Month: November 2025

AppLovin Q3: Flexes Bottom Line Muscle; AXON Self-Service Platform is Ramping 

Posted on by io-fund

AppLovin beat on the top line with revenue growth of 68.2% YoY and 11.6% QoQ. Management guidance is for a slight acceleration for QoQ growth of 12.8% in Q4. Growth on the top line is disproportionately flowing to the bottom line with EPS growth of 91.2% this quarter and growth expected to be 65% next quarter. As a reminder, they divested their Apps business in Q2 2025. 

Just when you thought AppLovin’s Adjusted EBITDA could not get any better, it expands again 100 basis points QoQ to 82% and is expected to expand 50 basis points next quarter to 82.5% at the midpoint. As we’ve pointed out, this is the best EBITDA margin in the market (that I’m aware of). The cherry on top was free cash flow growing 92% YoY. 

The earnings call Q&A was focused on the AXON ads manager self-service platform that launched October 1st.  The goal is to quickly scale by offering a self-service interface for Applovin’s 1 billion reach and also help expand Applovin’ from gaming inventory only to also include e-commerce. Previously, Applovin was limited to the number of advertisers the company could manually on board.

Applovin operates in sharky waters as one of the only contenders over the past decade to challenge the walled fortresses of Meta and Google. There is a current SEC probe, which is detailed below. Although the fundamentals are exceptional, this stock is not for the faint of heart with wild swings in both directions.  

We look at this and more below!  

High Growth AXON Ad Engine Expands with Self-Service Feature 

Although very early and based on small numbers, management stated AXON’s self-serve feature is seeing strong traction with advertiser spend growing 50% week-over-week since the launch October 1st. This is invite-only, referral based demand in the e-commerce vertical with the platform expected to open up more broadly in early 2026. 

“While it takes a while for new customers to get going, to integrate, to learn how to use our system and to ramp spend, we're already seeing spend from these self-service advertisers grow around roughly 50% week-over-week. It's too soon to be significant, but this type of early growth gives us even more confidence that our platform will excel at being an open platform to any type of advertiser.” 

The company uses AI to increase conversion rates; this can be considered a catalyst for future growth if the company expands conversion rates for advertisers compared to competitors. According to management, the model continually learns for better behavior targeting and ad personalization. Generative-AI based creatives are also a feature being built out to generate more effective ads (also leading to higher conversion rates). An area where Applovin sets themselves apart is the 35 second ad creatives compared to 7 seconds on social, which could (presumably) also lead to higher conversions.  

According to management, improving conversion rates is a path to sustained growth: “We believe that giving our powerful recommendation engine, a more diverse set of advertisers to recommend will dramatically improve conversion rates, paving the way for elevated growth rates for years to come.” 

Overall, it’s important to remember that Applovin is demand constrained rather than supply constrained as they reach over 1 billion users. Therefore, opening up the AXON ad manager to more demand is the primary catalyst for the next few quarters.  

According to data from eMarketer shows encouraging signs from the e-commerce sector: clients including Wayfair, Ashley Furniture and Dr. Squatch are scaling six-figure daily budgets. eMarketer adds that early Axon adopters see “strong click-through and conversion rates,” with one brand increasing spend by >500% after testing Axon. 

Regarding the size of the AXON ad manager, APP has not disclosed customer count, yet management said they have hundreds of gaming and hundreds of e-commerce customers, or a “platform that might have 1,500 advertisers,” yet opening the platform up could help them scale to “hundreds of thousands of customers” in the long run.  

On the call, the following information was shared regarding AXON’s current size: “I think it was in Q1 was $11 billion plus of ad spend. And then the disclosures we've given you across web advertisers and gaming advertisers puts it in the low thousands. So you've got such a high amount of spend for such a low amount of advertisers across over 1 billion daily active users.” 

20% to 30% Annual Growth Baseline Hinges on Two Factors 

At Goldman Sachs’ Communacopia conference, APP executives dove deeper into the long-term growth framework provided in Q2, calling for a baseline 20% to 30% annual growth. Management explained that this hinges on two primary factors: reinforcement learning and continuous improvement on the ad engine, and opening the recommendation engine up to e-commerce and exposing it to a wealth of new demand.  

The update regarding 20% to 30% growth is the self-service platform could help exceed this baseline: “We're still believing very confidently in this 20% to 30% long-term growth rate in our core category. But even in the core, we're beating that. And then now you're layering on, on top of that, all this opportunity with the self-service platform” 

Management also hinted that the public launch of Axon and expanding to the e-comm vertical could help drive significant customer growth leading to a flywheel. This was expanded on during the earnings call: “And so you're building up a data set that doesn't just limit itself to the shopping category or the website advertising category. It helps enable better advertising for the gaming customers as well. So you put all those pieces together, and I'm really confident that we're not going to squeeze anyone in our platform. We're probably going to have expansion across the board as we add more demand density and get more data into the system.” 

AppLovin Facing SEC Probe 

AppLovin dropped ~14% last month on reports of an SEC probe into its data practices, following short-seller and whistleblower allegations that APP used “unauthorized” tracking—such as device fingerprinting—to support targeted ads in ways that may conflict with platform rules (e.g., Apple). These remain allegations; no findings have been announced. AppLovin declined to comment, stating it does not discuss potential regulatory issues. 

Financials: 

Revenue beat by 4.7% 

AppLovin reported strong revenue of $1.405 billion, beating analysts' estimates by a solid 4.7%. The company’s revenue grew by 68.2% YoY and 11.6% QoQ. The growth was primarily driven by the strong gaming advertising revenue, with management stating: 

“Our teams delivered multiple incremental lifts in our core models this quarter. And our MAX supply-side platform, one of the best indicators of our end market growth continues to grow at very healthy rates. We also opened up international traffic for advertisers promoting websites or shops in Q3 ahead of schedule.” 

Management has guided for a strong Q4 guide of $1.57 billion to $1.60 billion, representing a YoY growth of 58.6% and 12.8% QoQ. The Q4 guide beat the analysts' estimates by 2.3%. Looking forward, analysts expect revenue to grow 33.5% YoY to $7.45 billion in 2026 and 28.2% YoY to $9.56 billion in 2027. 

Management highlighted that the priorities include improving the models, onboarding flows, and continued AI integration, positioning the company to acquire a large volume of new advertisers in the future. “Our focus for Q4 and 2026 will be the following, with priority always given to improving our models for all advertisers. We'll continue tuning our onboarding flows and ramping more AI agents into the workflow to support a seamless experience for new advertisers. Once we're satisfied with the quality and experience, we'll open the platform broadly beyond referral basis. We'll be testing generative AI-based ad creatives.” 

Advertising Revenue Grew by 68% 

The company’s Q3 advertising revenue grew by 68.3% YoY to $1.405 billion. The ad revenue exceeded the management guidance by a solid 5.6%, primarily driven by strong gaming advertising revenue.  

Management guided advertising revenue of $1.57 billion to $1.60 billion, representing a YoY growth of 58.6% at the midpoint. Management stated that the guidance incorporates optimism around the e-commerce referral program, continued model enhancements, and the normal holiday seasonality.  

Operating Margin of 76.8% 

AppLovin’s margin expansion is truly outstanding, primarily driven by strong operating leverage. The company’s AI-powered advertising engine, AXON 2.0, launched in Q2 2023, serving as a game-changer that drove strong revenue and profits. The company’s operating margin has increased from 17.5% in Q2 2023 to a remarkable 76.8% in the recent quarter. 

During the Goldman Sachs Communacopia conference, management highlighted that additional costs can be expected with the e-commerce push. They stated: “So as we push into things like e-commerce, where we are going to see new costs that investors should be aware of are for things like API calls as we use LOMs for agentic customer support, campaign analytics and management.” 

  • Gross profits grew by a solid 72.2% YoY to $1.23 billion, with a gross profit margin of 87.6%. The gross profit margin was up 210 basis points YoY and down 10 basis points sequentially. 
  • Operating profits grew by 102% YoY to $1.08 billion, driven by solid operating leverage. The operating margin improved by 12.8 percentage points YoY to 76.8%. 
  • The net profits grew by 92.3% YoY to $835.55 million or a net profit margin of 59.5% compared to 52% in the same period last year and 65.1% in the previous quarter. 
  • Adjusted EBITDA grew by 79% YoY to $1.16 billion. The adjusted EBITDA margin was 82%, beating management guidance by 100 basis points. Management also guided a strong Q4 adjusted EBITDA margin of 82.5% at the midpoint. 

GAAP EPS grew by 91% 

The company’s Q3 GAAP EPS grew by 91.2% YoY to $2.45, primarily driven by strong operating leverage. The EPS beat the analysts' estimates by 2.6%. Analysts expect strong EPS growth to continue as they expect it to grow 65.3% YoY to $2.86 in Q4 and 85.2% YoY to $3.09 in Q1 2026. 

Looking forward, analysts expect EPS to grow 51.2% YoY to $13.80 in 2026 and 31.4% YoY to $18.12 in 2027. 

Free Cash Flow Grew by 92% 

The company has an exceptionally strong cash flow margin profile, primarily driven by strong profits.  

  • Q3 operating cash flows grew by 91.3% YoY to $1.05 billion with a margin of 75%, up 9.1 percentage points YoY. 
  • Q3 free cash flows grew by 92.4% YoY to $1.049 billion with a free cash flow margin of 74.7%, up 9.4 percentage points YoY. 
  • The company’s cash improved to $1.67 billion, up from $1.19 billion at the end of the previous quarter. While debt remained the same at $3.51 billion.  
  • The company repurchased and withheld approximately 1.3 million shares worth $571 million in Q3, which was funded by free cash flows. Over the last 3 quarters, the company has been able to reduce the outstanding shares from 346 million in Q4 2024 to 341 million this quarter. During the quarter, the Board of Directors increased the share repurchase authorization by an incremental $3.2 billion. The total outstanding authorization is $3.3 billion as of the end of October. 

Conclusion: 

The management team has accomplished an unimaginable feat over the past 1-2 years, yet their success has also attracted short seller scrutiny. What keeps us coming back on this stock is the exceptional fundamentals and the understanding that Applovin is disrupting a massive industry. Thus, the reward could outweigh the risk given management’s strong history of execution.   

Equity Analysts Damien Robbins and Royston Roche contributed to this analysis. 

Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in APP at the time of writing.

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IREN Raises Cloud ARR to $3.4B for 2026, Yet Financing and Execution Remain

Posted on by io-fund

This evening, IREN reported record revenue of $240.3 million, up 355% YoY, and net income of $384.6 million, impacted by a $665 million gain on financial instruments. The company has experienced a significant rebound after retrofitting its Bitcoin mining operations for AI data centers, though its AI Cloud has not yet shown substantial growth, with just $7.3 million in revenue the quarter, up 4% QoQ with only 2,067 GPUs operational. However, cloud revenue growth is expected to accelerate rapidly to $500 million by Q1 and $3.4 billion by the end of 2026 – what remains is the financing and execution.

While the I/O Fund has participated in the AI-energy momentum with successful Bitcoin Miner entries, we want to be clear that these are currently momentum trades for us. In the most recent report, IREN provided a more detailed breakdown on how it will fund $5.8 billion in GPUs, using a $1.9 billion pre-payment, estimating $2.5 billion in financing secured against the GPUs and contract, and the remaining $1.4 billion from cash/cash flows, debt, equity or convertible notes. Payments for the GPUs will be phased in alignment with deliveries through 2026.

However, until financing for the full data center buildout is secured and ARR visibility materializes, we will continue to treat names like IREN as high-risk trades and adhere strictly to our stop levels.

IREN Signs $9.7 Billion Deal with Microsoft

Earlier this week, IREN announced a five-year, $9.7 billion data center with Microsoft, providing the cloud giant with 200MW of capacity of Nvidia’s GB300 GPUs. As is the case with miners, capacity will roll out in phases through 2026, with IREN aiming to deliver the full capacity by year-end. Delivery of the GPUs is not expected to commence until March 2026, hinting that the first tranche will likely not be deployed until calendar Q2.

IREN has provided a detailed breakdown of the deal value, capex costs and pre-payments:

  • $9.7 billion total deal value, translating to annualized run rate revenue of $1.94 billion per year, or $9.7 million per MW.
  • 85% estimated EBITDA margin, or ~$1.65 billion per year on average.
  • $1.94 billion pre-payment (20%) from Microsoft, credited to the third, fourth and fifth year of the deal, covering some of the upfront GPU costs.

Moving to capex and GPUs:

  • All-in GPU cost of $5.8 billion including InfiniBand, cabling, servers, etc; while IREN did not disclose the total contracted GPUs, prior GB300 purchases imply that this would represent approx. 72,500 GPUs.
  • Data center capex costs of $14-16 million per MW, including $9-11 million for infrastructure, $3 million for 100MW supercluster architecture and flexible rack densities, and $2 million to accelerate deployment of the full capacity by the end of next year.

As stated above, IREN provided a more detailed breakdown on how it will fund the $5.8 billion in GPUs, using the $1.9 billion pre-payment, estimating $2.5 billion in financing secured against the GPUs and contract, and the remaining $1.4 billion from cash/cash flows, debt, equity or convertible notes. Payments for the GPUs will be phased in alignment with deliveries through 2026.

IREN Raises ARR Projection to $3.4B by End of 2026 with ~140K GPUs

With the Microsoft deal now under its belt, IREN had updated its annualized run-rate revenue (ARR) projection to $2.5 billion, which reflects no change to its prior target of $500 million by Q1 2026 excluding the deal.

However, IREN now guided for $3.4 billion in ARR by the end of 2026, which includes its original $500 million target, plus an additional $1 billion ARR target for its remaining 110MW capacity at Mackenzie and Canal Flats. Again, IREN warns that this figure “is not fully contracted, there can be no assurance that it will be achieved, and actual revenue may differ materially.”

Source: IREN

IREN says this forecast assumes ~63K GPUs deployed at its British Columbia sites, which would require the company to procure, receive and install an additional ~40K GPUs before the end of next year. Considering that its ~23K GPU fleet cost upwards of $1.2 billion, IREN may need to find another >$2 billion to scale to 63K in British Columbia, or potentially even $3 billion if it goes primarily for GB300s. With the company already looking for several billions in funding for Microsoft will little to show for AI Cloud revenue, this could require more debt or creative financing methods such as GPU-collateralized loans.

IREN’s 2.9GW Places Third Among the Miners

In terms of overall power capacity, IREN would rank third in the miners with its 2.9GW, behind Applied Digital’s 4.3GW active development pipeline and Galaxy’s 3.5GW. IREN’s Sweetwater campus accounts for a majority of its capacity at 2GW, with substation energization for the first 1.4GW coming in the first half of 2026 and the second substation energization for the remaining 0.6GW in the second half of 2027. Considering the high costs of fully outfitting this entire 2.9GW of capacity with next-gen GPUs, it’s unlikely that IREN’s power pipeline will expand substantially in the near future.

The more important question for IREN is two-fold: how long after substation energization will Sweetwater be ready for service, and how can IREN fund a full 2GW build-out quickly? Big Tech and semis continue to harp on power being the primary constraint, and the differentiating factor for miners is who can deliver the most power the fastest.

Current timelines for Applied Digital, Galaxy and TeraWulf project each will have less than 1GW online by 2027 for key customers, but if IREN can bring the first 1.4GW of Sweetwater online by 2027 (or at least a portion of it), it could be in a better position to secure more lucrative cloud deals. However, self-funding the full buildout will be a challenge as current GPU prices suggest 2GW could cost nearly $60 billion.

Rental Pricing and Payback Periods

IREN’s October 7th announcement about securing multi-year AI cloud contracts included an important but potentially overlooked phrase: “New NVIDIA Blackwell GPUs continue to be contracted ahead of delivery on an average term of 2 years, at pricing that supports a ~2-year revenue payback.”

What this means is that customers are currently willing to contract Blackwell GPUs for two years, as Rubin GPUs will be released late next year and will likely be highly sought after, and IREN is expecting its Blackwell GPUs to be paid back in the same two year contracts.

However, considering how quickly Nvidia (and AMD) are upgrading GPUs and the performance gains each generation brings, these older generation GPUs quickly get priced out of the market. For example, Nvidia’s H100 GPUs were renting for approximately $3.00 per hour in January 2025, prior to Blackwell’s ramp, yet now are renting for <$2 per hour, a (33%) decline that is only likely to exacerbate as the Blackwell Ultras ramp up.

Source: Bloomberg via X

Thus, relying on a two-year payback period under a two-year contract suggests that residual revenue and cash flows from these Blackwell GPUs come 2027 could be significantly lower than current contractual terms. This is because rental rates are likely to follow a similar trajectory of the H100 and decline substantially for two primary reasons: Blackwell availability will be much larger as new systems ramp through the end of the year and 2026, and early Rubin availability will likely draw a significant amount of demand for the more-performant chip.

While it may seem to be a significant positive for IREN that it can realize a two-year payback for Blackwell GPUs, the dynamics of demand and the pace of GPU upgrades imply future revenue opportunities from Blackwell may be more limited in scope.

IREN has a Cash Flow Issue

Stocks like Oracle have recently come under pressure for the enormous debt load the company is expected to inherit to fund the company’s ambitious data center plans. For example, there is rumored to be a $38 billion debt offering as soon as next week, with Morgan Stanley stating the figure could be as high as $55 billion to $75 billion.

IREN is in a similar boat as its ambitions to scale into a competitive AI data center and cloud provider are not congruent with current cash resources, meaning capital intensity and how the company will expand the balance sheet will be a key focus for investors going forward.

Last quarter, we discussed that despite operating cash flow being positive for the fiscal year at $245.9 million, the overall picture of how GPUs and data center expansion would be funded was murky. Due to outsized capex, the free cash flow was ($1.13B) or a FCF margin of –226%. In other words, every dollar of operating cash flow generated was spent 5:1 on the buildout. This improved slightly in fiscal Q1, with every dollar of operating cash flow spent only 2:1.

Financing flows filled this gap with $1.30 billion raised via converts, equity, and leases. Net-net, IREN ended FY25 with $160 million more cash than it started with, despite billion-dollar capex outlays. After year-end, the Company raised another $253.5 million via ATM equity sales and finalized a lease program that funds GPUs entirely, with fixed monthly payments of ~$2.8M and a buyout option at 18% of cost after 36 months. This strategy shifts capital intensity away from cash up front, preserving liquidity while enabling AI Cloud scaling.

However, the issue lies with the more aggressive buildout that is in front of IREN. In the previous analysis, we pointed toward IREN needing $6 billion for a 112K GPU fleet:

At Horizon 1, IREN says that it can host ~19K GB300 GPUs at 50 MW IT load, which, based on prices calculated above, would cost the company upwards of $1.5 billion. Funding this and fully outfitting its British Columbia sites for 100% AI cloud capacity would likely cost $5 billion or more, or ~10x IREN’s most-recently reported cash holdings. This also does not account for its 2GW Sweetwater campus, which IREN says can support >600K GB300s.

Analysts are expecting IREN to quickly scale its fleet through 2026, with Roth Capital projecting IREN to reach a ~112K GPU fleet by year-end 2026. This ~90K increase in GPU fleet could require IREN to take on more than $6 billion in debt, per Roth’s calculations. This would represent nearly 60% its current valuation and likely cost ~$600 million quarterly, which would not be covered by revenue nor cash flows.”

$1 Billion Convertible Raise to Support Expansion

As we discussed in our prior analysis, IREN: GPU Fleet Doubled to 23K, AI Cloud ARR Guide Raised to $500M, outfitting its pipeline with tens of thousands of GPUs will not be cheap, with the company likely to pull out several billions in debt to scale its fleet towards 100K GPUs.

In mid-October, IREN closed a $1 billion convertible note raise, giving the company approximately $922 million in capital for general corporate purposes, which will likely go towards additional GPU purchases. Considering 200MW of GB300 GPUs will cost $5.8 billion, this raise will likely only fund another 20-30MW of capacity.

Microsoft’s Nebius Deal Highlights Miner Shortfalls

Microsoft had signed a similar five-year deal with Nebius in early September worth $17.4 billion for capacity at the neocloud’s upcoming data center in New Jersey, which is expected to have 300MW capacity.

Under such terms, the deal would be worth $3.48 billion on average per year, but on a per-MW basis, $11.6 million per year, or approximately a 20% premium to IREN’s deal. Considering timing is very similar with deployment occurring throughout 2026, Nebius’ ability to command a more valuable deal may stem from its full-stack, proprietary AI cloud purpose-built for AI workloads. Nebius can offer both the powered shell and its platform with MLops services, low downtime and high cost efficiency, offering up to 3x token savings with low latency, and up to 4.5x faster time to token versus other competitors.

This further reinforces that miners’ main value proposition is simply delivering the powered shell in a timely manner, leading to potentially lower deal economics versus neoclouds like Nebius who can combine power with AI-optimized software. It’s also likely why IREN is making a deeper push to bridge the gap with its own AI-optimized cloud offering, as it could drive more valuable deals with hyperscalers, versus a deal such as Cipher’s with AWS worth $1.22 million per MW per year on average.

Financials:

Revenue

IREN reported a record $240.3 million in revenue in Q1, up 355% YoY and more than 28% QoQ, driven primarily by Bitcoin mining revenue of $232.9 million. This beat estimates for $228.5 million the quarter.

AI Cloud Revenue

IREN’s AI Cloud revenue showed minimal growth in fiscal Q1 at just 4% QoQ to $7.3 million, though this was up more than 128% YoY. Operational GPUs rose just 9% from 1,896 to 2,067, less than 10% of the ~23K the company has purchased; considering the company has announced that 11K of its fleet has been contracted under multi-year deals and are expected to be operational by the end of the year, deliveries and revenue should ramp significantly in the December quarter.

Margins

Gross margin was 66.4% in fiscal Q1, down from 71.8% in Q4, as net power prices rose 31% sequentially. Bitcoin mining gross margin shrunk from 70.9% to 65.7%, while AI Cloud gross margin shrunk from 92.9% to 90.4%.

However, operating margin was (31.8%), a stark contrast to the 11% reported in Q4, driven by a 107% sequential increase in operating expenses to $236 million, or more than 98% of revenue. This was fueled by SG&A, which rose from $53.3 million in Q4 to $138.4 million in Q1, which IREN says was driven by a “materially higher share price” that resulted in an additional $23.9 million of stock-based amortization and $32.8 million in payroll taxes related to RSUs.

Net margin was 160%, as IREN reported $384.6 million in net income, impacted by a $665 million gain on financial instruments, primarily related to prepaid forwards and capped calls on convertible notes.

Adjusted EBITDA margin also contracted from 65.1% in Q4 to 38.2% in Q1.

Cash Flows, Cash and Debt

Operating cash flow was $142.4 million, though free cash flow was ($138.2 million) as IREN spent ($180.3) million on PP&E and another ($100.3) million in GPU prepayments.

IREN reported cash and equivalents of $1.03 billion at quarter end, though noted that at the end of October, cash and equivalents totaled ~$1.8 billion following its $1 billion convertible raise. This is a sharp increase from $564.5 million as of Q4.

Property, plant and equipment was $2.12 billion, up from $1.93 billion in Q4.

Debt (convertible notes) was reported at $962.4 million, though this does not include the recent $1 billion convertible raise. IREN also added that it secured an additional $200 million in GPU financing in the quarter, bringing its total there to $400 million. IREN expects future capex needs to be met by cash/cash flows, GPU financing, Microsoft’s prepayments and additional financing methods.

Equity rose from $1.82 billion to $2.88 billion, driven by an increase in cash, financial and derivative assets. Shares outstanding rose 4% from August to October, from 272 million to 283.5 million.

Conclusion:

IREN’s AI Cloud revenue is at $7.3 million with management forecasting $500 million by Q1 and $3.4 billion by the end of next year. Of this, $1.9B is to come from the Microsoft deal over a five-year period: “When combined with the $1.9 billion expected from the Microsoft contract and $500 million from our existing 23,000 GPU deployment, this expansion provides a clear pathway to approximately $3.4 billion in total annualized run rate revenue once fully ramped.”

Estimates call for $2.5 billion at the end of fiscal year 2027 ending in June, implying the Microsoft deal and the $500 million could already be priced in. At some point, the market will want to take a rest and watch how the financing and execution pieces comes together (not IREN specific).

Also keep in mind, IREN’s main source of revenue is Bitcoin and Bitcoin prices have been dropping. As stated in our original IREN coverage, this is more of a momentum trade setup: “We are watching IREN closely and would buy on a clear breakout only. If we were to buy, we’d closely adhere to all stops.”

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. Beth Kindig and the I/O Fund own shares in IREN at the time of writing and may own stocks pictured in the charts.

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Applied Optoelectronics Q3: Timing Miss yet Q4 Signals Inflection Point

Posted on by io-fund

Applied Optoelectronics missed revenue by $1.2M for revenue of $118.6M expected compared to $119.9M reported. The miss was due to a timing issue with management stating data center revenue was “a touch below our expectations, largely due to the timing of certain shipments at quarter-end. In particular, we had approximately $6.6 million in shipments of 400G transceivers to a large hyperscale customer, which was not able to be turned into revenue during the quarter due to various shipping and receiving delays and which we have booked in Q4.”

Although the headline numbers are causing an aftermarket selloff, the call was quite clear that the company AOI (Nasdaq: AAOI) is preparing to grow shipments significantly. Most importantly, there were discussions of an “imminent” 800G qualification coming in the next few weeks with additional hints of very strong QoQ data center growth next quarter. The earnings call signaled an important inflection point in Q4 that is not accurately depicted in Q3 numbers. We cover this and more below!

The Importance of the 800G Qualification

AOI is expected to become a large supplier for 800G and 1.6T optics, especially for its customer Amazon with a deal worth $4B over ten years. However, the 800G qualification is expected to expand beyond Amazon with management stating: “we believe we are near the final stages of qualification with several customers. We expect qualification in the near term based on conversations that we are having with our customers, and we continue to believe that we will produce meaningful shipments of 800G products in the fourth quarter.”

When asked how soon the qualifications could occur, management used the word “imminent.” This is noteworthy because AOI faced timing delays in Q3, which meant the quarter reflected very little contribution from AI data center revenue. In fact, roughly 83% of data center sales came from 100G products, while only 9% came from 200G and 400G transceivers. If we take management’s commentary at face value, this sets up a potential inflection point for AOI, as 400G — and especially 800G — products carry higher sales prices that can accelerate growth. With qualifications now described as “imminent,” AOI may be entering the part of the product cycle where higher-speed optics begin to materially impact the top line.

This understanding was echoed by management with the following statement: “Looking ahead to Q4, we expect a substantial sequential increase in our data center revenue driven by growth in 400G revenue, as well as layering in some increased 800G revenue.” Later, management quantified their expectations: “That means the data center growth should be a lot, okay, since the revenue increased by about 10% compared to Q3. That means data center revenue will increase by $25-$40 million in Q4.” Given that data center was $43.9 million this quarter, that would imply 74% data center growth at the midpoint – a sharp contrast to the (2%) decline QoQ in data center revenue this quarter.

This is supported by additional color in terms of where the company is now on shipping volumes compared to where they expect to be by year-end and mid-year 2026:

Right now, we’re only talking about maybe 10,000, 20,000. It’s a volume still far away from, quite away from. That’s why I say by end of December, we should have 100,000 per month. By end of June next year, we have 200,000 per month.”

AOI is Building USA’s Largest 800G and 1.6T Laser Production Capacity

As covered previously, in OFC in April, AOI outlined one of the most impressive capacity expansion stats that we have seen: an 8.5x increase for 800G and 1.6T products by the end of the year, with management reaffirming in both Q1 and Q2 that they remain on track to reach said target. Capacity for these high-speed products is split between two facilities, one in Taipei, Taiwan and the other in Sugar Land, Texas. Overlaying potential 3x growth industry this year with 8.5x capacity growth for AOI implies the company is eyeing market share gains into year end persisting through 2026.

If 8.5X growth was not enough, AOI is going further and aiming to double capacity again by mid-2026, stating in Q2’s call that they are expecting to be able to produce >200K 800G/1.6T products per month, with the majority produced in Texas. This corresponds to annual production of ~2.4 million 800G/1.6T products, up more than 16x from less than 150K annually prior to these expansion plans.

The fact AOI is on the verge of a sharp ramp was a central theme on the call with management stating:

As a reminder, we expect this will culminate later this year with what we believe will be the largest domestic production capacity for 800G or 1.6 terabit transceivers, approximately 35,000 transceivers per month, or roughly 35% of our overall capacity for these advanced optical transceivers. Notably, we will be able to accommodate this expansion in our current Texas facility footprint. Further, by mid-2026, we continue to expect to be able to produce over 200,000 pieces per month, with the majority produced in Texas.”

The only change in tone the I/O Fund team could pick up on is the Texas facility is expected to now produce 35% of overall capacity compared to commentary in the previous earnings call that Texas would contribute 40% of overall capacity. In Q2, it was stated:

We continue to expect to exit this year with a production capacity of over 100,000 units of 800G transceivers per month, with 40% of this production being done in the US”

Last week, the company announced its $150M investment for expansion in Texas to increase its USA production over a five-year period:

The expansion project, when complete, will have the largest production capacity for AI-focused datacenter transceivers in the U.S.”

Timing for 400G, 800G and 1.6T

I’m earmarking AOI to (hopefully) make a splash starting next quarter and into Q2 2026. It’ll be an interesting three quarters as 400G is expected to carry the revenue in Q4, then 800G in early 2026 with 1.6T taking effect by Q2.

Here is what was stated on the earnings call:

If you look at our guidance, again, just kind of go back to the segment guidance that we gave. It implies a dramatic ramp in data center revenue in the fourth quarter. We didn’t give annual guidance for next year, but we certainly believe that’s the beginning of a sustained ramp. I think we’re exactly in sync with what you described. We’re seeing that ramp first at 800G, but as we talked about, later next year, we expect 1.6 to be a strong contributor as well.”

Financials

Revenue

AOI reported $118.6 million in revenue in Q3, slightly below estimates for $119.8 million and at the lower end of management’s guidance for $115 to $127 million. This represented growth of 15.2% QoQ and 82.1% YoY, decelerating from 137.9% YoY in the second quarter, driven by strong cable TV demand and the ramp of 1.8 GHz amplifier products as data center revenue was soft.

For Q4, AOI guided for revenue between $125 and $140 million, up 11.7% QoQ and 32.1% YoY, another sharp deceleration though this comes against much tougher comps. Management expects to recognize 800G revenue in the fourth quarter: “we continue to believe that we will produce meaningful shipments of 800G products in the fourth quarter.”

Key Segments

CATV (Cable TV):

CATV revenue surged 237.1% YoY and 26.1% QoQ to a record $70.6 million, with management characterizing demand as “exceptionally strong.”

Data Center:

Data center revenue was $43.9 million, up 7.3% YoY but down (1.9%) QoQ, with management explaining that this “came in a touch below our expectations, largely due to the timing of certain shipments at quarter end due to various shipping and receiving delays.” AOI also added that it is seeing increased orders for 100G and 400G products from several large customers, and expects increased demand for both through the end of the year.

According to the opening remarks, the split across products was “In the third quarter, 83% of data center revenue was from 100G products, 9% was from 200G and 400G transceiver products, and 7% was from 10G and 40G transceiver products.”

Telecom/Other:

Telecom revenue rose 33.7% YoY and 92.8% QoQ to $3.74 million, while other revenue was $0.35 million.

Margins

AOI showed a marginal sequential improvement in GAAP operating margin despite GAAP gross margin contracting, though the company is not meaningfully closer to GAAP profitability.

  • GAAP gross margin was 28.0%, down 2.3 points QoQ but up 3.6 points YoY. Adjusted gross margin was 31%, at the high end of guidance and up 0.6 points QoQ and 6 points YoY.
  • GAAP operating margin was (15.3%), a slight improvement from (15.5%) in Q2 and up more than 10 points YoY. Adjusted operating margin was (8.7%), improving 1.8 points QoQ and 9.2 points YoY.
  • GAAP net margin was (15.1%), down from (8.8%) in Q2 but up from (27.3%) in the year ago quarter. Adjusted net margin was (4.6%), below guidance for (3.3%) but marking an improvement from (8.6%) in Q2 and (13.5%) in the year ago quarter.

For Q4, management guided for adjusted gross margin to be 29-31%, down 1 point QoQ but up 1.3 points YoY at midpoint. Adjusted net margin was guided at (4.5%), approximately flat QoQ.

EPS

AOI met adjusted EPS estimates this quarter at ($0.09), though Q4’s guidance missed as the company is still forecasting a small loss whereas estimates were expecting a shift to profitability, albeit at a thin $0.03.

  • Q3 GAAP EPS was ($0.28), improving from ($0.42) in the year ago quarter but widening from ($0.16) in Q2. This missed estimates for ($0.10).
  • Q3 adjusted EPS met at ($0.09).
  • Q4 adjusted EPS was guided to be ($0.13) to ($0.04), short of consensus for $0.03.

Cash and Balance Sheet

Cash flows significantly improved from Q2, and inventories rose sharply once again, likely in preparation for the ramp of 800G products.

  • Q3 operating cash flow was ($28.5 million) for a (24%) margin, improving from a (63.6%) margin in Q2 but down slightly from (22.2%) a year ago.
  • Q3 free cash flow was ($57.5 million) for a (48.5%) margin, improving from (101.3%) in Q2 but still lower from (32%) a year ago.
  • Cash and equivalents totaled $150.7 million and debt totaled $192.1 million.
  • Inventories were $170.2 million, up 22.5% or $31.3 million QoQ. Since Q1, inventories have risen by ~$68 million.

Conclusion:

If the market were always on our side, investing would be easy. What we’re seeing this quarter is a reminder that even when a company’s story remains intact, the market can still get the jitters. This stock, however, continues to get a green light from me across the board — the headline “miss” was a non-issue (on the contrary – it’s a boon for the strong QoQ commentary on Q4). Looking ahead, shipments are on track to increase 16X over the next year, kicking off soon with key 800G qualifications only weeks away. Management is feeling comfy enough to include 800G in the Q4 guide — a meaningful signal. Of course, nothing is ever certain in investing. But based on what I heard this evening, this is not a report I’m concerned about.

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. Beth Kindig and the I/O Fund own shares in Applied Optoelectronics at the time of writing and may own stocks pictured in the charts.

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Astera Labs Q3 Earnings: Blowout Report Meets UALink Uncertainty  

Posted on by io-fund

Astera Labs reported another impressive quarter in Q3 with revenue maintaining 20% QoQ growth, beating estimates by 11.7%, while GAAP operating and net margins showed solid QoQ expansion. Fiscal 2025 revenue is expected to be around $831 million at midpoint, $55 million above current estimates for $776 million and pointing to approximately 110% YoY growth. 

There are two items weighing on Astera’s report this evening. The first is the guide for Q4 of $249M at the midpoint, which implies 76.5% YoY growth yet 8% QoQ growth. This is a slowdown from the 20% QoQ growth this quarter.  

However, if we zoom out, we see this is actually a large beat as Q4 was slated to report $216.5M equaling a 15% beat. Also consider Astera has seen significant beats every quarter even after raising guidance, thus the conservatism we’ve seen thus far could continue. When looking at the bottom line, we see % surprise has been exceptional – don't believe I’ve seen this consistency and magnitude of bottom line beat before. 

Fundamentals aside, Astera’s stock has recently been haunted by Ethernet for Scale Up Networking (ESUN). ESUN was announced mid-October following the Open Compute Project conference with support from AI chip partners and strong Ethernet players, including Nvidia, AMD, Broadcom, Arista, Cisco, HPE, plus a few hyperscalers such as Meta, Microsoft and AI heavyweight OpenAI. The week of the announcement, Astera dropped as much as 33% from an October high of $225 to $154.  

Astera’s product line has greatly benefited from the boom in the PCIe networking protocol, and the readthrough is that PCIe will see competitive pressure from Ethernet.  

There is a lot to unpack from the earnings report, yet the PCIe versus ESUN debate takes precedence. As you can expect, the Financials section shows a trend very much in play, but we have to address the boogieman first before we can assess Astera’s ability to continue its remarkable growth trajectory.  

UALink versus Ethernet Scale-Up Networking (ESUN) 

UALink is an open-source alternative to proprietary interconnect protocols such as Nvidia’s NVLink. Astera offers a portfolio of UA linked connectivity solutions, including AI fabrics for signaling conditioning and other I/O components. The expectation is that PCIe’s low latency would carry UALink as a solid alternative to Nvidia’s NVLink with proliferation expected around 2027.  

In the past, Astera has counted ten customers as leveraging PCIe in the short term and a combination of PCIe and UALink in the midterm before “transitioning perhaps to a broader UA Link deployment in 2027 and later.” 

The market is concerned because ESUN is now a third viable option and one that comes with a sense of familiarity given its Ethernet based, has large backers and perhaps most importantly – can exceed UALink when it comes to time to market. As you’ve likely picked up on with our energy coverage, time to market is everything right now. The ESUN consortium is banking on Ethernet moving quickly for scale-up networking.  

As it stands now, PCIe is optimized for scale-up networks due to low latency and speed measured in nanoseconds whereas Ethernet is best for scale-out networks. However, ESUN is proposing an Ethernet solution for scale-up with the press release stating: “ESUN is a new workstream collaboration designed as an open technical forum to advance Ethernet in the rapidly growing scale-up domain for AI systems.” 

There are quite a few details to consider in terms of how this plays out, yet the most likely outcome (from where I stand today) is that both are needed. UALink has specific benefits that will be tough for Ethernet to displace. Here is the technical description: “The [UALink] specification enables load, store, and atomic operations between 100s of GPUs while optimizing the protocol stack to minimize end-to-end latency, reducing valuable die area on GPUs and switches, and reducing interconnect and switching power consumption. UALink will support state-of-the-art up to 200Gbps per lane (equivalent to Ethernet) to provide the high bandwidth required between GPUs while also keeping latency in the 100s of nanoseconds (vs. multiple microseconds for Ethernet)” 

It goes back to this last part, which is the 100s of nanoseconds for UALink versus microseconds for Ethernet (as it stands today) that will require a leap in product design and successful deployment in order to displace UALink and the PCIe protocol (where Astera’s solutions fit in). Market participants are doing what many time-strapped investors do – scanning and seeing the large backers for ESUN and assuming it means UALink will not be successful. There is a time to market issue for UALink, yet in the meantime, PCIe remains a strong choice for fast, scale-up systems. PCIe is deployable right now for scale-up pods and CXL is also a strong choice for memory pool connectivity (Astera participates in all of this). 

Quick Takeaway: ESUN is attempting to make Ethernet work for scale-up whereas UALink was built from scratch for scale-up. The primary benefit ESUN offers is to move quicker than UALink (as discussed above, ALAB is saying it’ll be 2027 for UALink to be fully deployed). However, in the meantime, Astera’s PCIe solutions are in high demand and deployable now. Even if ESUN moves faster commercially, there is a performance gap that helps to ensure that Astera’s positioning with PCIe/CXL remains intact. That performance gap is best described as the low latency required for what are the most in-demand AI workloads today – those that require memory pooling and GPU-to-GPU communication.  

Commentary on the Earnings Call regarding UALink and ESUN 

The first question on the call pertained to this concern with an analyst inquiring about any changes in management’s outlook given the recent developments around Ethernet. It’s important to note the analyst acquiesced that it could take 18-24 months for a new protocol to be spec’d out.   

Here is what was stated – providing a longer quote given this topic has caused the stock to selloff twice. 

“We continue to see our market opportunity grow for our scale-up products, particularly this Scorpio X product like you noted. Scale up, as you can imagine, it's a very large market. We estimate it to be in tens of billions of dollars like you correctly noted, some of these design wins take last over multiple generations, simply because of the investment that goes into developing the software and the hardware required for killer topologies.  

For us, if you think about our business today, we are getting ready to ramp into production with our PCIe-based scale-up solutions, it's been extremely popular. There are several customers that are using PCIe like protocols for scale. A new entrant was Qualcomm that publicly announced their new AI 200 inference rack that feature PCIe-based scale-up. For Astera, we have engaged with over 10 AI platform providers. And we expect that these design wins and engagements that we have will continue to ramp.  

In fact, we expect this to go 2029 just based on some of the multi-generation nature of these design wins. For us, UALink is also a very meaningfully additive opportunity as customers start adopting it, just based on the higher data rate support the spec has been around, like you noted, for over a year now in terms of the consortium being formed. The spec is stable, the ecosystem is forming, silicon development is in full gear. And many of these customers, we have currently engaged with RFPs and RFQ. So the momentum is really built up very nicely and continues to grow. So we do expect meaningful revenue from UALink to start coming in 2027.” 

Notably, there is already a hint that UALink could hurry along to become available in H2 2026: “We continue to expect a portfolio of UALink solutions to be available to customers in the second half of 2026 with early revenues generated in 2027.” 

Scorpio P-Series is Ramping Now, and X-Series will Ramp Early 2026 

The more immediate catalyst for Astera as we look toward Q4 and into early 2026 are the Scorpio products, which we’ve covered in the past.  

Scorpio P-Series represents 10% of revenue now, yet management stated it will quickly double to exit the year at 20% of revenue. From there, management has implied Scorpio X will exceed Scorpio P’s revenue percentage. Net-net, that means Scorpio will reach 50% of revenue sometime in H1 2026 up from effectively 0% of revenue in H1 2025. 

Here is a quick refresher on these two solutions: 

The Scorpio P-Series is a small chip that connects the CPU, GPU, NIC and NVMe storage. Rather than building a large switch, the company built a smaller device that is more efficient for high-speed signals to help feed GPUs with data. The fewer ports and smaller switch decrease complexity in a bid to compete against Broadcom with twice the lane count.  

The X-Series is for back-end networking in GPU-to-GPU configurations (and custom silicon configurations), and will offer a higher port count. Astera is essentially building something similar to Nvidia’s NVSwitch with the X-Series, but for PCIe-enabled GPUs and ASICs. Per an earnings call earlier this year: “And this one, like Mike noted, it's a greenfield use case, meaning if you keep Nvidia and NV Switch aside, everyone else is starting to build configurations that are obviously going to need some kind of a switching functionality, which is what we are addressing with our X Series device.”   

The X-Series improves efficiency for ever-increasing AI cluster sizes. The majority of AI clusters are in the tens of thousands GPUs, but are expected to go to the hundreds of thousands (already has with X and some other Big Tech companies), and will see AI clusters with millions of GPUs over the next couple of years.  

In an effort to identify a catalyst that can sustain Astera’s exceptional growth, it would be this product that does so. The X-series is used to interconnect GPUs for higher GPU utilization, resulting in higher ASPs. Per previous commentary: “So to that standpoint, X-Series does bring in a lot more value, and therefore, you can assume that the ASPs tend to be significantly higher. And that's — again, there are different — the X-Series is not one device, to be very clear, there are multiple part numbers. So there would be situations where maybe one part number is not at the same level as P-Series. But in general, you can just look at it from a per lane standpoint or per port standpoint, and look at the value delivered.  And on that basis, the X-Series will always be a much more valuable, much more higher ASP product than a P-Series.” 

Notably, Astera maintains their largest opportunity for the X-Series is on the custom silicon side although they foresee hyperscalers wanting to customize their racks in a way that prevents vendor lock-in from both Nvidia and Broadcom.   

“So these are fabric switches that are used to interconnect multiple accelerators together. So to that standpoint, a, it's not only a significant dollar opportunity because the ASP of this product tends to be high. But these are also products that are turning out to be anchor sockets for us. If you think of an AI rack being built, you have the accelerators and then you have the fabric that interconnects the accelerators.    

So what we are transitioning and what we're excited about is that the Scorpio X device is now translating to be an anchor socket. Think of it as like a mothership around which we are able to now add a lot more products that go along with it, whether it's the silicon level products or module or other form factors that we're considering.” 

The longer refresher on Scorpio P-Series and Scorpio X-Series is necessary because the primary catalyst we identified earlier this year has not even ramped yet. Scorpio P-Series only began shipping this quarter and Scorpio X-Series will begin to ship next year. Here’s the most recent update on when these are shipping: “Scorpio P-Series continued its initial volume ramp at our lead customer, and we are excited that our P-Series revenue will further broaden with recent new design wins across a variety of AI platforms at multiple hyperscaler customers. Scorpio X-Series is shipping in preproduction quantities with a volume ramp expected throughout 2026.” 

Management confirmed they continue to expect a strong ASP uplift for the upcoming Scorpio X-Series ramp in 2026: “Looking ahead, we are gearing up for Scorpio X-Series to shift to high-volume production over the course of 2026. With this ramp of Scorpio X-Series for scale-up connectivity topologies next year, we expect our overall dollar content opportunity per AI accelerator to significantly increase, representing another step-up from a baseline revenue standpoint.” 

To future proof Scorpio solutions, Astera Labs is acquiring xScale Photonics as the market is expected to rely more heavily on photonics (as opposed to copper) a few years from now with management stating: “However, as data rates increase and scale-up domains go beyond 1 rack, clearly, at some point, you will need optical interconnects for scale-up. And there is already a big market for optical interconnects at a data center scale.” The result will be photonic solutions with higher data rates for Astera’s Scorpio solutions. 

Financials 

Revenue Beats by Nearly 12% 

Astera delivered a strong beat on the top line in Q3, with revenue up 103.9% YoY and 20.1% QoQ to $230.6 million, beating the $206.4 million estimate by 11.7%. This maintained Q2’s sequential growth rate of 20%, though YoY decelerated by ~46 points as the company begins to lap tougher comps on a dollar basis. Management said the strong growth was driven by new AI platform ramps featuring multiple products and “robust demand” across its signal conditioning, smart cable module (SCM), and switch fabric portfolios. 

For Q4, Astera guided for $245 million to $253 million in revenue, coming in well ahead of estimates for $216.5 million and pointing to YoY growth of 77% and QoQ growth of 8%, driven by continued PCIe 6 momentum and robust growth from Taurus Ethernet SCMs. This would technically mark the company’s first <100% growth quarter since the end of 2024.  

While Astera did not provide a full-year guide, extrapolating from the midpoint of Q4’s guide projects FY25 revenue at ~$831 million, ahead of estimates for $776 million and corresponding to nearly 110% YoY growth. This will likely force FY26 revenue revisions to move at least $100 million higher from the current $1.04 billion assuming consensus continues to project 34-35% YoY growth. 

GAAP Operating Margin Expands ~32 Points YoY to 24% 

While the revenue beat and raise is certainly welcomed, the improvement in GAAP margins down the line was impressive, with GAAP operating margin expanding to 24%.  

  • GAAP gross margin was 76.2%, ahead of guidance for 75%. This marked a marginal 0.4 point sequential improvement but a 1.5 point YoY contraction. Adjusted gross margin was 76.4%. 
  • GAAP operating margin was 24.0%, well ahead of guidance for 17.9%, and expanding 3.3 points QoQ and nearly 32 points YoY. This YoY expansion from (7.9%) in Q3 ’24 is quite impressive considering the company was reporting triple-digit revenue growth in each quarter; this also reinforces that the company is comfortably GAAP profitable. Adjusted operating margin was 41.7%, up 2.5 points QoQ and 9.3 points YoY. 
  • GAAP net margin was 39.5%, up nearly 13 points QoQ and more than 46 points YoY. Adjusted net margin was 38.3%, down 2.4 points QoQ but up 2.7 points YoY. 

For Q4, Astera guided for slight sequential moderation in margins down the line, with gross margin guidance at 75%, in line with prior quarter guidance. GAAP operating margin was guided to be 22.2% at midpoint, down 1.8 points QoQ but still up more than 22 points YoY. Adjusted operating margin was guided at 39.9%, down 1.8 points QoQ but up 5.6 points YoY. 

GAAP EPS Beats by 92% 

With the strong expansion in GAAP net margin, Astera delivered a 92.3% beat on GAAP EPS, reporting $0.50 in Q3 versus the $0.26 estimate. Adjusted EPS was $0.49, up 113% YoY and solidly ahead of the $0.39 estimate. 

For Q4, Astera guided for $0.20 in GAAP EPS, below the $0.26 estimate due to a 45% income tax rate. Adjusted EPS was guided at $0.51, up 38% YoY. This guidance would bring FY25 GAAP EPS to $1.17 (versus estimates for $0.96) and adjusted EPS to $1.77 (versus estimates for $1.58).  

Cash and Balance Sheet 

Cash flow margins moderated quite sharply on both a QoQ and YoY basis, though cash flow generation remained decently strong with an OCF margin of 33.9%.  

  • Q3 operating cash flow was approximately $78.1 million for a 33.9% margin, down from a 56.2% margin in the year ago quarter and a 70.5% margin in Q2.  
  • Q3 free cash flow was approximately $65.8 million for a 28.5% margin, down from a 41.4% margin in the year ago quarter and 69.5% in Q2. 
  • Cash and equivalents totaled $1.13 billion and debt remained zero. 
  • Accounts receivable were $42.9 million, rebounding from $24.3 million last quarter but remaining lower than the $69.8 million from Q1. Inventories moderated slightly to $51.7 million from $58.6 million in Q2.  

Conclusion: 

We do a lot of checks and balances at the I/O Fund to figure out if a stock is seeing unexpected headwinds. We look for catalysts (Scorpio solutions), we double check our product understanding (PCIe has unique benefits over Ethernet that will be hard to completely displace especially for memory pooling and GPU-to-GPU communication), we do a thorough checklist of the fundamentals with Astera crushing on the top line and even more so on the bottom line.  

To me, ESUN signals that Ethernet vendors are a little afraid of being left out of the scale-up party. The most probable outcome is that both ESUN and UALink coexist to address different layers of an AI cluster and as part of a broader shift away from proprietary networking. Even in a downside scenario where Ethernet moves faster than expected, we probably have an 18-month window before those dynamics materially affect deployments. It won’t be a boring 18 months either, rather it’ll be pretty exciting in terms of the importance of AI networking.  

With that said, Astera is a hypergrowth stock with an AI valuation. We are always prudent with these stocks by following risk management plans. We saw this with Palantir this week, reminding us that price action doesn’t always follow fundamentals in the near term. Our antennas are up, not because of concerns specific to Astera, but because prudent positioning is part of being an investor in high-growth AI names. 

Equity Analyst Damien Robbins contributed to this article.

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.

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AMD Q3: The Catalyst is Expected in H2 2026, Could Ramp Sooner

Reddit Q3: Setting a High Bar with Top Line Strength and 10-point Sequential Margin Expansion

AMD Q3: The Catalyst is Expected in H2 2026, Could Ramp Sooner

Posted on by io-fund

AMD’s bigger moment was intra-quarter when the OpenAI deal was announced, as it’s a clear signal the company is able to grab the attention of AI’s leading development firm. According to Lisa Su, the 6GW deal is expected to amount to “generate well over $100 billion in revenue over the next few years.”  

However, as noted in July’s Top 15 Report, “the risk to AMD is primarily in Q2’s data center growth decline, and how quickly the company can ramp its MI355s and subsequent MI400s while in the midst of Nvidia’s large shadow – will we see a solid surprise arrive in Q3, Q4 or even into next year? My best guess is the most meaningful AMD moment is not likely to occur during Blackwell’s NVL72s release – I think 2025 belongs to Nvidia and somewhere between 2026-2027 we switch it up.” 

After putting the loss of China revenue in the rear-view mirror, the data center segment sharply rebounded this quarter, up 22% YoY and 34% QoQ for revenue of $4.34 billion. However, we aren’t quite there yet in terms of a strong inflection as it was stated data center would grow 4% QoQ with strong growth server (a nod toward CPUs instead of GPUs). 

AMD is a stock where I’ve been intentional about managing expectations. The upside is compelling — as the second place in data center GPUs is wide open. Yet for those who have followed our coverage, the timing has always been key: meaningful execution in AI accelerators is not expected to materialize until the second half of 2026. In other words, the long-term opportunity is substantial, but patience remains part of the thesis.

MI400s Arriving in H2 2026 

As stated in the most recent Top 15 AI Stocks report: “The MI400 series will be the start of rack-scale systems for AMD, starting with Helios, which will connect up to 72 GPUs similar to Nvidia’s NVL72 systems […] AMD stated in their last earnings report they have an ambitious goal of reaching tens of billions in MI400 sales. Investors should take note that management is specifically calling out the MI400 for this, arriving in H2 2026. The readthrough is that OpenAI is an early validator that the MI400s have serious chops, and where OpenAI goes, the rest of the AI market tends to follow.” 

I’m quoting all of my previous comments so the timing is crystal clear. Here was the update this evening in terms of timing – aligned with my current understanding: “But given what we see today, we see a very good demand environment into 2026, so we would expect that MI355 continue to ramp in the first half of '26. And then, as we mentioned, MI450 Series comes online in the second half of 2026, and we would expect a sharper ramp as we go into the second half of 2026 of our data center AI business.” 

Last month, more information was shared on AMD’s Helios systems, primarily that Meta’s Open Rack Wide specifications were met, which refers to improvements for power, cooling and serviceability. The end result is ecosystem validation that AMD can offer an open standard for AI infrastructure based on Meta’s data center rack designs.  

One key area where Helios stands out is memory — the platform offers roughly 50% more total memory capacity compared to Nvidia’s Vera Rubin rack architecture. That said, if you’ve followed AMD’s AI story as closely as I have (and I know many of you have), then the most important leap in this generation of GPUs is not found in Helios specs or even this quarter’s commentary. Rather, it’s in the demand signals. For the first time, some of the most influential AI customers — including OpenAI, Oracle, and Meta — are preparing to deploy the MI400 Series in meaningful volume. That level of hyperscaler commitment is something AMD hasn’t enjoyed in prior GPU generations (MI300s), and it represents an important shift in the company’s competitive positioning. 

AMD Signs 6GW Partnership with OpenAI 

In early October, AMD signed a landmark deal with OpenAI to supply the ChatGPT parent with 6GW worth of GPUs, starting with 1GW worth of AMD’s MI450 GPUs in the second half of 2026. AMD said the deal would be worth “tens of billions” but declined to provide exact specifics, yet analysts have chalked the deal as worth potentially upwards of $100 billion at the full 6GW scale. In conjunction with the deal, AMD is issuing a warrant to OpenAI to purchase up to 160 million shares. This enables OpenAI to take up to a 10% stake in the chipmaker, though vesting will not begin until the first 1GW deployment and is tied to certain share price targets. 

The deal is expected to provide significant upside potential for both revenue and earnings by 2030, per BofA’s estimates, even assuming a significant discount to Nvidia’s GPUs on a GW basis – AMD’s opportunity per GW is pegged at $17.5 billion, compared to $25 billion-plus for Nvidia’s Blackwell Ultra GPUs.  

BofA’s scenario analysis projects AMD’s total revenue as high as $63.1 billion by calendar 2027 assuming one full GW is deployed, a rather quick timeline considering first shipments are not expected to commence until the second half of next year.  

Under this assumption, BofA projects AMD’s earnings power as high as $10.15, a 35% uplift to consensus estimates at the time for $7.50. By calendar 2030, deployments are expected to culminate with 2GW, or ~$35 billion assuming the opportunity per GW remains flat at $17.5 billion; this could result in EPS as high as $15.80, per BofA, 47% above consensus prior to the deal.  

However, considering that next-gen GPUs continue to command higher prices (such as Nvidia’s Rubin and Rubin Ultra moving to $30-35 billion per GW), AMD may also be able to charge a higher premium for its GPUs and still maintain a significant price-performance advantage to Nvidia. Thus, assuming a mid-$20 billion per GW opportunity by 2030, AMD could see $45 billion-plus with 2GW delivered in the final tranches. Given consensus estimates were ~$65 billion prior to the deal, this would project revenue potentially at $110 billion by 2030. 

Our estimates are aligned with Lisa Su’s commentary, where she stated in the opening remarks that “We expect this partnership will significantly accelerate our data center AI business with the potential to generate well over $100 billion in revenue over the next few years.” 

One major question surrounding the deal is OpenAI’s spending spree, and how the company will not only fund this, but its other GPU and cloud computing deals it has signed over the last month. In September, OpenAI had already projected cash burn at $115 billion through 2029, yet has signed $1.4 trillion worth of deals with Nvidia, Oracle, Azure, AWS and others.  

Commentary for AI Growth in FY26-FY27 

The last guide that AMD provided on GPUs was $6.5 billion in revenue by the time we exit this year. Management is hinting they will see “tens of billions” in their AI business by 2027. If we assume this means a minimum of $20B (perhaps more) then it coincides with roughly minimum 200% growth in AMD’s AI business over a two-year time span.  

“In summary, our AI business is entering a new phase of growth and is on a clear trajectory towards tens of billions in annual revenue in 2027, driven by our leadership rack scale solutions, expanding customer adoption and an increasing number of large-scale global deployments. I look forward to providing more details on our data center AI growth plans at our Financial Analyst Day next week.” 

Current Consensus Estimates Show Mismatch In FY28-29 

Though it is still uncertain as to how the OpenAI deal will ramp with the subsequent 5GW and timing for those deployments, consensus estimates still show a mismatch in FY28-29, with YoY growth pegged at <2%.  

Some of this stems from the inherent difficulty from projecting 3+ years into the future (and a much smaller # of analysts projecting long-term, dropping from 32 in FY28 to 5 in FY29). However, running off the assumption that 6GW is worth >$110 billion with the opportunity per GW rising from $17.5 billion to mid-$20 billion over the course of the deal, there is a >$30 billion mismatch in forward estimates.  

For example, post-deal, estimates for FY27 have risen 22.5%, FY28 by 37% and FY29 by 22.5%. On a dollar basis, FY27 has risen by nearly $11 billion, FY28 by $14 billion, and FY29 by $11.5 billion. Adding in the $2 billion jump in FY26 and a ~$48 billion jump in FY30 (limited data but initial consensus at approx. $65 billion), the total increase in estimates amounts to ~$86.5 billion.  

Based on rough back-of-the-napkin math for ~$110 billion in the total opportunity, $23.5 billion is unaccounted for, likely landing in the FY27-29 time frame as deployments ramp. Thus, there could exist future upside to revenue estimates later in the decade as the pace and timing of the ramp becomes more clear.  

Oracle to Deploy 50K MI450 GPUs with Expansion Potential 

Oracle has emerged as another large, public backer for AMD’s upcoming MI450 GPUs, with the company announcing on October 14 that it would be deploying an initial 50,000 GPU cluster starting in the second half of 2026, with room to expand in 2027 and beyond. This builds on an existing planned deployment of a zetta-scale cluster of 131,072 MI355X GPUs announced earlier this summer. 

This deployment is expected to carry an all-in cost of $3.5 billion to $4 billion to Oracle for ~700 72-GPU racks, including storage and networking, or nearly $5.4 million per rack at the midpoint. For comparison, Nvidia’s GB300’s are estimated to carry an all-in cost of $80,000 per GPU, or ~$5.6 million per rack. 

Oracle Cloud Infrastructure executives said that they believe “customers are going to take up AMD very, very well — especially in the inferencing space.” This is where AMD is packing a punch with 31.1TB of HBM content in the MI450’s Helios rack, 1.5x more than the GB300 NVL72, to significantly increase bandwidth and throughput for inference tasks. The I/O Fund was early to discuss this angle in the analysis “AMD vs Nvidia” 

AMD expressed confidence in delivering for Oracle in future years, as well: “Oracle announced they will also be a lead launch partner for the MI450 Series, deploying tens of thousands of MI450 GPUs across Oracle Cloud Infrastructure beginning in 2026 and expanding through 2027 and beyond.” 

Q3 Revenue Grew by 36% 

AMD’s Q3 revenue grew by 35.6% YoY and 20.3% QoQ to a record $9.25 billion, beating estimates by 5.7%. The revenue growth accelerated by 400 basis points from the 31.6% growth reported in Q2, reflecting strong momentum across the data center AI, server and PC businesses. The strong sequential revenue growth was primarily driven by growth in the data center, client & gaming segment, as well as modest growth in the embedded segment. 

The company also guided for a strong Q4 revenue of $9.6 billion at the midpoint, representing a YoY growth of 25.4% and 3.8% sequentially. It beat the analyst's estimates by 4.3%. The revenue growth will be primarily driven by strong double-digit growth in the data center and client & gaming segments. Similarly, to the last quarter, the revenue guidance does not include any MI308 chip sales to China. However, this time management indicated that MI308 chip sales could be coming soon.  

“So look, it's still a pretty dynamic situation with MI308. So that's the reason that we did not include any MI308 revenue in the Q4 guide. We have received some licenses for MI308, so we're appreciative of the administration supporting some licenses for MI308. We're still working with our customers on the demand environment and sort of what the overall opportunity is. And so we'll be able to update that more in the next couple of months.” 

Analysts expect revenue to grow 19.4% YoY to $8.88 billion in Q1 and then accelerate to 24.6% growth to $9.58 billion in Q2 2026. Looking forward, analysts expect revenue to grow 27.9% YoY to $42.33 billion in 2026 and accelerate 8.5 percentage points to 36.4% YoY growth to $57.72 billion in 2027. 

Data Center Segment Grew by 34% QoQ 

Data Center revenue rebounded strongly in Q3 as it grew by 22% YoY and 34% QoQ to a record $4.3 billion. The strong growth was primarily driven by the ramp of the Instinct MI350 Series GPUs and server share gains. Server CPU revenue reached an all-time high as adoption of 5th Gen EPYC Turin processors accelerated rapidly, accounting for nearly half of overall EPYC revenue in the quarter. The sales of prior generation EPYC processors also continued to be strong. 

The company also reported record sales as hyperscalers expanded EPYC CPU deployments to power both their own first-party services and public cloud offerings. Hyperscalers launched more than 160 EPYC-powered instances in the quarter. Currently, there are more than 1,350 public EPYC cloud instances available globally, up by about 50% YoY. 

Management expects cloud demand to remain very strong as hyperscalers are significantly increasing their general-purpose compute capacity as they scale their AI workloads. Many customers are now planning substantially larger CPU buildouts in the coming quarters to support the strong AI demand. Also, enterprise demand is very strong as the EPYC server sell-through increased sharply YoY and sequentially, reflecting accelerating enterprise adoption. 

AMD’s Instinct GPU business continues to accelerate. It is witnessing a sharp ramp of MI350 GPU sales and broader MI300 deployments. Multiple MI350 Series deployments are underway with large cloud and AI providers, with additional large-scale rollouts on track to ramp up over the coming quarters. 

Management was quite optimistic about future AI business growth. “Looking ahead, our data center AI business is entering its next phase of growth with customer momentum building rapidly ahead of the launch of our next-gen MI400 Series accelerators and Helios rack-scale solutions in 2026.” 

Client and Gaming Segment Grew by 73% YoY 

The client and gaming segment grew by 73% YoY and 12% QoQ to $4.05 billion. The strong growth was primarily driven by the acceleration in the Ryzen portfolio. It was stated: 

“Our PC processor business is performing exceptionally well with record quarterly sales as the strong demand environment and breadth of our leadership Ryzen portfolio accelerates growth. Desktop CPU sales reached an all-time high with record channel sell-in and sell-out led by robust demand for our Ryzen 9000 processors which deliver unmatched performance across gaming, productivity and content creation applications. OEM sell-through of Ryzen-powered notebooks also increased sharply in the quarter reflecting sustained end customer pull for premium gaming and commercial AMD PCs.” 

The gaming revenue grew by 181% YoY and 16% QoQ to $1.3 billion. The strong growth was driven by higher semi-custom revenue and strong demand for the Radeon GPUs. Management stated, “Semi-custom revenue increased as Sony and Microsoft prepare for the upcoming holiday sales period. In gaming graphics, revenue and channel sell-out grew significantly driven by the performance per dollar leadership of the Radeon 9000 family.” 

Embedded revenue was down (8%) YoY and up 4% sequentially to $857 million. Revenue increased sequentially as the demand environment strengthened across multiple markets. 

Margins 

The company’s profits are growing. However, margins are negatively impacted by higher operating expenses to support strong future AI opportunities.  

  • The company’s Q3 gross profits grew by 40% YoY and 56% QoQ to $4.78 billion. The gross margin was 52%, up 200 basis points YoY primarily driven by a higher profitable product mix. The adjusted gross margin was 54%, in-line with management guidance. Management has guided an adjusted gross margin of 54.5% for the fourth quarter. 
  • Operating income was up 75% YoY and up 1048% QoQ to $1.27 billion. The operating margin improved by 300 basis points YoY to 14%. Adjusted operating margin was down by 100 basis points YoY to 24% and missed the management guidance of 25% as the adjusted operating expenses increased by 42% YoY to support the significant AI opportunities and go-to-market activities for revenue growth. Management has guided an adjusted operating margin of 25% for the fourth quarter. 
  • Net income was up 61% YoY to $1.24 billion or 13% of revenue, up 200 basis points YoY. The adjusted net income was up 31% YoY to $1.97 billion or 21% of revenue, down 100 basis points YoY.

Adjusted EPS Grew by 30% YoY 

The company’s GAAP EPS grew by 59.6% YoY to $0.75, beating estimates by 10%. Adjusted EPS rose by 30.4% YoY to $1.20, beating estimates by 2.4%. 

Analysts expect adjusted EPS to grow by 22.3% YoY to $1.33 in Q4 and accelerate to 26.4% growth in Q1 and 183.2% YoY growth in Q2 to $1.36. Looking forward, they expect the adjusted EPS to grow by 61% YoY to $6.35 in 2026 and 45.7% YoY to $9.25 in 2027.

Cash Flow and Balance Sheet 

The company’s cash flows are growing primarily driven by higher revenue and profits.  

  • Q3 operating cash flows grew by 185% YoY to $1.79 billion or 19% of revenue, up 10 percentage points YoY. 
  • Q3 free cash flows grew by 208% YoY to $1.53 billion or 17% of revenue, up 10 percentage points YoY. 
  • The company had cash and short-term investments of $7.24 billion at the end of the quarter, up from $5.87 billion in the previous quarter. While debt remained the same at $3.22 billion. 
  • Inventories increased by 10% sequentially to $7.3 billion. 

Conclusion 

For the far majority of stocks, we would not have a placeholder in the I/O Fund portfolio this far ahead of execution. AMD is unique because the data center GPU market desperately needs a second-place contender. Investors may appreciate Nvidia’s pricing power, but hyperscalers and companies like OpenAI do not; they’d like to see more competition and optionality including lower prices. That is why we are seeing Meta work alongside AMD to bring Helios to market. There are many investment opportunities in AI across AI networking, AI energy, AI software, AI data layer and more – but none compare to the sheer size and strategic importance of GPUs, particularly when there are so few players competing for that share. That scarcity dynamic is precisely why AMD remains a special case in our portfolio. 

Equity Analyst Royston Roche contributed to this analysis. 

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.

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Talen Energy: Acquisitions May Unlock Data Center Deals, Amazon Ramping Soon 

Posted on by io-fund

Talen is an independent power producer with more than 10GW of generation capacity with 2.2GW of that being nuclear. The company’s assets are primarily located in Pennsylvania, Maryland and now Ohio, yet data center regions and capacity are growing including a long-term power purchase agreement with Amazon to fuel data centers in Pennsylvania.

Talen is expanding its power production portfolio with recent acquisitions of two combined-cycle gas turbine (CCGT) plants, Freedom Energy Center and Guernsey Power Station, for ~$3.8 billion. The two plants will add 2.8 GW to Talen’s energy assets in the PJM region – both are suitable for hyperscale data center power supply. This comes at a time when data center construction is surging in PJM’s region as its grid faces increasing strain, meaning the plants could be more valuable for meeting near-term hyperscaler power needs.

While Talen is inherently higher-risk having emerged from Chapter 11 bankruptcy in 2023 with a significantly reduced balance sheet, its cash balance has returned to extremely thin levels. On the flip side, the company expects strong cash flow generation to support rapid deleveraging, with substantial upside possible from its Amazon PPA and potential future data center deals. To first set the stage of why Talen is positioned well to power future AI data centers, it’s crucial to cross-examine strong construction activity in the region and the health of PJM’s grid.

Strong Growth in Data Center Buildouts in Data Center Alley, Pennsylvania

The data center market in the US remains heavily constrained as high levels of demand are outstripping surging supply, even as data center construction reached $40 billion annualized in June, up 30% YoY and a new record. In Northern Virginia, the so-called ‘Data Center Alley’ accounting for ~35% of total hyperscale data centers worldwide, demand and construction activity signals remain robust.

Data from CBRE showed that in the first half of 2025, data center capacity under construction in the region rose 80% YoY to nearly 2.1GW, or 35% of new construction activity across primary and secondary markets.

Available capacity in Northern Virginia was just 25MW, with the vacancy rate shrinking to just 0.7%, down 0.8 points YoY, signaling a very strong demand environment. Rental rates were estimated at $190 to $235/kW/month, above the primary market average of $188.75/kW/month, also indicative of strong demand.

Pennsylvania, while a smaller market versus Data Center Alley, has seen rapid growth in data centers over the past few years. A report from data center intelligence firm DC Byte estimated that the state’s data center capacity has surged nearly 34X since 2021 from 0.23 GW to over 7.8 GW, with the majority of this growth coming in the last year alone.

There have also been a handful of large-scale investments in the state – Google this summer announced a $25 billion investment over the next two years for data center infrastructure, while Blackstone also announced a $25 billion investment to build out data center and energy infrastructure. Additionally, Pennsylvania Data Center Partners and PowerHouse Data Centers are constructing a 1.35 GW hyperscale data center facility, expandable up to 1.8 GW, adding significant capacity to the state.

This strong demand and construction environment is coming head-to-head with a PJM grid that is at increasing risk of shortfalls as early as next year.

PJM Grid Sees Sharp Capacity Crunch, Facing Large Data Center Load Growth

Come 2026, PJM’s grid is expected to be at elevated risk of shortfalls during extreme conditions, per NERC. This is something the grid operator is well aware of, having stated before that they have been “warning for over two years of the prospect that parts of our country could run short of power during high demand periods.” Board Chair Mark Takahashi repeated in December 2024 that a shortfall “could emerge as early as the 2026/2027 delivery year.”

To understand why this is important, consider the high concentration of data centers in Northern Virginia plus the strong construction activity in the region. Companies looking to build new data centers in PJM’s grid – either in Virginia, Pennsylvania, Ohio or surrounding states – may struggle to get power in a timely manner.

For example, a survey conducted by Bloom Energy found that hyperscalers and developers expect to have power delivered to data centers by 2027 in Northern Virginia, though utilities do not expect to be able to deliver power until 2028 on average. Even back in 2024, Bloomberg reported that utility Dominion Energy said >100MW data centers in Virginia were facing up to seven year wait times for new connection hookups.

The 2026/27 base residential auction (BRA) this summer reaffirmed that the grid remains in a tight spot, with a handful of more concerning trends seen this year. Generation capacity offered in this year’s auction declined for a fifth consecutive year, with just 135.2GW offered, down from a peak of 183.6GW in the 2021/22 auction. As such, uncleared capacity shrunk to just 800 MW, down from a peak of more than 22GW in 2022/23, indicating the supply/demand balance has rapidly tightened rapidly over the last two years.

This built on similar trends from the 2025/26 auction, which saw supply/demand tighten, with POWER Mag saying that a “major driver behind the market imbalance is unforeseen demand growth from data centers and industrial electrification.” Talen provided a brief look ahead to the 2027/28 auction, noting there is potential for further tightening, as the auction parameters “‘include ~6 GW demand increase vs expectation of ~4 GW in incremental supply.”

Because of the rapid tightening in power supply, clearing prices have surged, to the tune of 11X over the past two years. Much of this arose in the 2025/26 auction, where clearing prices jumped 833% from $28.92/MW-day to $269.17/MW-day, reaching the annual cap. The 2026/27 auction saw prices once again hit the FERC-approved cap at $329.17/MW-day, a 22% YoY increase.

Skyrocketing power prices and elevated risk of grid shortfalls from a fifth consecutive year of declining supply puts major emphasis on adding new capacity to the grid. This is especially important when considering the increasing load from data centers. PJM reported in August that it's long-term projected load growth from 2024 through 2030 would be 32GW, with 30GW of that coming from data centers, assuming many data center projects materialize on time.

PJM’s 2025 forecast projects peak summer load at nearly 184 GW by 2030, up 30 GW from 2025’s peak forecast of 154 GW. Much of this growth is coming from PJM West, or Ohio, western Pennsylvania, western Virginia, with some additional growth in eastern Pennsylvania – primary regions where Talen’s assets are located.

However, the problem here is that PJM’s forecasting has recently underestimated peak demand growth, even with significant upward revisions over the last few years. For example, realized peak demand is already approaching 160 GW, nearly two years ahead of current forecasts, and if data center builds progress at current (or accelerated) paces, peak load may continue to outpace forecasts through 2030.

Source: Talen

This raises the risk that peak growth may continue to outpace PJM’s baseline projections, and could require additions well beyond 30 GW of new generation capacity, net of plant retirements, to meet load growth and reduce risk of shortfalls. Talen’s opportunity surfaces here as it is acquiring two new plants with 2.8 GW of capacity that could be prime targets for data center supply in two of PJM’s highest load growth regions.

Freedom and Guernsey Acquisitions May Expand Data Center Opportunities

While Talen has already made its first foray into colocating power and data center infrastructure at its Susquehanna nuclear plant in Pennsylvania (discussed more below), the company announced the acquisition of two combined-cycle gas turbine (CCGT) plants that may expand its presence in powering AI data centers. These assets could prove to be valuable to Talen as the two combined could help meet ~10% of estimated data center load growth in PJM’s grid through 2030, and Amazon’s deal economics suggest both combined could be worth easily more than $1 billion in annual revenue in a hyperscaler PPA.

Talen signed definite agreements in July to acquire Caithness Energy’s Moxie Freedom Energy Center (Freedom) in Pennsylvania and Caithness Energy and BlackRock’s Guernsey Power Station (Guernsey) in Ohio. The two CCGT plants will boost Talen’s portfolio by nearly 2.9 GW, with 1.84GW at Guernsey and 1.05GW at Freedom.

The transaction is valued at $3.8 billion gross, or $3.5 billion net after estimated tax benefits, expected to close in Q4 pending regulatory approval. Talen says the purchase price is an “attractive” multiple of 6.7x 2025 EV/EBITDA for the plants, or $1,300/kW, which it believes is a “material discount to current new-build CCGT costs.” This is around 35% cheaper to recent new build costs of ~$2,000/kW, per GridLab.

Talen believes the two new plants will facilitate service to data center loads, being located in close proximity to major new buildouts in northeast Pennsylvania and Columbus, Ohio, as seen in the diagram below. The two sites are capable of supporting gigawatt-scale buildouts based on generation capacity, and both could be attractive to hyperscalers and developers as gas turbines are increasingly popular to meet near-term AI data center power needs.

Source: Talen

Talen has provided some color on the synergies the plants will provide and how it is funding the transaction. Once integrated, Talen expects both the plants to be immediately accretive to free cash flow, by over 40% in 2025 and >50% through 2029.

On the flip side, Talen has issued ~$3.8 billion in new debt across various methods to fund the purchase and refinance some existing debt, which would more than double its pro-forma net debt to $6.56 billion. The company drew $1.2 billion in a term loan, upsized its revolving credit facility and stand-alone credit facility by $200 million each to $900 million and $1.1 billion, and priced $1.4 billion in senior notes due 2034 and $1.29 billion in senior notes due 2036.

Although the company expects strong free cash flow generation to allow it to rapidly deleverage this debt and reach a <3.5X net leverage ratio by year-end 2026, the high indebtedness raises risks substantially as cash has declined nearly $1 billion over the past year to just $135 million.

$18 Billion, 17-Year Power Purchase Agreement with Amazon in Pennsylvania

Talen’s sole AI ties presently are to Amazon, having expanded and signed a 17-year power purchase agreement through 2042 to power the hyperscaler’s data center adjacent to the Susquehanna plant, and potentially other facilities in the Pennsylvania region.

Talen signed the 1.92 GW agreement worth $18 billion in June, and expects to deliver the first 240MW by mid-2026 and scaling up in 120MW phases through mid-2028 to reach 480MW at a minimum. Full volume is expected to be reached no later than 2032.

Economics of Amazon’s Deal

At face value, the Amazon deal is worth more than $1 billion in average annual notional revenue to Talen, though it will take up to seven years to reach full volume. Talen has provided a glimpse into how the deal will accrete to FCF in the ramp stage:

  • FY25 FCF estimated to be $0.70 per share with 120MW delivered.
  • FY26 FCF estimated to rise ~121% to $1.55 per share, before rising at a ~27% annually to $2.50 per share by FY28
  • FY29 FCF estimated to rise between 60% to 130% to $4.00 to $5.75 per share, with anywhere between 840MW to 1,200MW delivered. Reaching the upper end of this range would require Talen to accelerate the ramp significantly and likely reach 960MW by 2028.
  • By FY32, when the plant ramps to full volume, Talen expects FCF in the range of $7 to $8.25 per share.

35% Free Cash Flow CAGR Supports Debt Deleveraging

A key highlight for Talen’s financials is the strong free cash flow growth the company is targeting over the next few years, driven in part by the Amazon deal and the PJM auction pricing. The major downside is the recent CCGT acquisitions have substantially boosted debt, with Talen’s pro-forma debt-to-equity ratio sitting around 5.3X.

Talen is targeting adjusted free cash flow growth at a >35% CAGR through fiscal 2028, rising from $10.30 per share at midpoint in fiscal 2025 to more than $27.40 per share, with room for significant upside to that terminal target.

In FY26, Talen is guiding for $21.40 to $25.80 in adjusted free cash flow per share, up 129% YoY at midpoint, and a significant 52% increase from its February guidance for $15.55 per share. For FY27, Talen is projecting $23.10 to $31.10 in adjusted FCF per share, up 15% YoY at midpoint. FY28 adjusted FCF is seen increasing marginally to $27.40 at midpoint, though Talen identified multiple outlets for additional upside to the mid to high-$30 per share range.

For example, if Talen fully executes its $2 billion share repurchase plan by 2028, this is expected to add ~10% upside to adjusted FCF, or ~$2.74 per share. If Talen accelerates the delivery of its Amazon colocation to 960MW by 2028, this could provide another 10% potential upside, while its recent acquisitions could provide 20% to 35% upside, with the higher range stemming from a potential 1 GW data center PPA.

Source: Talen

To put in perspective why this free cash flow generation is important, Talen’s pro-forma net debt would be approximately ~$144 per share, with adjusted FCF generation through FY27 covering about 40% of that at the high end of this projected range. Considering debt does not begin to mature until 2030, Talen has a long runway and strong visibility into cash flows that will help it deleverage this debt load.

EOS Energy Partnership

Talen and battery energy storage startup EOS Energy partnered earlier this week to combine EOS’ Z3 battery tech with Talen’s assets in Pennsylvania, to promote grid reliability, increase capacity utilization from existing energy assets, and help meet growing demand from AI data centers.

The two are reportedly currently working to “identify and develop multiple storage projects” across Pennsylvania totaling multiple GWh of capacity. The two have not provided a timeline on when projects would begin deployments, but considering EOS is still ramping production up to an annualized rate of 2 GWh of capacity by year-end, this may be more of a medium-term story.

Battery storage systems are emerging as a suitable answer for reliability and backup power for AI data centers, especially as grid strain increases. Storage systems help reduce reliance on the grid and ensure reliable backup power is available is times of disruption, including outages or inclement weather.

Financials

Q2 Revenue grew by 29% YoY

Talen’s Q2 revenue rose 29% YoY and 62% QoQ to $630 million, positively impacted by a $176 million gain on derivatives (compared to a $76 million gain in the year ago quarter). Revenue from contracts with customers was $409 million, up 18% YoY but down (-37%) QoQ. This shows the quarterly fluctuations that can stem from commodity contract hedging. For the first half of the year, Talen’s revenue was $1.02 billion, up 2% YoY, though revenue from customer contracts was $1.06 billion, up 40% YoY.

  • Capacity revenue grew by 91% YoY to $88 million in Q2, primarily driven by a $60 million increase due to higher cleared capacity prices through the PJM BRA for the 2025/2026 capacity year, partially offset by a (-$18 million) decrease due to lower volumes cleared through the BRA.
  • Energy revenues were flat YoY at $366 million. However, with a net of Fuel and Energy Purchases it had a $12 million favorable increase. It was primarily due to the combined effects of $70 million increase in margin associated with electric generation and ancillary revenue, primarily due to higher realized prices received at Susquehanna and the PJM fossil fleet, partially offset by lower generation volumes at Susquehanna and lower ancillary revenues; and $10 million increase in realized hedge results. It was partially offset by a (-$68 million) decrease in digital revenue and Nuclear PTC revenue.

Analysts expect revenue to grow 8.9% YoY to $707.9 million in Q3 and then accelerate to 53.4% growth in Q4 and 184.5% growth in Q1 2026.

Analysts expect 2025 revenue to grow by 11.4% YoY to $2.36 billion and accelerate to 69% growth in 2026 to $3.98 billion. During the recent Investor Day, management provided guidance for Energy revenue to be $2.89 billion in 2026, with more visibility arising from the BRA auction where Talen cleared 6.7GW translating to $805 million in Capacity revenue for the planning year from June 2026 to May 2027. As a result, Talen expects 2026 Capacity revenue of ~$747 million, up ~124% from $333 million projected in 2025; combined with Energy revenue, this gives visibility to $3.63 billion in revenue.

Margins

Talen’s gross margin (operating revenues including derivatives minus energy expenses) was 60% in Q2, down from 64% in the year-ago quarter due to unrealized losses from derivative instruments compared to an unrealized gain in the same period last year.

The Q2 operating margin was 10.5%, up from 5.5% in the same period last year, as the general and administrative expenses were flat. However, it was negatively impacted by higher maintenance expenses at the Susquehanna facility during its planned annual spring refueling outage.

Net margin was 11.4% in Q2, which does not compare with the asset-sale-impacted margin of 92.8% from the year-ago quarter. Q1’s net margin was (-34.6%), dragged down by derivatives.

Q2 adjusted EBITDA grew by 3.4% YoY to $90 million or an adjusted EBITDA margin of 14.3% compared to 17.8% in the same period last year. It was lower due to higher maintenance expenses at the Susquehanna facility during its planned annual spring refueling outage.

During the recent Investor Day held in September, management guided that 2025 adjusted EBITDA would be at the lower end of its previously guided range during the Q2 results of $975 million to $1,125 million, due to lower market opportunities in July and August than initially expected.

Management increased the adjusted EBITDA guidance for 2026 during the recent investor day, primarily due to the synergies from the Amazon deal. Management has guided the 2026 adjusted EBITDA to $1.9 billion at midpoint, an increase of approximately $600 million from the prior 2026 outlook given in July.

For 2027, management expects adjusted EBITDA in the range of $1.79 billion to $2.29 billion, representing a 7.4% YoY increase at the midpoint of $2.04 billion. For 2028, it expects to be above $2.06 billion, implying continued growth momentum.

EPS to surge in 2026

Talen reported GAAP EPS of $1.50 in Q2, rebounding from ($2.94) in Q1, which was down due to sharper losses on commodity contracts. This is also not comparable to the year-ago quarter, where Talen reported $7.60 in EPS, as this included an approximate $9.40/share benefit from the sale of its Cumulus data center to Amazon.

Analysts expect Q3 EPS to be down (-0.2%) YoY; however, it will be up by a solid 120% sequentially to $3.29, then accelerate to 49.3% YoY growth to $2.70 in Q4.

For fiscal 2025, Talen is expected to report $5.45 in GAAP EPS, signaling a strong second half of the year, with 2026 EPS projected to surge 269% YoY to $20.71.

Cash Flow Guidance Points to Strong 2H Despite Softer View

Talen’s operating cash flow was (-$184 million) in Q2 for a (-29.2%) margin, bringing 1H operating cash flow to (-$65 million) for a (-6.4%) margin, down from $150 million for a 15% margin in the year-ago period.

Adjusted FCF was (-$78 million) in Q2 for a (-12.4%) margin, with 1H adjusted free cash flow of just $9 million. Talen updated during the recent Investor Day that they expect its adjusted free cash flow to come at the lower end of the guidance range of $450 to $540 million for the year, primarily due to lower market opportunities in July and August compared to its initial expectations at the end of Q2. However, it still implies that it will be significantly stronger in the second half of the year.

For fiscal 2026, Talen is guiding adjusted free cash flow in the range of $980 million to $1.18 billion, more than doubling YoY, and for fiscal 2027, adjusted FCF of $1.055 billion to $1.425 billion. This would represent about 175% growth in two years or a compound annual growth rate (CAGR) of 66%.

Talen’s cash balance is extremely thin at $135 million versus its reported debt at $3.02 billion in Q2. However, pro-forma debt is much higher at $6.56 billion, including $3.8 billion for the acquisitions of the Freedom and Guernsey plants.

Management sounded optimistic on future cash flow generation during the Investor Day and increased the share repurchase authorization by $1.0 billion to $2.0 billion and also increased expiration by two years to December 31, 2028.

Valuation

Talen is trading just off peak multiples on the top-line at 7.4x forward revenue, more than 2x its average multiple of 3.6x but below its recent peak of 8.6x from early October. On the bottom-line, Talen trades at 70.5x estimated FY25 EPS, again just below peak levels, but for FY26 EPS, Talen trades at a more reasonable 19.1x multiple, far below its peak 1-year forward multiple of nearly 41x.

On an adjusted FCF basis, Talen trades at 18.8x FY26’s adjusted FCF per share guidance of $23.60 at midpoint, versus 43.1x FY25’s adjusted FCF of $10.30 at midpoint. Talen is quickly growing into this multiple with rapid FCF growth next year and additional growth opportunities arising in 2027 and 2028.

Notable Risks

Talen has a thin balance sheet with substantial debt, and has launched multiple financings via term loans, revolving credit facilities and senior notes to fund its recent acquisitions, though it still may need more cash over the next few quarters. The Amazon deal does de-risk the future growth story by locking in substantial revenue and free cash flow growth, but not for its immediate-term cash needs.

Talen had emerged from Chapter 11 bankruptcy in 2023 with a significantly reduced balance sheet, though its cash balance has returned to extremely thin levels; the Amazon deal beckons a strong ramp in FCF that may be able to pad the balance sheet in the future.

Conclusion

Talen is inherently higher-risk with thin cash and now elevated debt following its two plant acquisitions, though it expects strong, visible cash flow generation to allow it to quickly deleverage said debt. Talen is aiming to ramp to 480MW for Amazon’s data center by 2028 with the potential to accelerate that delivery to 960MW, providing more upside to cash flows and revenue if this materializes. The Freedom and Guernsey plants could command similarly valuable data center opportunities with key positioning near high-growth data center regions alongside with rising stress on PJM’s grid.

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.

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Vertiv Q3: Orders Surge 60% YoY, 20% QoQ, FY25 Guidance Raised

Posted on by io-fund

Thematic: 8/10
Fundamentals: 8/10
Valuation: 3/10

Brief Overview 

Vertiv will not win any hypergrowth stock awards, especially as management has previously offered CAGR guidance of 15% to 17% through 2029. Rather, it’s where Vertiv is positioned as an AI infrastructure partner especially as the trend turns toward modular infrastructure that makes this a stock to watch.  Essentially, all roads point toward Vertiv’s power and thermal solutions becoming increasingly important for future generations of rack scale solutions, with the company already preparing 800V DC solutions for Nvidia’s Rubin Ultra platform due in 2027. 

Revenue 

Vertiv reported revenue up 29% YoY and 1% QoQ to $2.676 billion, well ahead of its original guidance for 23% growth in the third quarter. This was driven by 43% YoY growth in the Americas on accelerated AI demand and 20% growth in APAC.  

For Q4, Vertiv guided for revenue to be $2.81 billion to $2.89 billion, up 6.5% QoQ and 18-22% YoY at the $2.85 billion midpoint. While this was ahead of previous guidance for $2.735 to $2.815 billion, this would still represent a nine point deceleration on the topline at midpoint. Management expects Americas revenue to be up high-30s, APAC up mid-single digits and EMEA down high single digits but up mid-teens QoQ. 

The strong outperformance in Q3 also led to Vertiv hiking its FY25 revenue guidance from $10 billion at midpoint to $10.2 billion at midpoint, pointing to organic growth of 26-28% YoY. Management did not provide any direct insight into FY26, though they did say that based on the “substantial backlog and clear visibility of pipeline, we anticipate continued significant organic sales growth in 2026,” with EMEA potentially reaccelerating in 2H 2026. 

AI Revenue Metrics 

Vertiv’s backlog rose ~30% YoY and 12% QoQ to $9.5 billion, reaccelerating from 21% YoY growth last quarter. More importantly, the $1 billion sequential increase in backlog was the largest in more than two years. However, one of the stronger metrics was order growth, with Vertiv reporting organic orders up 60% YoY and 20% QoQ in Q3. This drove a ten point rebound in TTM organic order growth to 21% YoY, from 11% in Q2. 

However, starting in Q4, Vertiv will no longer report on quarterly orders and backlog information, and instead will report a new metric “projected full year orders.”  

The following was stated in Q2: “Beginning on our Q4 and full year 2025 earnings call, we will provide projected full year orders rather than quarterly orders and backlog information. We believe this better aligns with how we run our business. We will provide updates on the full year projections quarterly as we progress through the year and as we deem necessary.”  This could create a boost to Vertiv’s stock to remove the lumpiness from quarterly reports and to also be more forward looking in terms of visibility offered to investors.  

Earnings 

Vertiv reported adjusted EPS up 63% YoY to $1.25 in the quarter, beating the $0.99 estimate by 25%. GAAP EPS of $1.02 beat estimates by 16.7%. For Q4, adjusted EPS was guided to decelerate to 27% growth to $1.26 at midpoint.  

For the full year, Vertiv raised its adjusted EPS forecast to $4.07 to $4.13, up from its prior view for $3.75 to $3.85. At midpoint, this represented a nearly 8% hike, now pointing to 44% YoY growth versus 33% previously.  

Margins 

Vertiv reported expanding margins across the board in Q3, though Q4 is expected to be approximately flat for adjusted operating margin.  

  • Gross margin was 37.8%, up 1.3 points YoY and 3.8 points QoQ. 
  • GAAP operating margin was 19.3%, up 1.4 points YoY and 2.5 points QoQ. Adjusted operating margin was 22.3%, up 2.2 points YoY and 3.8 points QoQ, driven by tariff mitigation efforts and strong execution addressing operational inefficiencies.  
  • Net margin was 14.9%, up 6.4 points YoY and 2.6 points QoQ. 

For Q4, adjusted operating margin was guided to be up 0.9 points YoY and approximately flat QoQ at 22.4%, as “progress addressing operational inefficiencies [is] offset by acceleration in growth investments and negative impact from new tariffs.” This is a rather steep decrease from Q2’s guidance for 23.6%, which would’ve been its best adjusted operating margin print since going public in 2020.  

For FY25, Vertiv slightly raised its adjusted operating margin forecast by 0.2 points at midpoint to 20.2%, representing YoY expansion of 0.8 points. This is strong as it comes in the face of “significant headwinds from tariffs and operational inefficiencies driven by supply chain actions to mitigate tariffs.” Tariff impacts are expected to be materially offset exiting Q1 ’26. 

Cash 

Vertiv reported strong cash flows in Q3, with operating cash flow of $508.7 million, up nearly 36% YoY. OCF margin was 19%, up 1.8 points YoY and 6.8 points QoQ. 

Q3 adjusted free cash flow was $462 million, up 32% YoY. Adjusted FCF margin was 17.3%, up 1.1 points YoY and 6.8 points QoQ. Q4 adjusted FCF was guided to be $496 million for a 17.4% margin, up marginally from Q3. Vertiv boosted its adjusted FCF guidance by $100 million, now forecasting $1.5 billion for the year, up from $1.4 billion previously. This corresponds to a 14.7% margin.  

Accounts receivable dipped (1%) QoQ to $2.81 billion, while inventories rose less than 2% YoY to $1.43 billion. 

Cash, equivalents and investments totaled $1.94 billion, while debt totaled $2.90 billion. 

Valuation 

Vertiv is trading at peak multiples on the top line, and slightly below peak on the bottom line. Vertiv’s forward PS is 7.2x, above its late 2024 peak of 6.8x, and substantially higher than its April low at 2.2x forward PS. 

On the bottom line, Vertiv is just below peak multiples, at 47.3x forward earnings versus its peak at 52.5x.  

Notable Risks 

Vertiv’s extended valuation is a primary risk as the company contends with a sharper deceleration on the top line heading into Q4, as well as a sharp deceleration in EPS growth from 63% in Q3 to 27% in Q4. Margins are also a line item to watch, considering management had guided for a Q4 adjusted operating margin of 23.6% back in Q2 but then subsequently cut that guide to 22.4% in Q3. 

Conclusion: 

The current quarter was not a showstopper as we prefer to be allocated more heavily to stocks that are showing signs of imminent Blackwell participation. However, Vertiv remains one to watch as the backlog increasing 12% QoQ and order growth increasing 20% QoQ could be signaling an inflection.

Damien Robbins, Equity Analyst at I/O Fund contributed to this analysis.

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.

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