenue has declined for two consecutive quarters, in part due to tough comps in late 2022. Management explained that product revenue “will continue to be impacted by project and product digestion in 2024,” though the “selling environment should improve in the second half of 2024 and into 2025.”
Source: I/O Fund
Services revenue growth has slowed to under 25%, the lowest level since early 2022. Given services’ share at nearly 66% of revenue in Q4, a prolonged deceleration would bode negatively for revenue growth moving forward. There were positives emerging in SecOps, which grew 44%, and SSE element of SASE, which management added also witnessed more than 40% growth in the quarter.
Palo Alto: Billings and Revenue Forecasts Cut in Platformization Approach
Palo Alto shares plunged over (28%) after its fiscal Q2 earnings report when management cut its billings and revenue forecast for the full year. We had informed our readers in the analysis “The Strongest Cybersecurity Stocks in Q3” in December following Palo Alto’s weak billings in Q1 that this was “amplifying concerns that revenue and billings growth is decelerating.”
Palo Alto also unveiled a stronger push for “platformization” among its three platforms to drive vendor consolidation, saying that it intends to make “significant additional investments” in this strategy as it will be “a major area of focus for us as we move forward.”
Revenue in fiscal Q2 increased 19% YoY to $1.98 billion, a 1 percentage point deceleration from 20% in Q1. Palo Alto cut its full year revenue guide by $0.2 billion to $7.95 billion to $8.0 billion, for growth of 15% to 16% YoY, and also cut its billings forecast by ~5%. Palo Alto is now seeing billings at $10.1 to $10.2 billion, for growth of 10% to 11% YoY, down from its prior view for $10.7 to $10.8 billion due to impacts in its federal government business. This implies a further deceleration over the next two quarters, potentially to revenue growth in the low teens.
However, next-gen offerings continued to see strong demand and growth: networking security SASE ARR increased more than 50% YoY for the fifth consecutive quarter, while Next-Gen Security (NGS) ARR rose 50% YoY to $3.49 billion. Palo Alto also saw the highest number of deals signed for XSIAM (Extended security intelligence and automation management) in the quarter.
Source: I/O Fund
Palo Alto is taking a more aggressive approach to “platformizing” its offerings as customer LTV increases exponentially per platform added. It sees the near-term headwinds to revenue and billings growth as merely a blip in its long-term target to reach $15 billion in NGS ARR by 2030, up from its guided $3.95 to $4 billion in 2024. Revenue growth is expected to remain pressured through FY24 and begin inflecting higher through the end of FY25 (12 to 18 months), as the headwinds of this approach begin to fade.
Source: Investor Relations
While this exponential increase in customer long-term value alone can support this strategy shift, peer Fortinet also highlighted other positives around this approach: “Consolidation allows security solutions to share data and communicate with each other, reducing complexity, improving security effectiveness, easing the need for skilled labor, and lowering the total cost of ownership. Consolidation drove our SecOps business to 44% growth, with strong growth from EDR, SIEM, email security, and NDR.”
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Zscaler: Calculated Billings to Decline Sequentially
Zscaler beat on the top and bottom line, and marginally boosted its full year revenue and calculated billings forecast. Despite the beat and raise, Zscaler guided for a (7%) sequential decline in calculated billings for Q3, suggesting further deceleration in this key metric to the low-20% range.
Revenue increased 35% YoY to $525 million, a slight deceleration from 40% growth in Q1; Zscaler guided for 28% YoY growth in Q3 to $535 million at midpoint. As a result, Zscaler marginally boosted its full year revenue outlook to $2.118 to $2.122 billion, up approximately 1% from its prior view for $2.09 to $2.10 billion.
Zscaler tightened its billings growth outlook to $2.55 to $2.57 billion, at the upper end of its prior forecast for $2.52 to $2.56 billion. This correlates to 25% to 26% YoY growth. We had said in December following Q1’s release that the fact Zscaler “did not raise its full-year billings outlook as it tends to do” suggested that ‘billings growth will decelerate through the remainder of the fiscal year.” This is currently what is playing out – calculated billings increased 34% in Q1, decelerating to 27% in Q2. Q3’s forecast for a (7%) QoQ decline implies calculated billings of $584 million, or a further deceleration to just 21% growth.
Source: I/O Fund
GAAP profitability remains elusive, unlike peers CrowdStrike and Palo Alto, who have both recorded quarters with GAAP operating and net profitability. Zscaler has been making inroads on the GAAP profitability front, with GAAP operating margin just above (9%) and GAAP net margin at (6.7%) for the past two quarters. However, until Zscaler can meaningfully reduce operating expenses, currently at approximately 87% of revenues, GAAP profitability will continue to remain elusive should growth decelerate.
Interestingly, Zscaler commented that it believes it is “still operating in a challenging macroenvironment and customers continue to scrutinize large deals,” and that its 2024 outlook balances its “business optimism with ongoing macroeconomic uncertainties and sales leadership changes.”
CrowdStrike: Shares Fly With Record Net New ARR, Robust RPO, Margin Strength
CrowdStrike reported a new record for net new ARR in Q4, far surpassing the record it set in the previous quarter, as GAAP margins continued to strengthen. For FY25, CrowdStrike’s guide was marginally above consensus, yet the market is clearly pleased with this continued expansion in operating and net margins. The turnaround on net new ARR is notable, yet the turnaround on GAAP profitability is what is most impressive compared to its cloud peers, especially considering the far majority of cloud stocks are years away from GAAP profitability (if they ever get there). We covered the earnings report in-depth for our premium members here.
Net new ARR accelerated significantly in the quarter to 27% growth, which is a 14-point acceleration from 13% growth in Q3. This is up from 2% growth for net new ARR in the year ago quarter. The turnaround in this particular key metric is notable, especially compared to other cloud stocks whose key metrics are decelerating. ARR increased 34% to $3.44 billion, which was down 1 percent from 35% growth last quarter.
CrowdStrike’s management stated that the company continues “to aggressively invest in our innovation engine and flank the company to achieve its vision of reaching $10 billion in ARR over the next 5 to 7 years.” That would imply about 200% growth in 5-7 years. The growth of deals with total value exceeding $1 million accelerated to “over 30%” this quarter for 250 customers.
Source: I/O Fund
Margins strengthened across the board – driven by four quarters of GAAP gross margin at 75% and GAAP subscription margin at 78%, both up from the prior year. To further illustrate CrowdStrike’s margin expansion, GAAP operating income was $30 million this quarter compared to (-$61.5) million in the year ago quarter. This is up from $3.2 million last quarter. For the full year, CrowdStrike nearly broke even from operations, reporting just a ($2 million) loss from operations, or a (0%) margin, an 800 bp improvement from FY23. CrowdStrike also reported its first full year with GAAP net profitability, reporting a 2.9% net margin, compared to an (8.2%) margin in FY23.
CrowdStrike echoed Zscaler with its macro commentary, saying that it believes the “current macro environment remains stable and consistent with prior quarters,” as it expects “continued deal scrutiny throughout this coming year.” Management added that its fiscal Q1 and FY25 guidance “assumes a consistent, challenging macro backdrop.”
Conclusion
The 1-year performance across cybersecurity leaders is quite variable, ranging from an impressive 161% to a mere 17%. This makes it well worth our time to monitor the metrics driving performance in this sector. Billings growth will be important to continue to track, as some hints of weakness last quarter spilled over into reduced forecasts from Palo Alto and Fortinet. Revenue deceleration will also be a key metric to watch given the decelerations guided from Palo Alto and Fortinet. Most importantly, these key metrics can provide clues as to which companies will be strongest moving into the rest of 2024 and beyond.
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Broadcom is firing on all cylinders and this earnings report cemented the company as number two in terms of AI revenue. It’s not only the AI revenue that sets Broadcom apart, but also its developing software strategy with VMWare.
The headline numbers don’t help to translate underlying AI strength as Broadcom reiterated its full year guidance yet raised AI revenue. This is because some of Broadcom’s segments are coming in lower than expected, while AI is coming in higher than previously guided.
This comment kicked off the tone of the call: “I know we told you in December, our revenue from AI would be 25% of our full year semiconductor revenue. We now expect revenue from AI to be much stronger, representing some 35% of semiconductor revenue at over $10 billion.” This is up from $7.5 billion expected this year, and also up from a $6 billion run rate last quarter ($1.5B per quarter). The AI revenue is roughly 70% ASICs and 30% AI Networking.
In addition to stronger-than-expected AI revenue, Broadcom is expecting dramatic, sequential growth in software bookings, which are expected to grow about 70% QoQ. We need another quarter or two to verify if the rapid growth from VMWare Cloud Foundation will continue, but management implies it will continue to be strong. If so, Broadcom is quickly asserting itself as a leader in AI software as consolidated bookings are expected to add $1.2 billion QoQ from $1.8 billion this quarter to $3 billion next quarter.
Financials Overview:
Revenue and EPS:
Q1 revenue was $11.96 billion, beating estimates by $240 million, and representing YoY growth of 34%. Excluding VMWare, revenue growth was 11% for a 7 percentage point acceleration over the past two quarters, at 4% in the October quarter and 4.9% growth in the July quarter.
Q4 adjusted EPS was $10.99, beating estimates by $0.57. GAAP EPS was $2.84, compared to $8.80 in the year ago quarter.
Broadcom reiterated its fiscal year revenue guide of $50 billion and full year EBITDA guidance of 60%. This compares to an EBITDA margin of 63% to 65% in previous quarters.
Margins:
Q1 GAAP gross margin was 61.7%, compared to 67.4% in the year ago quarter. Amortization of acquisition-related intangible assets adversely impacted gross margin by ~1150bp in the quarter. Adjusted gross margin was 75.4%, compared to 73.8% in the year ago quarter.
Q1 GAAP operating margin was 17.4%, compared to 46% in the year ago quarter. The operating margin was mainly lower due to the increase of amortization of acquisition-related intangible assets, restructuring charges, and stock-based compensation. Adjusted operating margin was 57.1%, compared to 60.9% in the year ago quarter.
Q1 GAAP net margin was 11.1%, compared to 42.3% in the year ago quarter. The net margin was mainly lower due to the increase of amortization of acquisition-related intangible assets, restructuring charges, and stock-based compensation. Adjusted net margin was 43.9%, compared to 50.3% in the year ago quarter.
Cash and Debt:
Q1 operating cash flow was $4.82 billion, representing a 40.3% margin.
Q1 free cash flow was $4.69 billion, representing a 39.2% margin. Excluding restructuring and integration spend of $658 million, free cash flow was 45% of revenue.
Cash, equivalents and short-term investments totaled $11.9 billion.
Debt totaled $75.9 billion. The debt increased from the $39.2 billion in the previous quarter due to the additional debt taken to finance the VMware purchase and the company also assumed $8.3 billion VMware’s debt. We had discussed this in our deep-dive here. The average coupon-rate and years to maturity of fixed rate debt of $48 billion is 3.5% and 8.4 years, respectively. The average coupon-rate and years to maturity of floating rate debt of $30 billion is 6.6% and 3 years, respectively. This week, the company repaid $2 billion of floating rate debt and intends to maintain this quarterly repayment throughout FY2024.
In Q1, Broadcom paid stockholders $2.4 billion of cash dividends based on a quarterly common dividend of $5.25 per share. The company repurchased $7.2 billion of common stock and eliminated $1.1 billion of common stock for taxes due on vesting of employee equity, resulting in the repurchase and elimination of approximately 7.7 million AVGO shares. The Q2 non-GAAP diluted share count is expected to increase to approximately 492 million as the shares issued including VMWare.
Days sales outstanding were 41 days in the first quarter compared to 31 days in the fourth quarter on higher accounts receivable due to the VMware acquisition. This is due to the accounts receivable from VMware having payment terms of 60 days compared to Broadcom’s 30 days.
The company ended the first quarter with inventory of $1.9 billion, up 1% sequentially.
Key Segments:
Software Revenue:
Management reiterated their software revenue guidance of $20 billion this year.
Q1 Software segment revenue of $4.6 billion was up 156% year-on-year and included $2.1 billion in revenue contribution from VMware. In the previous quarter, software was $1.97 billion. This implies 27% QoQ growth in software after stripping out VMWare. When asked about this, management said to not get too excited about this particular growth as it’s due to strong contract renewals. Instead, the CEO explicitly stated: “Yes, don't get too excited over that. So that has also accelerated, but that's not the star of this show, Stacy. Star this show is the accelerating bookings and backlog we are accumulating on VMware.” In fact,it was indicated that some of this could fall off in future quarters given the software guide was not raised.
What the CEO is referring to as the star of the show is the consolidated bookings in software, which grew sequentially from less than $600 million to $1.8 billion in Q1 and is expected to grow to over $3 billion in Q2. Per management: “Revenue from VMware will grow double-digit percentage. Sequentially, quarter-over-quarter, through the rest of the fiscal year.”
Management stated the rapid growth from the VMWare segment is because: “We are focused on upselling customers, particularly those who are already running their compute workloads with vSphere virtualization tools to upgrade to VMware Cloud Foundation, otherwise branded as VCF […] VMware and NVIDIA entered into a partnership called VMware Private AI Foundation, which enables VCF to run GPUs. This allows customers to deploy their AI models on-prem. And wherever they do business without having to compromise on privacy and data — in control of their data. And we are seeing this capability drive strong demand for VCF, from enterprises seeking to run their growing AI workloads on-prem.”
We covered the VMWare acquisition recently in our Broadcom deep dive here.Broadcom deep dive here.
Semiconductor Revenue:
Semiconductor solution sales increased 4% YoY to $7.39 billion, a slight uptick from 3.3% growth in the prior quarter. Stronger-than-expected growth from AI more than offsetting the cyclical weakness in broadband and server storage. According to Bloomberg, this was a bit shy of expectations for $7.7 billion in revenue. This was most likely due to weak wireless, broadband, and server storage segments.
Q1 networking revenue of $3.3 billion grew 46% year-on-year, representing 45% of semiconductor revenue. Management stated the following: “For fiscal 2024, given continued strength of AI NAND working demand, we now expect networking revenue to grow over 35% year-on-year compared to our prior guidance for 30% annual growth.”
Q1 wireless revenue of $2 billion decreased 1% sequentially and declined 4% year-on-year representing 27% of semiconductor revenue. Wireless is expected to be flat YoY for FY2024.
Q1 server storage connectivity revenue was $887 million or 12% of semiconductor revenue, down 29% year-on-year. The company revised its server storage revenue to decline in the mid-20 percentage range compared to prior guidance for a decline in the high teens.
Broadband Q1 revenue declined 23% year-on-year to $940 million and represented 13% of semiconductor revenue. Broadcom revised its outlook for fiscal '24 broadband revenue to be down 30% year-on-year from prior guidance of down mid-teens year-on-year.
Q1 industrial resales of $215 million declined 6% year-on-year. Management stated that industrial resales will be down high single digits this year.
Earnings Call:
Right out the gate, an analyst asked about the surprising acceleration in QoQ bookings on software. Because it’s QoQ, this isn’t accretive software growth from the acquisition (that’s the $600M to $1.8B), rather next quarter represents new, accelerated growth from $1.8B to $3B. The comment from management that “revenue from VMware will grow double-digit percentage. Sequentially, quarter-over-quarter, through the rest of the fiscal year’ helped to solidify that we are already seeing VMWare’s contribution accelerate. We need a few more quarters to figure out if this is a pull forward of some kind and to see where the growth rate will eventually settle. Certainly, it’s off to a promising start.
Question Harsh Kumar (Analyst)
Once again, tremendous results and tremendous activity that you guys are benefiting from in AI. But my question was on software. I think if I heard you correctly, Hock, you mentioned that your software bookings will rise quite dramatically to $3 billion in 2Q. I was hoping that you could explain to us why it would rise almost 100% up, if my math is correct, in 2Q over 1Q. Is it something simple? Or is it something that you guys are doing from a strategy angle that's making this happen?
Answer Hock Tan (Executive)
As I indicated, with the acquisition of VMware — we're very focused on selling, upselling and helping customers, not just buy but deploy this private cloud what we call virtual private cloud solution or platform on their on-prem data centers. It has been very successful so far. And I agree it's early innings still at this point. We just have closed on the deal — well, we closed on the deal late November, and we are now March, early March.
So we had the benefit of at least 3 months, but we have been very prepared to launch and focus on this push initiative on private cloud, VCF. And the results has been very much what we expect it to be, which is very, very successful.
This was also stated later in the call by the CEO:
“All that focus is on the largest, I would say, 2,000 strategic customers. These are guys who want to still have significant distributed data center on-prem […] today's environment, most of these customers do not have an on-prem data center that resembles what's in the cloud, which is very high availability, very low latency, highly resilient, which is one we are offering with VMware Cloud Foundation of VCF. It's exactly replicate what they get in a public cloud. And they love it. Now 3 months. But we are seeing it in the level of bookings we are generating over the last 3 months.”
Near the Semiconductor Trough
Regarding Broadcom’s underperforming segments, the company reiterated what was heard in the Marvell call that we are near the bottom.
Karl Ackerman (Analyst)
Hock, weakness in broadband, server and storage customers is understandable given what your peers have said this earnings season. But perhaps you could speak to the backlog visibility you have with your customers in those markets that would indicate those markets could begin to order again and see sequential growth in the second half through our calendar year?
Answer Hock Tan (Executive)
You're correct. We are — as I say, we are almost like near the trough. This year, '24, first half, for sure, will be the trough. Second half 24, don't know yet. But I tell you what, we have 52-week lead time, as you know. We are very disciplined in sticking to it. And based on that, we are seeing bookings lately, significantly up from bookings a year ago.
Conclusion:
Broadcom’s PS valuation is quite high at 16 compared to the 3-year median of 8. The PE ratio of 42 compares to a 3-year median of 28.5. How to approach this position is not easy given the report was quite strong and there is reason to believe Broadcom will end this year with more beats/raises now that VMWare Cloud Foundation is rapidly accelerating and we already got a $2.5B raise in AI revenue. It’s likely we close Marvell tomorrow and re-allocate some to Broadcom, while taking our time to find an additional entry in the coming weeks.
Marvell’s Q4 was primarily in line with consensus, though GAAP EPS reported a rather large miss. The Q1 forecast across the board was very weak, with revenues guided 16% below consensus with margins firmly negative.
Q4 saw a marginal YoY increase in revenue, breaking a three-quarter string of declining growth, but Marvell guided for a (13%) YoY decline in revenue in Q1 at midpoint, suggesting that it is not yet out of the woods with weak growth in all of its end markets except for data center. Management dangled some carrots in the earnings call, primarily that Q1 would mark the bottom and that qualifications for ASICs are now moving to production for full ramp in FY26 (one year from now).
Revenue and EPS:
Q4 revenue was $1.43 billion, beating estimates by $10 million, and representing YoY growth of 0.7%.
Q1 revenue guidance missed at $1.15 billion, +/-5%, representing a YoY decline of (13%) at midpoint. As stated above, this is 16% below consensus with expected revenue of $1.37 billion.
FY24 revenue was $5.51 billion, a decline of (6.9%) YoY. Prior to the report, analyst consensus was for an acceleration in FY2025 to 11.1% YoY to $6.11 billion and 19.9% YoY to $7.33 billion in FY2026. The acceleration will likely still materialize but could be delayed given the weak Q1.
Q4 adjusted EPS was $0.46, meeting estimates and representing flat YoY growth. GAAP EPS was ($0.45), missing estimates for $0.00.
Management guided for Q1 EPS of ($0.23) +/- $0.05 and adjusted EPS of $0.23 +/- $0.05. This is a miss compared to consensus for $0.40 adjusted EPS.
FY24 adjusted EPS was $1.51, a decline of (40.4%) YoY. GAAP EPS was ($1.08), compared to ($0.19) in FY23. Previously, EPS was expected to rebound to 33.1% YoY growth to $2.01 in FY2025 and 40.4% YoY growth to $2.82 in FY2026. These estimates may come down given the weaker Q1 guide.
Margins:
Margins were weak, as Marvell reported a negative GAAP operating margin whereas it had guided for a thinly positive operating margin in Q4.
Q4 GAAP gross margin was 46.6%, compared to 47.5% in the year ago quarter. The adjusted gross margin was 63.9%, up from 60.6% in the previous quarters. Per management last quarter: The CFO, Willem Meintjes, said in the earnings call, “Our forecast for this large sequential improvement is driven by expectations of a significantly stronger product mix and our ongoing cost optimization activities. Looking forward, we expect that product mix as well as the overall level of revenue will remain key determinants of our gross margin in any given quarter.”stronger product mix and our ongoing cost optimization activities. Looking forward, we expect that product mix as well as the overall level of revenue will remain key determinants of our gross margin in any given quarter.”
Q4 GAAP operating margin was (2.3%) versus its guide for 1.6% at midpoint. This compares to 1.6% in the year ago quarter. GAAP operating margins for Q1 are expecting to fall further, with management guiding Q1’s GAAP operating margin at (12.3%) at midpoint, a 1000 bps sequential decline. Regarding GAAP OPM, management stated this includes “stock-based compensation, amortization of acquired intangible assets, restructuring costs and acquisition-related costs.” Stock based compensation was $155.3 million, or 11% of revenue.
Adjusted operating margin was 33.8% for adjusted operating profits of $482.6 million. This fluctuates due to seasonality in payroll taxes and employee salary increases.
Q4 GAAP net margin was (27.5%), compared to (1.1%) in the year ago quarter and (11.6%) in Q3. Adjusted net margin was 28.2% for adjusted net profits of $401.6 million.
FY24 GAAP gross margin was 41.6%, compared to 50.5% in FY23. Adjusted gross margin was 61.2% compared to 64.5% FY23.
FY24 GAAP operating margin was (10.3%), compared to 4% in FY23. Adjusted operating margin was 29% down from 36% in the previous year.
FY24 GAAP net margin was (16.9%), compared to (2.8%) in FY23. Adjusted net margin was 23.8% down from 30.8% the previous year.
Cash and Debt:
Q4 operating cash flow was $547 million, representing a 38.3% margin.
FY24 operating cash flow was $1.37 billion, an increase of 6% YoY.
Cash, equivalents and short-term investments totaled $950.8 million.
Debt totaled $4.16 billion. Gross debt-to-EBITDA ratio was 2.19X and net-debt-to-EBITDA ratio is 1.69X. This has been slightly trending down but is still a concern.
Inventory at the end of the fourth quarter was $864 million, down by $77 million from the prior quarter. DSO was 77 days, decreasing by a day from the prior quarter.
The company returned $52 million to shareholders through cash dividends and repurchased $100 million of our stock during the fourth quarter, double from the prior quarter. The company expects to further increase repurchases in the first quarter of fiscal 2025.
Marvell's Board approved the largest repurchase authorization in company history, increasing the current plan by $3 billion, for a total available authorization of $3.3 billion
Key Segments:
Data Center:
Data center revenue was the strongest point of the report, with growth at 54% YoY in Q4, breaking a four-quarter string of declining growth. Data center revenues increased 38% QoQ, ahead of the mid-30% range management had guided and a sharp acceleration from 21% QoQ growth in Q3 and 6% QoQ in Q2.
Data center accounted for 54% of revenue in the fourth quarter, a large increase from 39% in the prior quarter. According to the opening remarks, it was a mix of primarily traditional data center and some AI driving this increase: “The strong revenue growth in the quarter was driven by the cloud portion of our data center end market. While AI has been a key growth driver, I am pleased that our standard cloud infrastructure revenue has also grown every quarter, and we see that continuing next year. Our 800-gig PAM solutions led our growth in the fourth quarter. We also benefited from higher sequential demand for our storage products as that portion of our data center end market continues its recovery. Revenue from our Teralynx, Ethernet switches also grew sequentially in the quarter.”
Management said data center revenue for next quarter will be in the low single digits QoQ: “Turning to the first quarter of fiscal 2025. We expect our overall data center revenue to grow in the low single digits sequentially on a percentage basis. We expect revenue from both AI and standard cloud data centers to continue to grow sequentially. We project our [ Electro ] optics revenue to continue to be strong, and we also expect to benefit from the initial shipments of our cloud optimized AI silicon programs. Partially offsetting this growth, we are projecting a more than seasonal sequential decline in revenue from enterprise on-premise data centers.”
The main carrot that was dangled on data center as it pertains to AI is for H2 growth. I’ve included that commentary below.
Enterprise Networking & Carrier Infrastructure – Steep declines in Q1, Mgmt says will mark the bottom
Enterprise Networking revenue was $265M (down 28% YoY, down 2% QoQ).
Enterprise is expected to decline 40% QoQ in Q1.
Carrier Infrastructure (5G) revenue of $170M (up 38% YoY, down 46% QoQ).
Carrier is expected to decline by 50% QoQ in Q1.
Per the comments on the call, Q1 is expected to be the bottom.
“As we have been communicating, these end markets [enterprise and carrier] have been dealing with a period of soft industry demand. As a result, both were down sequentially in the fourth quarter and we expect them to decline again in the first quarter […] Looking ahead, we expect revenue declines in these end markets to be behind us after the first quarter and forecast a recovery in the second half of the fiscal year. Longer term, these are large and enduring end markets, which are critical to the global economy. As a result, we expect both of these end markets to eventually return to contributing over $1 billion each in revenue on an annual basis once demand normalizes, and we begin to realize the benefits of upcoming Marvell-specific product cycles.
Consumer:
Consumer revenue of $143.9M (down 20%, down 15% QoQ). Consumer is expected to decline (70%) QoQ in Q1.
Per management remarks: “This forecast reflects the completion of deliveries for an end-of-life program in the prior quarter as well as significantly weaker demand from the game console market.”
Automotive:
Automotive/Industrial revenue of $82.3M (down17% YoY, down 23% QoQ). This is a small segment for Marvell that has been impacted by the softness in EVs. For the fiscal year 2024, automotive was up double digits YoY. It’s expected to be flat QoQ in Q1.
Earnings Call:
AI Revenue Ramping in H2 & Beyond
Marvell has to find a way to impress Wall Street on AI despite the fact that it’s ramping much slower than its peers. If we read between the lines, a run rate of about $500 million will happen early FY2026. That’s my rough math, but given commentary in the opening remarks, we are looking at $200M per quarter right now on AI networking/optics and can expect $200M by Q1 FY2026 on ASICs/compute. So, if we assume AI networking grows by 50% this year, we arrive at $500M in about 12 months from now.
Here's the commentary I’m basing that on – it’s the second paragraph that has more information on AI revenue specifically:
“We now have a clear view of demand for both this fiscal year as well as fiscal 2026. We have been working closely with our suppliers and are confident that we have secured capacity for the ramp. With the visibility we now have for these programs, along with many new opportunities, we are very excited about the potential scale of long-term revenue for Marvell from this business. As the initial set of design wins reach its full run rate, we expect annual revenue from cloud optimized silicon has the potential to rival our fast-growing data center optics business, which, for reference, grew to over $1 billion in fiscal 2024.”
Additionally, management offered a few more breadcrumbs as to AI revenue, such as: “AI was a key driver of our data center growth in fiscal 2024, contributing over 10% of total company revenue, well above our initial forecast. This was a substantial increase from approximately 3% in the prior year. Our momentum accelerated throughout the fiscal year with AI revenue well over $200 million in the fourth quarter, driven mostly from Optics […] In fact, as our cloud optimized AI silicon programs reach high-volume production, we expect our overall cloud optimized revenue to exceed $200 million exiting the fourth quarter.As a result, on a run rate basis, this momentum would put our overall cloud optimized silicon revenue above the annual $800 million target we had provided at our last Investor Day. And with the full year of contributions in fiscal 2026, we expect to be way ahead of the prior target. In aggregate, we see a favorable setup for the second half of this fiscal year, driven by continued growth from our data center end market, ongoing growth from automotive, and a recovery in carrier, enterprise and consumer.”
Later in the Q&A, this was the better question in terms of discussing potential AI revenue in custom silicon moving from qualification to production:
Question Harlan Sur (Analysts)
Matt, you mentioned the initial shipments of your AI ASIC program. Can you just clarify because I know last you updated us, these programs were in qualification. So have you guys passed Qual on both these programs? And is it sort of the initial start of the full production ramp? Or maybe you're still in Qual, but you've got enough line of sight to passing the Qual just given you're at the tail end of this process? And maybe more importantly, have you guys secured the follow-on AI programs for these two initial projects?
Answer Matthew Murphy (Executives)
So yes, we are in the initial start of the production ramp on both products. And then as far as the follow-on, like I said, the opportunity funnel we see across all of the various opportunities right now is significant, and we're involved in, we believe, we think, every single one of them. So yes, and there'll be more to come sort of at our AI day, but I would just say our 3-nanometer funnel and our 3-nanometer hit rate and design win rate is very encouraging and it really gives us this tremendous confidence in where this business is headed. It also has a side benefit by driving this advanced technology for the custom ASIC side, is it's pulling along the technology development that benefits all the other businesses in Marvell, like our high-performance switching, our DSP for optics, et cetera. So there's actually kind of a virtuous cycle happening where being at that bleeding edge is now we're able to show our other solutions that interoperate with this custom silicon, really a best-in-class road map there.
Q1 is the Bottom
The CFO later reiterated that Q1 will be the bottom:
“Yes, so we're really working with customers to focus on Q1 being the bottom, really confident that, that's the bottom. And then we see growth resuming in the second half across enterprise networking, carrier and consumer so really just trying to make sure that we put this behind us really quickly and see growth in the second half.”
Conclusion:
As I left the Marvell call and moved along to join the Broadcom earnings call, there is no doubt which company is stronger right-here, right-now. It’s Broadcom. Marvell has a strong product story but it’s in a sea of AI whales that are ramping quickly. The $500M in AI revenue per quarter (run rate) estimated to be reported in about 12 months time is a strong start, but the stock is trading quite high. Also, the need to impress the market is high and Marvell management is trying hard with this very-forward-looking commentary.
At the right price, Marvell will make a great stock. But unfortunately, it’s the opposite which is that at this valuation, we plan to sell Marvell. The PE Ratio is similar to PS Ratio, which is that it’s trading in a range that the stock struggles to maintain.
In previous quarterly webinars, we’ve pointed out that Marvell is our weakest stock in an environment where rates remain elevated given its debt-to-equity ratio and GAAP profitability issues. Meanwhile, Nvidia’s PS Ratio and PE Ratio is near it’s October 2022 lows and Broadcom stated today it’s expecting $10B in AI Revenue this year, or 20% of its total revenue for this calendar year compared to Marvell’s 13%. Given Q1 is quite troublesome for Marvell with steep sequential declines and AI revenue that is likely priced in, we will look to trim or exit and buy lower. You can also expect us to re-allocate some of this to AVGO in the meantime. Or, perhaps, we will buy more Nvidia as we go along. Overall, we see both as stronger choices at the moment, and will revisit Marvell when it’s either cheaper or moving quicker in terms of its AI growth trajectory.
CrowdStrike reported a new record for net new ARR in Q4, far surpassing the record it set in the previous quarter, and GAAP margins continued to strengthen. Net new ARR accelerated significantly in the quarter to 27% growth, which is a 14-point acceleration from 13% growth in Q3. This is up from 2% growth for net new ARR in the year ago quarter. The turnaround in this particular key metric is notable, especially compared to other cloud stocks whose key metrics are decelerating. ARR increased 34% to $3.44 billion, which was down 1 percent from 35% growth last quarter.
For FY25, CrowdStrike’s guide was marginally above consensus, yet the market is clearly pleased with the continued expansion in operating and net margins. The turnaround on net new ARR is notable, yet the turnaround on GAAP profitability is what is most impressive compared to its cloud peers, especially considering the far majority of cloud stocks are years away from GAAP profitability (if they ever get there). We covered this in-depth here.
Revenue and EPS:
Q4 revenue was $845.3 million, beating estimates by $5.3 million, representing YoY growth of 33%. This is down from 36% growth in the previous quarter.
Q1 revenue was guided between $902.2 million to $905.8 million, representing YoY growth of 30%.
FY24 revenue was $3.06 billion, an increase of 36% YoY.
FY25 revenue was guided at $3.925 billion to $3.99 billion, slightly ahead of consensus for $3.94 billion and representing YoY growth of approximately 29% at midpoint.
Q4 adjusted EPS was $0.95, beating estimates by $0.13 and representing YoY growth of 102%. GAAP EPS was $0.22, compared to ($0.20) in the year ago quarter.
FY24 adjusted EPS was $3.09, an increase of 101% YoY. GAAP EPS was $0.37, compared to ($0.79) in FY23.
The bottom line is expected to grow steadily over the next two fiscal years, suggesting that GAAP profitability is permanent. With that said, analyst consensus for next quarter of $0.82 is lower than Q4’s EPS of $0.95. It’s likely we see upward revisions to Q1’s EPS over the next few days, although management guided for an adjusted operating margin that is four points lower QoQ than the current quarter.
Margins:
Margins strengthened across the board – driven by four quarters of GAAP gross margin at 75% and GAAP subscription margin at 78%. For the full year, CrowdStrike nearly broke even from operations, reporting just a ($2 million) loss from operations, or a (0%) margin, an 800 bp improvement from FY23. CrowdStrike also reported its first full year with GAAP net profitability, reporting a 2.9% net margin, compared to an (8.2%) margin in FY23.
Q4 saw net margin more than double sequentially, from 3% in Q3 to 6.4% in Q4, as net income surged 101% QoQ to $53.7 million – this means that CrowdStrike generated 60% of its GAAP net income in Q4 alone.
Q4 GAAP gross margin was 75.3%, compared to 72% in the year ago quarter.
Q4 GAAP operating margin was 3.5%, the second straight quarter with a positive margin and an increase from 0.3% in the previous quarter.
o To further illustrate CrowdStrike’s margin expansion, GAAP operating income was $30 million this quarter compared to (-$61.5) million in the year ago quarter. This is up from $3.2 million last quarter.
o CrowdStrike’s adjusted operating income was $213.1 million for a margin of 25%. The company is guiding for a lower margin next quarter of 21%.
Q4 GAAP net margin was 6.4%, the fourth consecutive quarter with a positive margin and an increase from 3% in the previous quarter.
Stock based compensation was 20.9% of revenue compared to 20.3% of revenue in the previous quarter for a total of $176.3 million.
Fiscal Year 2024 Margins:
FY24 GAAP gross margin was 75%, compared to 73% in FY23.
FY24 GAAP operating margin was (0%), compared to (8%) in FY23.
FY24 GAAP net margin was 2.9%, compared to (8.2%) in FY23.
For FY2025, the CFO provided the following color: “As a result of increased hiring in the first half of the year, changes to the timing of our merit cycle and the timing of certain marketing programs, we expect operating leverage to be more weighted to the back half of FY '25.”
Cash and Debt:
CrowdStrike is known for its strong cash flow margins and this quarter was no exception. The company raised its FY2025 free cash flow target by 1-point at the midpoint. Per the CFO: “Next, we are raising our free cash flow target for FY '25 from between 30% and 32% to between 31% and 33% of revenue.”
Q4 operating cash flow was $347 million, representing a 41% margin. Free cash flow in the quarter was $283 million, a 33.5% margin.
FY24 operating cash flow was $1.16 billion for a margin of 38%. Free cash flow was $938.2 million for a margin of 30.7%.
Cash, equivalents and short-term investments totaled $3.47 billion.
Debt totaled $742.5 million.
Key Metrics:
CrowdStrike added a record $281.9 million in net new ARR in Q4, far surpassing its previous net new ARR record of $223 million set just in Q3. Net new ARR increased 27% in Q4, a 14 percentage point acceleration from just 13% growth in Q3.
According to the CFO: “while we do not specifically guide to ending or net new ARR, given the incredible performance of Q4, I will share our currerpnt seasonality assumptions with respect to net new ARR in Q1, which calls for Q1 net new ARR year-over-year growth to be at least double digits up to the low teens.” The CFO is tempering expectations that 27% is not realistic for next quarter, but strong growth is still achievable.
ARR of $3.44 billion was up 34% YoY compared to ARR of $3.15 billion and growth of 35% in the previous quarter. Management has stated: “We continue to aggressively invest in our innovation engine and flank the company to achieve its vision of reaching $10 billion in ARR over the next 5 to 7 years.” That would imply about 200% growth in 5-7 years. The growth of deals with total value exceeding $1 million accelerated to “over 30%” this quarter for 250 customers.
Deferred revenue of $3.05 billion was up from $2.36 billion in the year ago quarter. The sequential increase from $2.5 billion suggests that billings are strong. Billings for this quarter comes to $1.36 billion, up 65% QoQ and up 39% YoY. There was mention on the call that total billings outgrew short-term billings, which translates to customers committing for longer contracts. Management likes to remind analysts that ARR is a better measure of their business, even during quarters when deferred revenue and billings are strong.
Similar to deferred revenue, RPO reported an astonishing surge that points toward CrowdStrike being resilient compared to its peers. RPO was up 35% YoY and up 24% QoQ to $4.6 billion. This is the highest QoQ growth we’ve seen the company report since tracking this metric over the past 11 quarters. Compare the 24% QoQ growth to only 3% QoQ growth last quarter.
Subscription revenue of $795.9 million increased 33% compared to 34% last quarter. Professional Services grew 26.3% for revenue of $49.4 million.
Customers with multiple modules increased 1% across the board, including in the 7+ module cohort, 6+ module cohort, and 5+ module cohort.
Dollar based net retention was 119%, same as last quarter. The company offered visibility (finally) into the quarterly DBNRR over the past year of “Net retention was 119% in Q3, 119% in Q2 and 122% in Q1.” These numbers had been left vague before. It’s softening a bit and 120% is the benchmark CrowdStrike has stated they want to achieve.
Earnings Call:
Data-Centric Architecture in a Single Platform:
The predominant question in the Q&A is why is CrowdStrike resilient when peers are not. As you’re likely aware, Palo Alto Network, Fortinet and Zscaler saw turbulence following their earnings reports. Overall, the CEO and management team focused on why a platform is important instead of a fragmented approach to acquisitions from “multi-platform hardware vendors [that] evangelize their stitched together patchwork of point products, masquerading as thinly veiled piecemeal platforms.” Wow, those are strong words. CrowdStrike is not shy about naming the companies they are taking business from. In this call, it was Azure Sentinel, Splunk and Palo Alto Networks. Later on, there was a quote that I think best juxtaposes the differences between the piecemeal platforms and what CrowdStrike is offering:
“So when we think about architecture, architecture does matter and really what we've created is a very data-centric architecture that allows us to get data at scale into our platform, leverage our AI and then create the outcomes. It's that collect once, use many. We have a single platform. Our competitors have many other platforms as they call them. We have a single agent. Our competitors have 5, 6, 7, 8 agents depending on the competitors.
So when we look at our architecture, it was really designed from the beginning to solve the problems of today and the future problems. And the result of that is ease of use, the outcome that a customer is looking for, stopping breaches and lowering the cost, and future proofing what they want. I've — in a prior life, I've been involved in companies that acquired a lot of products. And I can tell you, it is near impossible to stitch all this stuff together, particularly at the agent level unless you're very diligent about it.
This was further quantified in the opening remarks when it was stated that a recent IDC platform is “showcasing $6 of return for every dollar invested in the Falcon platform.”
It’s important to drop a note that many companies can break out AI revenue, whereas CrowdStrike’s data-driven AI features are inherent to the platform. Therefore, I don’t believe it’s possible to have a separate AI segment the same way other companies offer.
“The statement that CrowdStrike’s data is more valuable is based on the vast number of threats their platform has already detected. Essentially, the argument is that their XDR platform is better than competitors, and therefore, their data is better than competitors, which results in smarter and more accurate AI output. Here is how management spoke about it: “we actually have a very well-defined training set that's annotated based upon all the threat hunting that we've done over the last 10 years.”
Automation reduces the number of false positives. Instead of getting every piece of telemetry that requires the security team to investigate, AI-assisted endpoint detection and response solutions eliminates the noise so that the security team is only responding to those that have the potential to be critical. Fundamentally, cybersecurity is a data problem. CrowdStrike’s Falcon platform ingests, correlates, and queries petabytes of structured and unstructured data from ever-expanding disparate external and internal sources in real-time. It builds rich context and delivers greater visibility by constructing a dynamic representation of data across an organization. As a result, the company’s AI models are often highly accurate in triggering a response.
However, in the earnings report this quarter, the CEO stated a few new things that investors should see creates a more all-encompassing AI platform:
“We collect trillions of threat signals daily creating one of the world's largest and fastest-growing cyber threat data set. From day 1, we've been an AI company, training the industry's most effective and accurate AI models to prevent attacks based upon our data moat.”
Falcon for IT:
On the same note that AI is not a separate revenue segment for CrowdStrike, there are additional ways CrowdStrike plans to leverage its “AI-native” platform. One of the more popular hybrid use case is called Falcon for IT, which allows IT teams to leverage AI and automation to query the IT systems and servers. This is useful for things like fleet management, compliance, and performance monitoring. By using generative AI, IT Teams can query assets for unauthorized software, outdated machines, patch status and also schedule queries to detect anomalies.
I’m highlighting this as a segue into the broader idea that AI and automation is likely to have a large impact on CrowdStrike (and perhaps more immediate) compared to other cloud stocks on the market.
This was the CEO’s commentary on the call:
“Customers are looking for a better solution in this area. And one of the things that we found is that the security team has been solving a lot of IT problems and challenges for IT for a long time, and we really needed to carve out a home for IT. So when you look at some of our competitors in that market, it's — obviously, it's a pretty big market, but having a single agent and the ability to actually solve IT problems, which many of our customers were doing already, is fantastic.
So again, early days, but the feedback and the interest is off the charts for Falcon for IT, and it goes to the heart of how we built the platform. To collect data, it doesn't have to be security data. It can be almost any data related to either our agent first-party data or now third-party data we can ingest. And that solves many use cases beyond what we originally came to market with. So I think the sky is the limit there.”
FY2025 Net New ARR Commentary
Since ARR and net new ARR is what moves the stock, I wanted to include what the CFO stated in terms of FY2025. It’s very vague but sounds positive in terms of net new ARR building from Q1 and beyond.
Question Matthew Hedberg (Analyst)
I'll offer my congrats as well, guys. Burt, your new ARR commentary was helpful for Q1. I'm curious, this time last year, I believe you talked about flat net new ARR growth for fiscal '24. And obviously, I think you guys did about 6% this year. Any just sort of like directional guardrails you give us from a full year perspective in terms of just thinking about it from a net new perspective?
Answer Burt Podbere
So with respect to ARR, obviously, we don't guide to it. But we have talked about in the past where we've started the year in Q1 and build from there. And that's kind of really all I can really comment on ARR. You can kind of infer where we're going with our guide. And — but at the end of the day, our guide — the methodology has remained consistent, and that's how we think about it.
Conclusion:
CrowdStrike’s post-earnings reaction is as much about CrowdStrike as it is about the weakness of its peers. The excellent timing of the increasing GAAP profitability merging with accelerating key metrics is something we are not likely to see in any other best-of-breed cloud company this earnings season.
The market is anxious to find AI winners early-on. By combining cybersecurity with AI in a single platform with a data-centric architecture, CrowdStrike is emerging as one of the few cloud companies that has resiliency and the AI “it” factor. We continue to believe that 20 Forward P/S is the ceiling for cloud stocks, yet we also continue to believe that CrowdStrike is the leader in the cloud category. For reasons quite apparent this evening, CRWD is one of two that we are interested in owning now and into the foreseeable future out of the dozens and dozens of cloud stocks on the market.
Note: We have updated the analysis on 03/06 with the following: Billings for this quarter comes to $1.36 billion, up 65% QoQ and up 39% YoY.
This article was originally published on Forbes on Feb 29, 2024, 09:34pm ESTForbes Forbes on Feb 29, 2024, 09:34pm EST
The Magnificent 7, defined as Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia and Tesla, have seen a “magnificent” run fueled by AI optimism over the past fourteen months. The Magnificent 7 returned more than 106% in 2023, doubling the Nasdaq 100’s nearly 54% gain and significantly outperforming the S&P 500’s 24% gain. At first glance, it may appear that the Magnificent 7 are continuing their outperformance of the broader indexes in 2024.
However, like dominos falling, these market generals are topping out and diverging from the broad market. First Tesla in July of 2023, then Apple and Google in February have topped, and now Microsoft is not making a new high with the broad markets’ most recent run higher.
The Magnificent 7 of 2023 have now become 2024’s Magnificent 3: Nvidia, Meta and Amazon. Of these, Nvidia’s saw a stellar start to the year as shares have gained nearly 60% YTD due to the GPU leader’s beat-and-raise quarters.
Source: TradingView
There are two reasons why this matters – which we also outlined in our analysis “Five Stocks (Not Seven) Can Lead to New Highs” from October – that “a handful of these stocks [the Mag 7] can push the bigger markets higher,” but now we’ll need more than just three to keep the rally going.
First, these 7 stocks hold a significant weighting within the indexes. It will be difficult for a sustained push higher to continue if these FAANGs do not participate, considering their outsized weighting.
The Mag 7 comprises more than 40% of the Nasdaq 100 and more than 29% of the S&P 500.
MSFT, GOOGL, AAPL, and TSLA account for about 18% of the S&P 500 and about 25% of the NASDAQ-100.
For reference, just Apple and Microsoft combined hold a larger weighting in the S&P 500 than Berkshire Hathaway, JP Morgan, UnitedHealth Group, Visa, Exxon, Mastercard, Johnson & Johnson, Procter and Gamble, Home Depot, Costco, Merck, and Chevron combined. If these companies collectively all stalled, it would be a major warning sign. Yet, Apple and Microsoft are both stalling.
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Secondly, when the cycle leaders start to underperform, it tends to mark the start of a trend change. The FAANGs have been the undoubted leaders of this bull run, and we are now seeing them start to trend lower against the indexes. More times than not, the leaders on the way up, tend to be the leaders on the way down.
In today’s bull cycle, this leaves Nvidia, Meta and Amazon as the three remaining generals making new highs with the markets.
Nvidia, Meta and Amazon are the three remaining generals making new highs with the markets. Source: TRADINGVIEW
Combined, the trio account for approximately 15.8% of the Nasdaq 100 and 10.8% of the S&P 500. Nvidia’s post-earnings surge, in which the chip giant added nearly $250B in value, helped the S&P 500 add more than $2 trillion in market cap as it boosted other AI and tech stocks in general. Should the trio begin to follow in the path of the four fallen dominos, setting a high and drifting lower, the market may be at risk of giving up some of its newfound gains, similar to what we had discussed in our analysis “Apple Can’t Save This Tech Rally” at the end of January. In this, we outlined how both the bull and bear cases for the market “are calling for a level of volatility in 2024 that will, at least, retrace the rally we’ve seen since November 2023.”
Concentration Risk Elevated
To an extent, the narrow leadership of this market stemming from the Magnificent 7’s AI-powered gains has raised warning bells for some investors, as the market’s concentration has surpassed levels seen in the dot-com bubble. To be clear, my firm is a pioneer in building an AI portfolio, and a selloff would be a buying opportunity. However, narrow leadership is a problem not to be ignored, and this is best illustrated by the chart below:
Source: CME
As mentioned earlier, the Magnificent 7 account for more than 29% of the S&P 500, more than the 21% concentration of the top 7 stocks in the S&P 500 seen in 1999 and 2000 — keep in mind that Tesla is no longer one of the top 10 largest stocks in the S&P 500, so the concentration of the top 7 today is above 30%. This also marks a dramatic increase from the 14% concentration seen a decade ago.
What this means is that as the Magnificent 7 as a whole continue to outperform – the seven have already gained more than 22% YTD in 2024 – they will continue to cover up the turbulence in the broader market that is brewing under the surface. For example, at the end of February, the Nasdaq 100 and S&P 500 are up nearly 9% and over 7%, respectively, while the equal-weighted S&P 500 has gained just over 2%.
Source: TradingView
This concentrated dominance has helped the S&P 500 push to new highs, more than 6% above its 2021 high, while the equal weight S&P (orange) has yet to reclaim that 2021 high, sitting about 100 points lower. The influence of the Magnificent 7 is clearly visible — the S&P 500 has a 26 percentage point outperformance of the equal-weight index, returning 81% versus 55% over the past five years; this gap has widened throughout 2023, from 8 percentage points in April to 14 percentage points in July to 20 percentage points in October.
Source: YCharts
I/O Fund Portfolio Manager Knox Ridley outlined in our analysis in October, 5 Stocks (Not 7) Can Lead To New Highs that “a handful of these stocks [the Mag 7] can push the bigger markets higher, and even potentially make another high in the NASDAQ-100.” The setup was that the indices were “due for a sizable bounce over the coming weeks – months, which we believe will be led by a handful of Big Tech names.” Now that we are at new highs, we think we will need more than just three of the Mag 7 to keep going.
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Valuations Relatively Intact
Though the recent momentum-filled surges in AI favorites including Super Micro and Nvidia have some investors drawing parallels to Cisco’s ascent in 2000, valuations for the Magnificent 7 are relatively intact.
Tesla is struggling with earnings growth as price cuts bite margins, while Apple’s growth headwinds are leading to minimal earnings growth; on the other hand, Amazon is showing strong earnings leverage from improvements in its margins, Google is trading at a near 30% discount to its year-ago PE of 30x, and Nvidia is eerily cheaper now than it was when it had bottomed in October 2022 in the low $100 range.
Source: YCharts
Compare this to Cisco, given the parallels being drawn, which traded at more than 150 times earnings at the peak of the dot-com bubble – or more than twice as high a multiple as the most expensive of the Mag 7 of today.
We discussed on Fox Business News this week that keeping an eye on valuation is important for determining which stocks to buy on dips. The impact AI has had is very visible on the top line with blowout quarters from Nvidia, and on the bottom line with blowout quarters from both Nvidia and Meta. However, AI’s impact on valuations is being overlooked as these valuations are low and setting up a new buying opportunity should the broad market present weakness.
Conclusion
We will continue to track how the Magnificent 3 perform over the next few weeks, and whether Meta, Nvidia, and Amazon will continue to lead or if they will follow the trend of the remaining four in underperforming versus the broader indices.
When these cycle leaders start underperforming, it usually marks the start of a trend change. The FAANGs undoubtedly have led this bull run since 2023. We are now looking for what will lead the market next, and most importantly, when.
If you own AI stocks or are looking to own AI stocks, consider joining us for our next broad market webinar. Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, manage risk, as well as revealing our various long-term game plans regarding stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.
I/O Fund Portfolio Manager Knox Ridley and I/O Fund Equity Analyst Damien Robbins contributed to this report.
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.
Broadcom has greatly outperformed the FAANGs over the past decade yet is rarely discussed as one of the market’s top-performing stocks. The ticker certainly does not participate in a catchy acronym. Half the battle with Broadcom is there are many revenue segments to analyze, some go through harsh cyclical downturns, and it acquires companies hand over fist. To put it plainly, this is not an easy stock to cover; there are no pithy ways to summarize the products and it doesn’t offer growth stock qualities.
Broadcom is reporting the second highest AI revenue on the stock market today, accounting for 16.1% at $1.5 billion, up from the July quarter at $1 billion and 11.3% of revenue. Of the smaller players, peers like AMD have guided for AI revenue of $3.5 billion in 2024, which would account for about 13.6% of the 2024 estimated revenue. Marvel expects AI revenue of $400 million in 2023 or 7% of revenue and is rising to $800 million or 13% of the expected 2024 revenue. Therefore, Broadcom is in second place, but notably, does not have a large lead by percentage of revenue. Juniper at 23.5% of revenue has a higher percentage yet is being acquired by HPE.
Ultimately, our goal is to get this stock lower, but to put into motion now the in-depth research required for a potential entry. As stated in the 2023 Year in Review webinar, Meta was the one that got away given its bottom line fits our criteria, but I consider Broadcom the one sitting in plain sight.
Broadcom has many departments that have been strung together through acquisitions with a vision of consolidating Ethernet, ASICs and now virtualization under one company. The reason this company is sitting in plain sight is because it was a major winner from the mobile era, is partnered with Big Tech as we move in the AI era, and is putting together the pieces to participate in AI strategically by not needing to compete on GPUs.
Broadcom’s Switch Products and Switch Fabric
Broadcom has a dominant market share of switching and routing semiconductors for hyperscalers and is seeking to maintain its market share, most especially as AI changes networking requirements. The Jericho3-AI launch was last April, which is a redesign intended to compete with Nvidia’s InfiniBand.
Broadcom has three switch products. The Tomahawk is the high-bandwidth switch platform, Trident is the platform with more features, and the new Jericho line combines the Jericho switch with routing ASICs. The Jerico3 was redesigned with deep packet buffers. Tomahawk and Trident are used in data centers yet are not optimized for AI workloads, especially when compared to InfiniBand.
Jericho has 160 switch ports dedicated to switch fabric, which allows multiple ASICs to be stitched together to support GPU clusters. The asymmetric split helps the chip overcome network congestion and network failures. According to Broadcom, Jericho3-AI performed 10% better than “alternative network solutions” — which is a clear reference to InfiniBand.
A few specs before we go deeper into how Broadcom’s solutions compare to Nvidia’s. As you’ll note, the specs for InfiniBand are superior with support for 64X 400Gbp or 128 200 GB/s ports compared to Jericho’s 36X 400 GbE and 72X 200GbE network-facing ports.
Jericho has 144X SerDes lanes and 106Gpbs PAM4 supporting 18X 800Gbe, 36X 400 GbE and 72X 200GbE network-facing ports. The Jericho3-AI allows for more than 32,000 GPUs to be linked for a massive AI training system and links directly to GPUs without the need for a server bus.
Tomahawk5 runs at 100 GB/second with PAM4 with aggregate bandwidth of 51.2 Tb/s
Compare this to Nvidia’s Quantum-2 InfiniBand which has support for 64X 400Gbp or 128 200 GB/s ports with 51.2 Tb/s and 66.5 billion packets per second.
Nvidia’s new Spectrum X Platform is an Ethernet solution that delivers 1.6X better networking performance than traditional Ethernet with 256X 200 Gbe ports or 16,000 ports for larger training systems.
On a similar note, and while we are on the topic, Marvell has some skin in the game too by offering a 51.2T switch called Teralynx 10 that offers ultra-low-latency at 80% cost savings. According to Moor Insight Strategy, Marvell is the supplier for AWS for “electro-optics, networking, security, storage, and custom-designed solutions.”
Marvell’s Nova 1.6 Tbps PAM4 electro-optics have eight 200G lanes that “double the networking bandwidth while reducing power and cost per bit by 30%.” According to the press release, “by doubling the bandwidth per lambda, the Nova-based modules reduce the number of lasers and related optical components by 50%.”
Marvell hopes to help data centers transition to 51.2 Tbps networking architectures by offering a platform that needs 32 optical modules instead of 64 optical modules.
Here’s a a quick glance on the rankings for AI networking revenue (approx. revenue)
Nvidia in first place with $2.5B per quarter from InfiniBand
Broadcom in second place with $1.5B from AI, primarily networking
Marvell at $200M per quarter from AI, primarily networking
Juniper Networks reported $321.2 million in the AI enterprise segment, or 23.5% of revenue. Recently, it was announced that Juniper is being acquired by HPE.
Further out in FY2025 and/or CY2025:
Cisco is expecting $1 billion in orders from a recent Nvidia partnership, per the earnings call: “our expectation is the majority of that $1 billion in orders will turn into revenue in our fiscal '25, just to be clear.”
Arista is expecting $750 million by 2025: “We are cautiously optimistic about achieving our AI revenue goal of at least $750 million in AI networking in 2025.”
AI Networking
We’ve covered networking as it relates to data centers, 5G, cloud applications and enterprises when we wrote about Nvidia’s acquisition of Mellanox in 2020 and Marvell’s acquisition of Inphi.
A few years back, we discussed that Nvidia acquired Mellanox for the strategic synergy that InfiniBand and Ethernet can provide in boosting GPU performance. Without proper interconnection, GPU performance could be limited, and so Nvidia strategically wanted to create the best-case scenario of owning both markets for AI accelerators — and their fabric and interconnects.
Mellanox supports Virtual Protocol Interconnect (VPI), which allows the ubiquitous Ethernet to provide bandwidth as cheap as possible, and InfiniBand to deliver higher throughput and fewer bottlenecks during high loads. In 2019, the split in Mellanox’s revenue was about 40% InfiniBand and 60% Ethernet. By leveraging a hybrid of Ethernet and InfiniBand, Mellanox was able to take market share from Ethernet incumbents.
The acquisition went under review in China, with officials believing Mellanox’s market share at the time was about 55% to 60% of the global interconnect market and 80% to 85% of the Chinese market. This illustrates how popular Mellanox was before Nvidia acquired the company.
The outcome of the review was that Nvidia was required to decouple the sale of InfiniBand from the sale of its GPUs to where a customer could buy one but not the other at no penalty. Even if a customer can buy them separately, there are many cases where it’s not practical to do so, such as with the DGX and HGX systems which achieve optimal performance with the A100s/H100s and InfiniBand.
Nvidia has stated that InfiniBand increase the effectiveness of AI infrastructure by 20% to 30%. Remote Direct Memory Access (RDMA) reduces CPU overhead by offloading data movement to network adaptors. In addition, Ethernet has quality of service (QoS) flow control and advanced error handling mechanisms that increase its network efficiency capabilities.
In the last earnings report, Nvidia stated in the opening remarks that “Networking now exceeds a $10 billion annualized revenue run-rate. Strong growth was driven by exceptional demand for InfiniBand, which grew fivefold year-on-year […] Azure uses over 29,000 miles of InfiniBand tabling, enough to circle the globe.”
The software defined fabric is popular for its low latency as its architecture reduces packet loss, high bandwidth and low management costs. The high-speed data transfer has link speeds of 10 to 400 gigabits per second due to its low overhead and efficient transport protocols, which is why InfiniBand is adopted by supercomputers and also AI/Big Data applications with high performance clusters. Due to very low latency, InfiniBand delivers real-time data transfer.
The $10 billion in annualized revenue run-rate reported by Nvidia in the Q3 October quarter represented 500% growth, which is nearly double the growth rate of the overall data center. Per the Q3 earnings call: “Networking now exceeds a $10 billion annualized revenue run-rate. Strong growth was driven by exceptional demand for InfiniBand, which grew fivefold year-on-year [..]” At the time, the data center had a run rate of $60 billion, so networking was 16.6%. In Nvidia’s most recent quarter, networking grew 155%.
According to Del’Oro, a research company out of the UK, AI systems account for less than 10 percent of the total addressable market for network switching, and of that, 90 percent are using Nvidia/Mellanox InifiniBand due to InfiniBand reducing packet loss, which is ideal for AI training workloads.
If right now, you’re thinking: “I thought this analysis was about Broadcom, not Nvidia!?” then that’s a fair question. Given AI networking is heating up across the board (Nvidia’s run rate, Broadcom, Juniper/HPE, Marvell, Cisco potentially, Arista), it’s important we touch on why Infiniband owns 90% of the AI market right now. We are overdue on revisiting Mellanox/InfiniBand as it’s been four years since we covered the acquisition. This also helps frame how Broadcom intends to compete with Ethernet.
Ethernet Vs InfiniBand
I wish I could make networking more conversational, but it’s pretty challenging to do that! Here are some bullet points on how the two compare; I’ve bolded the more important takeaways:
Benefits of Ethernet:
Raw bandwidth is a benefit with Ethernet hitting 51.2 Tb/s two years ago with support for 800 Gb/s port speeds. InfiniBand lags by topping out at 51.2 TB/s with 400 Gb/s port speeds. Although typical server nodes do no need the extra bandwidth, AI clusters come with 400 Gb/s NIC per GPU with some nodes having four to eight GPUs. By 2025, Dell’Oro believes switch ports for AI networks will be operating at 800 Gb/s and will further double to 1600 GB/s by 2027. Dell’Oro believes switch ports for AI networks will be operating at 800 Gb/s and will further double to 1600 GB/s by 2027.
smartNICs and AI-optimized switch ASICs help to reduce packet loss
Large pool of vendors whereas InfiniBand increases dependency on Nvidia.For this reason, AWS and Google Cloud have remained on Ethernet as they prioritize custom silicon.
Ethernet is the incumbent networking standard and most cloud providers have invested heavily here already. With Ethernet, providers don’t have to manage a new network stack.
Ethernet switching has evolved to where a new term has been coined “lossless” Ethernet. Even Nvidia is moving in this direction with their Spectrum X platform, due out this year.
Benefits of InfiniBand:
Outperforms for AI/ML workloads due to low latency and by reducing packet loss. Data packets are sent in a serial approach so multiple channels of data can be sent simultaneously. This is much better for AI/ML than a parallel approach for internal data flow, which creates bottlenecks.
Has 3X to 4X lower latency than traditional Ethernet switches based on ASICs
Highly scalable, can support tens of thousands of nodes per subnet. InfiniBand is also cheaper as it requires fewer connections for reliability.
Its QoS and failover capabilities are a reason it’s adopted for high-performance computing environments.
Reduces CPU resources
So, why is Ethernet Making a Comeback?
Broadcom’s Jericho3-AI has some promising benchmarks that could help shift the dominant market share InfiniBand has in AI networking (or at least prevent a monopoly). These benchmarks showed the Jericho3-AI outperforming InfiniBand by 10%, which is substantial when dealing with AI systems as it’s enough to increase the collective operations of the system.
“Leveraging this unique functionality, the Jericho3-AI fabric provides at least 10 percent shorter job completion times versus alternative networking solutions for key AI benchmarks such as All-to-All. This performance improvement has a multiplicative effect on decreasing the cost of running AI workloads since it implies that expensive AI accelerators are used 10 percent more efficiently. The network, in effect, pays for itself.” — You can read the press release here.
This means bare metal can work more effectively. Per Broadcom: “because it can handle 800Gbps port speed (for PCIe Gen6 servers) and more, it is a better choice [than InfiniBand.” At high price points, all hyperscalers want to see their investments working at maximum clock times. This is achieved by better load balancing and congestion control to improve network latency, whereas InfiniBand reduces port and hop latency inside the switch. Broadcom calls their product differentiation “Perfect Load Balancing” and “Congestion-Free Operation.”
A note on PCIe
The maximum bandwidth supported by PCIe 5.0 is 400Gbps per port. By using 106Gbps PAM4 SerDes, ASICs can be tuned to support 100, 200 and 400 Gbps port speeds. To work around this, and to achieve 800Gbps, chip makers are building NICs directly into the accelerator. According to The Register, the 800Gbps ports built into accelerators may reduce bottlenecks before PCIe 6.0 arrives on the market. The Register, the 800Gbps ports built into accelerators may reduce bottlenecks before PCIe 6.0 arrives on the market. This is what Broadcom is referring to.
Jericho3-AI supports 36 ports at 400 Gbps speed, and this can support Nvidia’s powerful DGX H100, which have 8 ports of 400 Gbps speed. In this case, four node racks are within Jericho’s capabilities. However, the Quantum-2 InfiniBand can handle 64 ports of 400Gbps, and so for Nvidia’s GPUs, it outperforms. Broadcom’s answer to this is that AWS and Google still prefer to not have vendor lock-in with Nvidia and use the Jericho3-AI to make use of their extensive Ethernet systems.
Overview of Custom Silicon (ASICs):
In addition to AI networking, Broadcom participates in the custom silicon market. ASICs are application-specific integrated circuits that are customized to perform a specific function for a specific application, hence the term “application-specific.” This is in contrast to GPUs which are more general-purpose. ASICs are expensive at the onset, yet become cheaper with volume production. We first published this graph in 2019 but the comparison still applies:
For now, custom silicon only makes sense for a company with deep coffers that has immensely popular applications – such as Google, Meta, Amazon. These companies use custom silicon to drive down costs on GPUs for their most popular applications. Across ASICs, the most well-known is Google’s tensor processing unit (TPU).
Google was one of the first to require low-power machine learning workloads for Search, YouTube and Google Maps. The compute intensive workloads were running on Nvidia’s GPUs for both training and inferencing until Google made their own processing unit, TPUs, to perform workloads at a lower cost and higher performance.
Performance between TPUs and GPUs is often debated depending on the current release (A100 versus fourth-generation TPU, for example). In some cases, TPUs have better performance per watt for power-constrained applications. Notably, some of this comes with the territory of being an ASIC, which is designed to do one specific application very well whereas GPUs can be programmed as a more general-purpose accelerator. In this case, the benchmarks where TPUs compete are object detection, image classification, natural language processing and machine translation — all areas where Google’s product portfolio of Search, YouTube, AI assistants, and Google Maps, for example, excels.
Notably, TPUs are used internally at Google to help drive down the costs and capex of its own AI and ML portfolio and they are also available to users of Google’s AI cloud services. For example, eBay adopted TPUs to build a machine learning solution that could recognize millions of product images.
Unless Google releases an internal technology as open-source, it won’t be adopted by the competitors. This is where Nvidia’s neutral position as traditionally a hardware company becomes a positive as it’s universally used by Amazon, Microsoft, Google — — and Alibaba, Baidu, Tencent, IBM and Oracle. Meanwhile, TPUs create vendor lock in (with a direct competitor) which most companies want to avoid. eBay is the exception here as the company needs Google-level object detection and image classification.
Why ASICs are Not a Near-Term Threat to GPUs
AI investors will need to get comfortable hearing about the battle between ASICs and GPUs. This debate has been going on since at least 2018, when Nvidia’s biggest threat was thought to be Google’s custom TPUs. There is some merit to these concerns as the largest customers for Nvidia’s GPUs have enough cash to make custom chips. There’s roughly $35B to $40B per Big Tech company per year that executives will naturally want to optimize to drive down costs.
To program ASICs is difficult, and they are application-specific, which means they cannot be reconfigured. Nvidia is wildly popular because GPUs are easy to program and are the best choice for a wide range of applications. Developers create the moat, which was our original Nvidia thesis. Therefore, I don’t believe there is much risk that Big Tech commercializes AI accelerators.
However, it’s quite plausible that someday Big Tech will reallocate capex toward more ASICs and fewer GPUs to where it will impact Nvidia. For now, demand outstrips supply, and there are long lead times for Nvidia’s GPUs. If a company like Google reallocates to more TPUs, another enterprise will certainly step up to fill those orders.
Broadcom & Google Partnership
It was confirmed last year that Google is a customer of Broadcom for its ASICs (TPUs). This was officially reported when The Information wrote an article stating Google wanted to ditch Broadcom in 2027, which Google has since denied:
“We are productively engaged with Broadcom and multiple other suppliers for the long term. Our work to meet our internal and external cloud needs benefit from our collaboration with Broadcom; they have been an excellent partner, and we see no change in our engagement." -Google’s response to The InformationGoogle’s response to The Information
Prior to this, it was never directly stated that Google was Broadcom’s main ASICs customer. Here is how Broadcom discussed it: “As you know, we supply a major hyperscale customer with custom AI compute engines. We are also supplying several hyperscalers a portfolio of networking technologies as they scale up and scale out their AI clusters within their datacenter.”
The following has also been stated about the Google-Broadcom relationship: “Broadcom supplies wireless chips for Google phones as well as chips for its data center and cloud services. At the same time, Broadcom is one of Google Cloud’s biggest customers for its cloud products. This bidirectional relationship has also forged a special bond." Per the same report, Meta is also working with Broadcom on ASICs, although does not deploy many of these “yet”
Last April, Broadcom migrated its infrastructure from AWS over to Google Cloud. Per the announcement: “Broadcom, a provider of enterprise security solutions, recently worked with Google Cloud Consulting to migrate its infrastructure from Amazon Web Services (AWS), and found the combination of technology and expertise critical for success. “Google's deep technical skills and its data, security and AI offerings have accelerated our transformation towards becoming a software-led company,” said Andy Nallappan, Vice President, CTO and CSO, Broadcom.
VMWare –Software-Defined Networks and Data Centers
In November, Broadcom closed its acquisition of VMware for $69 billion. VMWare is virtualization software that virtualizes compute and data centers. The software creates an abstraction layer, or a “hypervisor” which is the technical term for a computer or server that runs virtual machines called ESX. VMWare was the first company to virtualize x86 machines and was founded in 1998. Operating systems, such as Linux, Windows and MacOS, can share the same, virtualized resources by running on a x86 machine.
Over the past decade, VMware pivoted to offer a software-defined data center. On the most recent earnings call, Broadcom discussed building essentially a private cloud on-premise, which has some advantages, such as lowering capex by pooling memory, security, networking and server resources. “Our strategy going forward is simply to enable global enterprises to run their applications across the other data centers as well as on public clouds by consuming VMware’s higher-value software stack.”
Later it was stated: “We are creating with VMware, the same experience of virtualization of the data center on-prem for those companies, which has workloads, by the way, that are already running VMware products that application that’s already written on VMware Cloud Foundation. This is then giving these enterprises the opportunity to have a hyperscaler on-prem. That’s the plan we’re doing, plain and simple.”
Where software defined networks have seen quite a bit of success is with 5G networks. SDNs separate the control plane on embedded switching systems. This allows the networks to be managed remotely. Products from different suppliers can be used without incompatibility issues. By using open APIs, the 5G market has benefited from a more neutral ecosystem by allowing products from different suppliers. This is because SDNs allow network functions to be programmed by APIs instead of proprietary interfaces.
In 2012, VMWare acquired Nicera to create VMware NSX, virtual networking and security software that virtualizes network components. The NSX products, including NSX-T data center, programmatically creates and manages virtual networks from Layer 2 to Layer 7, which is defined as switching, routing, access control, firewall and QoS. NSX Manager and transport nodes can be assembled in seconds for proof-of-concept deployments, deployments with up to 64 hosts, or large-scale environments. Software-defined networks have a natural synergy with Broadcom, the leader in networking hardware.
A few years ago, VMWare expanded to virtualize containerized workloads for Kubernetes clusters. This product is referred to as Tanzu. This was a necessary evolution to keep cloud native customers. Many Kubernetes clusters use something called a multi-tenancy solution, which is to have non-connected “tenants” use a common pool of resources. This can be hard to implement correctly, and also has limited functionality once it’s set up. Virtualized containers are similar to a single-tenancy solution by having its own API server, controller manager and storage for data. Yet, it’s similar to a multi-tenancy solution by using a common pool of resources. Per the Broadcom earnings call: “And to attract and keep these workloads across the environment, we are investing in a rich catalog of microservices tools. This will be our focus. And the noncore businesses of end-user computing and Carbon Black will be divested.”
All of this sounds good, but virtualization is not a wild success. The software defined data center market at one time was expected to reach $77 billion by 2020 but instead has only reached $28 billion as of 2023. There are many vendors in the space, which creates pricing wars.
And so, it’s speculative as to how the software defined data center or networks would ultimately accelerate in growth based on AI workloads. The anticipated acceleration is mainly from restructuring, rather than product-market fit. This is what management said on the earnings call: “And it just doesn’t stop there because it’s the math and the trajectory. And to answer your question, you’re right, we are accelerating from $12 billion, and we’re probably seeing a double-digit growth for the next three years, just by sheer math of selling that higher value virtualization stack versus the very loose component sales in the past, particularly on compute only.”
There was a solid question about this in the Q&A which I’m quoting in full below.
Harlan Sur:
[…] but given the significant performance requirements of these workloads, right, training, inference, it appears that more of the near-term adoption of running these workloads is on bare metal, GPU, TPU, accelerated servers. So, how is the team exploiting a software-defined data center solutions via either cloud foundations or Tanzu to try to help customers focus on AI sort of drive better utilization, better economics, faster deployments on this very fast growing part of the market?
Hock Tan, CEO:
Well, as you may be aware, in the last VM Explore in Las Vegas, VMware came out and announced in partnership with NVIDIA, the VMware Private AI Cloud Foundation. Another way of describing it is, the VMware Cloud Foundation Software Stack, the whole VCF stack runs NVIDIA coder, runs the NVIDIA GPU. That is the partnership. So, if you’re an enterprise, it’s a very easy step to get into gen AI analytics because the data center that you as an enterprise own on-prem that runs VCF will by default run the NVIDIA GPU software stack as well.
Another way to put it, it virtualizes the NVIDIA GPU. That’s the VMware software stack as well. So it’s a very strong attraction in our — from our perspective to, in fact, accelerate thinking of a lot of enterprise to adopting the whole VCF site. It’s simply because not only does it virtualize the data centers and make your data on-prem data center much more resilient, easier to manage, lower cost to manage, it has the added benefit, a big attraction this is of being able to right away start running AI workloads
Broadcom’s Financial Overview:
Broadcom consistently delivered a net profit margin exceeding 37% throughout fiscal year 2023. Additionally, Broadcom demonstrates exceptional cash flow generation, with free cash flow exceeding 44% in each quarter of FY2023 and even surpassing 50% in the last three quarters.
Broadcom's acquisition of VMware in November 2023 is intended to bolster the company's position in the AI space, while also strengthening its software business. Secondly, the merger will eventually create recurring revenue streams, which once complete, will be a positive. Furthermore, this acquisition diversifies Broadcom's portfolio, with infrastructure software projected to account for roughly 40% of FY2024 revenue compared to 21% in FY2023. This shift mitigates the impact of cyclical downturns inherent to the semiconductor industry.
The integration process is expected to take a year and will initially have a drag on profit margins due to transition costs and VMware's lower margin profile, cost-cutting measures and merger synergies are anticipated to improve margins in the long term.
When an acquisition is complete, it typically weighs on stock price while investors move to the side lines to see how the teams merge internally and also externally for customers. Unfortunately, the VMware acquisition is not going too well with rumors that customers are disgruntled alongside Broadcom spinning off non-core segments and selling them off to other companies.
That complicates the picture as it requires understanding the precise impact of each segment independently, which is impossible to do given cloud companies tend to cross-sell products. It's also important to note that Broadcom is transitioning VMware clients to a subscription-based business. Per the earnings call: “[…] and we are converting more and more customers step-by-step as they come up for renewal into this higher value stack, and we’re doing it on a subscription basis. So become very focused. So we will kick it off at a much lower rate — because subscription generally brings down revenues, as you know, in software based on revenue recognition. But we see a trajectory of accelerated growth even in 2024 — through 2024. And it just doesn’t stop there because it’s the math and the trajectory. And to answer your question, you’re right, we are accelerating from $12 billion, and we’re probably seeing a double-digit growth for the next three years, just by sheer math of selling that higher value virtualization stack versus the very loose component sales in the past, particularly on compute only.”
When looking at revenue growth, it’s important to strip out VMware’s contribution post-acquisition. Management is firm in the earnings calls that the VMware will accelerate. If this comes to fruition, the Street will likely reward Broadcom as VMware is the primary risk given the synergy of the rather large acquisition ($60 billion) is unproven. However, due to the uncertainty around restructuring the VMware acquisition, time is on our side to try to get AVGO at a lower price.
Broadcom’s Revenue and EPS:
Broadcom’s revenue in the Q4 FY2023 ending Oct grew by 4.1% YoY to $9.3 billion. Revenue was in line with the analyst consensus.
Analysts expect revenue to grow 31.6% YoY to $11.73 billion in the next quarter. Since the company completed the acquisition of VMware on November 22, 2023, these estimates include VMware’s revenue. Headline revenue numbers are expected to accelerate for the next four quarters due to VMware and then will re-acclimate in the January 2025 quarter at 16.4% growth. These quarters are likely to be watched closely due to reasons outlined above, which is that it will be apparent and quite easy to model VMware’s impact.
Organic revenue, excluding the VMware acquisition, represents a 6.1% YoY growth for FY2024 ending in October, down from 7.9% in FY2023 due to the cyclical slowdown in the semiconductor sector. See more discussion on this below.
However, the company will see a higher growth rate in FY2025 at 10.9% YoY for $55.28 billion. The growth rate is helped by an increasing contribution from AI. Management stated in the earnings call that revenue from generative AI will grow from 15% in FY2023 to more than 25% in FY2024. The company’s CEO, Hock Tan, said in the earnings call, “Revenue from generative AI in fiscal ‘23 reached 15% of semiconductor revenue, in line with our expectation. And moving on to fiscal ‘24, we forecast semiconductor solutions revenue to be up mid- to high-single-digit percent year-on-year. We expect revenue from generative AI to represent more than 25% of the semiconductor revenue, consistent with prior guidance, which more than offset the lack of growth from non-AI semiconductor revenue.”
Management chose to not provide quarterly guidance, and to instead provide FY2024 guidance of $50 billion, representing YoY growth of 39.6% at the mid-point. This is a break in style as quarterly guidance is typically given. Here is what was said on the call: “Now on to guidance. As Hock discussed, with the recent closing of our VMware acquisition and the integration process, which will take at least one year, for fiscal 2024, we will provide our outlook for the full year instead of quarterly guidance. Based on current business trends and conditions, our guidance for fiscal year 2024 is for consolidated revenues of $50 billion. Within this, our fiscal year 2024 semiconductor revenue is expected to grow mid- to high-single-digit percent year-on-year. Our fiscal year 2024 infrastructure software segment revenue from continuing operations is expected to be $20 billion, including $8 billion from CA, Symantec Enterprise and Brocade and $12 billion from VMware.”
Management mentioned that VMware’s 11 months expected contribution from the time the acquisition is closed is $12 billion for the FY2024 ending October.
Pictured Above: Revenue includes VMware acquisition. Organic revenue, excluding the VMware acquisition, is expected to be 6.1% YoY growth for FY2024 ending in October, down from 7.9% in FY2023.
Segments
The Semiconductor Solutions segment revenue grew by 3% YoY to $7.3 billion and has witnessed a cyclical slowdown. It is down from 5% growth in the previous quarter and 26% growth in the same quarter last year.
In this segment, networking revenue is the largest by end markets, constituting 42% of Q4 semiconductor revenue.
Networking revenue grew by 23% YoY to $3.1 billion due to strong demand from hyperscalers. Due to AI, management expects FY2024 networking revenue to grow 30% YoY, up from 21% in FY2023.
The company is a beneficiary of generative AI and reported $1.5 billion in Q4 FY2023, for a run rate of $6 billion per year. Citi Analyst, Christopher Danely, said in a research note that the company’s AI revenue will double from $4 billion in FY2023 to $8 billion in FY2024, and he expects the AI business will offset the correction in the semi-business.
Looking further out, Mizuho analyst Vijay Rakesh said “that Broadcom’s AI revenue will likely grow from $8 billion in 2024 to $20 billion in the calendar year 2027, thanks to its custom ASIC AI portfolio.”
The company’s CEO, Hock Tan, said in the earnings call, “This was primarily driven by strong demand from hyperscalers for our custom AI accelerators and as well for our networking switches, routers and NICs, Network Interface Cards, dedicated towards scaling our AI data centers.”
“As you know, even as Ethernet is the standard protocol in front-end networks, hyperscalers are also deploying Ethernet predominantly in their AI networks. In fiscal ‘23, networking revenue grew 21% year-on-year to $10.8 billion. If we exclude the AI accelerators, networking connectivity represented about $8 billion, and this is purely silicon, not systems, not cable nor subsystems. In fiscal 2024, we expect networking revenue to grow 30% year-on-year, driven by accelerating deployment of networking connectivity and expansion of AI accelerators in hyperscalers.”hyperscalers are also deploying Ethernet predominantly in their AI networks. In fiscal ‘23, networking revenue grew 21% year-on-year to $10.8 billion. If we exclude the AI accelerators, networking connectivity represented about $8 billion, and this is purely silicon, not systems, not cable nor subsystems. In fiscal 2024, we expect networking revenue to grow 30% year-on-year, driven by accelerating deployment of networking connectivity and expansion of AI accelerators in hyperscalers.”
The infrastructure software segment grew by 7% YoY to $2.0 billion and accelerated from 5% growth in the July quarter.
Due to the cyclical correction, server storage connectivity Q4 revenue declined by (17%) YoY to $1 billion. For FY2023, it grew by 11%. However, the cyclical weakness is expected to continue, and revenue is expected to decline in the mid-to-high teens for FY2024.
Broadband Q4 revenue also declined by (9%) YoY to $950 million due to the cyclical correction. The management expects the trend to continue, and for FY2024, revenue is expected to be down in the low-to-mid teens. In FY2023, broadband revenue grew by 8% YoY to $4.5 billion.
Wireless revenue declined by (3%) YoY to $2 billion. In FY2023, revenue was down (2%) YoY and the management expects revenue to be stable in FY2024. Lastly, the industrial resale revenue was flat at $236 million.
In the Core software segment, the consolidated renewal rates averaged 119%, up from 117% in the previous quarter. In the strategic accounts, it averaged 130% and was the highest in the last five quarters.
EPS:
EPS came in at $8.25 compared to $7.83 in the same period last year. The adjusted EPS came at $11.06 compared to $10.45 for the same period last year.
Analysts expect adjusted EPS to grow 0.9% YoY to $10.42 in the next quarter.
Prior to acquisition, VMware reported adjusted EPS of $1.83 in its last quarter (July 2023) as a public company.
Margins:
Gross margin for Q4 FY2023 ending Oct was 68.9% compared to 66.4% in the same period last year and 69.5% in the previous quarter.
The operating margin improved 100 bps YoY to 45.6%. The adjusted operating margin improved 20 bps YoY to 61.8%.
The company has a very strong bottom line. The net margin improved by 30 bps YoY to 37.9%. The adjusted net margin improved 90 bps YoY to 51.8% and was flat sequentially.
The adjusted EBITDA margin was 65.1% compared to 64.1% in the same period last year and 65.4% in the previous quarter.
VMWare’s EBITDA margin prior to acquisition in the July quarter was 28.6% compared to Broadcom’s 55.3%. The operating margin of VMware was 16% compared to 43.4% for Broadcom.
The adjusted EBITDA for the FY2023 ending Oct was 64.8%, and the management guide for the FY2024 is 60%, including VMware. The margin drop is mainly due to VMware's current lower margin. However, through cost-cutting initiatives like job cuts, Broadcom will aim to reach a 65% adjusted EBITDA margin for VMware. One focus area is SG&A expense, which constituted around 41% of revenue for VMware compared to around 4% for Broadcom. Hock Tan said in the earnings call, “At steady state, we’ll get to pretty close to 65% on VMware.”
The management also clarified that they are confident of achieving $8.5 billion EBITDA from VMware.
Harlan SurHarlan Sur
And then, just on my first question, are you guys still targeting $8.5 billion of EBITDA in three years on VMware?
Hock TanHock Tan
As Kirsten indicated, as we exit fiscal ‘24, we are practically at a run rate of $8.5 billion EBITDA.
Management said that the integration of VMware will take until the end of the fiscal year and require about $1 billion in transition spending. The CFO, Kirsten Spears, said in the earnings call, “During fiscal ‘24, we expect to incur about $1 billion of spend related to transitioning VMware into the new Broadcom model. This transition spending will be largely completed by the end of the fiscal year as our VMware spending run rate exits fiscal ‘24 at approximately $1.4 billion per quarter, down 40% from a year ago.”
The adjusted EPS for FY2024 is expected to grow 10.8% YoY to $46.83 and a further 19.4% YoY to $55.90 in FY2025. UBS analyst, in a research note, had earlier said that the VMware deal “to be 10% accretive to 2024 EPS and about 17% accretive to 2025.”
Cash Flow and Balance Sheet
Broadcom uses its large cash margin to frequently acquire companies.
Operating cash flow margin for Q4 FY2023 ending Oct was 51.9% compared to 53.2% in the previous quarter.
The free cash flow margin was 50.8% compared to 51.8% in the previous quarter.
The company has cash of $14.2 billion and debt of $39.2 billion. While the short-term debt is $1.6 billion, about $31.3 billion will mature after FY2028. At the end of FY2023, the company took a loan of $30.39 billion to finance the VMware merger and assumed $8.3 billion of VMware debt. While high debt is a concern, most of Broadcom’s debt has long maturities, and the company generates strong cash flows.
The company spent $15.3 billion for FY2023 in cash dividends and share repurchases. It had $7.2 billion remaining in the authorized share repurchase program.
More AI Commentary:
Vivek Arya, Bank of America analyst asked about Broadcom’s participation in the $400 billion AI accelerators market.
Hock Tan
“And we’re seeing this as we all are seeing LLM models continue to change and the face — the shape of generative AI dynamically change more and more, where training and inference are now starting to, in a way, converge and the chip designs are changing. And we are seeing that in the way we design specific custom chips for hyperscalers. That’s interesting. So that’s a very interesting opportunity for us. And as I indicated in my remarks, we see that revenue as part of networking revenue, $4 billion and networking — AI networks and going — doubling almost during 2024. Nothing new. We have said that before. And if anything else, we are reinforcing that particular guidance.”And as I indicated in my remarks, we see that revenue as part of networking revenue, $4 billion and networking — AI networks and going — doubling almost during 2024. Nothing new. We have said that before. And if anything else, we are reinforcing that particular guidance.”
Conclusion:
My takeaway is that the I/O Fund is likely to own Broadcom this year, but our goal is to enter at a lower price. Broadcom is trading above its 3-year median on PE Ratio at 40 PE compared to a 28.5 median. The current sales valuation of 15.5 PS is about double the 5-year median of 7.5 and about double the 3-year median of 8. When we go back to 2014, Broadcom has only traded above a PS Ratio of 10 one time at the height of the 2021 market. However, at a certain price, Broadcom belongs in our AI portfolio. Over the next few years, Big Tech is likely to diversify away from Nvidia’s GPUs, plus Ethernet networking continues to be upgraded for AI purposes, which means Broadcom should be on our radar.
In addition to valuation, for our purposes, we think the timing will be better once the VMware acquisition has settled as there are mixed reports from the customer perspective. Once this blows over and the restructuring is complete, it will be a more optimal time to enter Broadcom, which is richly valued at the moment.
