Marvell reported strong Q4 results and is on the precipice of ramping demand from 5G and cloud infrastructure spending heading into FY2023. We have discussed throughout our coverage of Marvell and Inphi that the combined company is well positioned to benefit from these two trends.
Beth had outlined that “the growth opportunity for Marvell (and the reason I am investing) is for the lead Marvell currently has in 5G”, adding that datacenter will also be a strong tailwind for the company. With 5G ramping and datacenter growth expected to surge in the upcoming quarter, Marvell is well-positioned to benefit from these two secular trends. Importantly, Marvell has the inventory on hand to meet the rising demand, a trend that deserves a premium in today’s supply-constrained economy.
We expect that our thesis around 5G and datacenter growth will be realized in the first half of 2022, leading to outsized growth. Marvell’s financials have also been improving and the company will likely resume share repurchases later this year. While the outlook for Marvell is strong, we will be monitoring the back half of the year for a potential slowdown in growth as the 5G ramp peaks. However, this should be offset by strong demand from datacenters and edge computing tailwinds. I discuss Marvell’s latest results and drivers of demand in more detail below.
Marvell: Q4 Earnings Review and Outlook
In the latest quarter, sales increased 68% YoY to $1.3 billion, an acceleration from the 61% YoY growth rate in Q3 and beating estimates by 1%. During the year, Marvell merged with Inphi in a $10 billion transaction in Q1, and then also purchased Innovium for $1 billion in October. The recent M&A activity has skewed results, but on a Pro-forma basis, 2021 sales growth accelerated to 26% YoY, up from the prior year Pro-forma growth rate of 22%.
Sales were driven by strong growth in Datacenter and Carrier infrastructure (5G). Datacenter growth increased 113% YoY (15% QoQ) to $574 million or 43% of Q4 sales. On the Q4 call management explained that “the majority of the growth was from cloud, driven by robust demand from hyperscale customers.”
Carrier infrastructure increased 45% YoY to $241 million (18% of sales), and also accelerated on a sequential basis, growing 12% QoQ, up from 9% QoQ in the prior quarter. The strong growth was driven by Marvell’s 5G business, which grew sequentially by over 30% and exceeded management’s initial guide. On the call, management explained that it benefitted from the broader roll out of 5G technologies, and expects growth to continue into Q1 FY2023. I outline expectations for 5G spending in more detail below.
A rising trend for Marvell is its Enterprise Networking, which grew sales 64% YoY to $263 million. Management explained on the Q4 call that this end market was “going through an inflection” as hybrid work environments are driving demand for an “extended period of refreshing [enterprise] infrastructure”. This includes increasing bandwidth and improving security. To be complete, automotive increased 134% YoY to $79 million and Consumer increased 11% YoY to $185 million.
Gross margin declined YoY from 53% to 50%, which was driven by a step-up valuation in inventory and other non-cash charges following the M&A activity during the year. Non-GAAP gross margin increased 160 bps YoY to 65%, which is high relative to peers. Following the rise in non-cash expenses, operating margin fell YoY from 5% to 3% while non-GAAP operating margin expanded 860 bps YoY to 36%. GAAP earnings were $0.01/share, which missed estimates by a penny while non-GAAP EPS of $0.50 beat estimates by $0.02 and grew 72% YoY.
Cashflows from operations were $346 million and net leverage was reduced to 2.3x. Management explained on the call that they are on track to reach their targeted leverage ratio of 2x by the end of Q2, at which time they expect to restart share repurchases. This is a favorable trend and could support a higher share price, all else equal. Prior to the Inphi merger, nearly 100% of free cash flow was directed towards share buybacks. Utilizing Management’s long-term guide for 32% FCF margins, Marvell has capacity to lower its share count by about 4% per year, which will accelerate EPS growth.
Looking forward, sales are expected to accelerate and grow 71% YoY (6% QoQ) to $1.425 billion. Datacenter sales are expected to grow over 100% YoY in Q1 and in the mid single digits on a sequential basis, while Carrier infrastructure sales are expected to grow over 40% YoY and in the low-single digits on a QoQ basis. Enterprise networking sales are expected to accelerate and grow in the mid-teens on a QoQ basis while Automotive is also expected to remain strong and grow QoQ in the high-single digits. Finally, Consumer is expected to be flat QoQ. Non-GAAP EPS growth is expected to accelerate and rise 76% YoY to $0.51. I discuss the core drivers of Marvell’s demand in more detail next.
Update on 5G infrastructure
As outlined in our initial analysis, Marvell has a leading position as a 5G supplier and supplies the components for 5G base stations to customers such as Nokia and Samsung. We expected that Marvell would take a commanding lead in 5G infrastructure in 2021, a trend that we can see has finally arrived, as Marvell’s 5G sales increased 30% QoQ in the latest quarter.
Marvell’s 5G customers include Nokia and Samsung, which partner with carriers such as T-mobile, Verizon and AT&T to build out their 5G infrastructure. As a result, looking at capex plans from these telecoms can provide insight into the expected ramp in 5G spending going forward. As I’ll highlight below, the big three American carriers expect to ramp spending on 5G deployments by about $10 billion in 2022, which will drive demand for Marvell’s products.
Verizon explained on their Q4 call that they expect incremental capex related to the 5G upgrade cycle to peak this year and then start to normalize. Specifically, Verizon CFO Matt Ellis explained that Verizon had guided for “incremental [5G CapEx of] $10 billion over five years. We're going to see the biggest part of that come through this year”. In the chart below, Verizon highlights that its C-Band overlay spending will ramp in 2022. C-band is the wavelength that Verizon is using in its 5G deployments. Importantly, the accelerated $10 billion in 5G spending is expected to conclude in 2023, so the 5G ramp will be a quick, but significant trend for Marvell.
Verizon Outlook for Capital Expenditures
AT&T also guided that its capital expenditures are expected to ramp in 2022 and 2023. AT&T’s CEO stated during the company’s 2022 investor (03/11/2022) day that “it's a race to the home and to deploy 5G across the country. Our capital investment will be elevated over the next few years as we aggressively build a next-generation network with fiber and 5G”. AT&T’s guide for CapEx is expected to rise to $5 billion in both 2022 and 2023, driven by 5G deployments (shown below).
AT&T Outlook for Capital Expenditures Capex guide
Finally, T-mobile recently increased its capex guide for 2022 to maintain the company’s position in 5G. T-Mobile’s capex has grown from $6 billion in 2019 to over $12 billion in 2021. Looking forward, T-mobile expects its capex to continue to rise to another $2 billion and reach around $14 billion in 2022 as it pulls forward 5G spending.
In aggregate, Verizon, AT&T and T-mobile are guiding for a ~$10 billion (~16%) rise in capital expenditures in 2022, mostly driven by the deployment of 5G infrastructure. Nokia, which is a significant customer of Marvell’s, explained during its Q4 earnings call that spending plans from American telecoms is a favorable trend. Specifically, management stated that “listening to the CapEx plans of the key [telecom] customers in America that is of course a reason for optimization”.
We expect that 2022 will be a peak year for 5G spending, directly benefitting Marvell. However, trends in datacenter are long-term secular trends that should sustain topline growth beyond 2022. I discuss this in more detail next.
Update on datacenter
With 5G ramping and likely peaking this year, Marvell will also be benefitting from another trend that is just now beginning to ramp: COLORZ II. We had outlined COLORZ in our Inphi analysis, explaining that “Inphi’s COLORZ silicon photonics technology allows data centers in the same metropolitan region to function like a mega data center. This facilitates faster edge computing within an 80/120 km distance for 30-megawatt data centers as they will be linked together and function like a 120-megawatt data center … When the COLORZ ZR 400G launches, it has the ability to become a critical supplier for data center interconnects and the converged edge of telecom and cloud connections.”
The time has arrived for the ramp in COLORZ 400G ZR. Management explained on the Q4 call that it expects datacenter revenue (its largest segment) to increase more than 100% YoY driven by the “strong ramp” in its 400-gig ZR datacenter interconnect products, which is termed COLORZ II.
CEO Matt Murphy added that the first iteration of COLORZ peaked at a $100 million run rate, which was driven primarily by one customer (Microsoft). In the upcoming iteration of COLORZ II, revenues will surpass the prior peak of $100 million in Q1 and will continue to grow from there. This is because the 400ZR is being adopted by multiple hyperscale customers, so revenues will be more substantial.
To get a sense of the cadence of topline growth we can expect from COLORZ II, we can use Inphi’s prior financials to provide a guide. COLORZ first shipped in volume in 2017 and Inphi recorded $59 million in sales from COLORZ in 2017, which then grew into $89 million in sales by 2020 and eventually peaked at a $100 million run rate, or nearly doubling overtime. CEO Murphy is saying that COLORZ II will start at the $100 million run rate and continue to grow thereafter. Considering COLORZ II has multiple customers, the ramp should be even more robust than the first iteration and COLORZ II sales could more than double overtime.
Since Marvell is directly tied to datacenter infrastructure spending, a decent proxy for demand is trends in CapEx from leading cloud providers such amazon AWS, Google Cloud and Microsoft Azure. As shown below, AWS, Azure and Google Cloud have ramped spending, and this spending is expected to continue to grow.
Specifically, Amazon stated during its Q4 call that “Just under 40% of that CapEx is going into infrastructure, most of it’s feeding AWS … If I look to the future, we’re still working through some of our plans 2022, but it’s coming into focus a bit. We see the CapEx for infrastructure [AWS] going up. We still have a very fast-growing business thats growing globally, and we’re adding regions and capacity to handle usage that still exceeds revenue growth in that business”
Google stated during its Q4 call that “In 2022, we expect a meaningful increase in CapEx.” And Microsoft added that it expects capex will be up YoY in the upcoming quarter. The increased capital expenditures from cloud providers is a favorable trend that will benefit Marvell’s topline going forward.
Marvell has the inventory to meet demand but there are risks
Given the expected ramp in Datacenter and Carrier infrastructure sales, which collectively accounted for over 60% of Q4 sales, it is important that Marvell has the necessary inventory to supply this demand. Marvell’s inventory levels have increased sharply recently, and rose 169% YoY to $720 million, outpacing the 68% YoY rise in quarterly sales. Moreover, since Marvell has the inventory on hand, it backs up management’s statements that they expect a significant ramp in revenue in the near term.
However, having excess inventory is typically an unfavorable trend, since the technology can quickly become obsolete which leads to lower prices, impacting earnings. This concern is somewhat offset by the scenario outlined above about ramping demand from both 5G and datacenters, suggesting that the build-up of inventory is appropriate. Furthermore, Marvell’s inventory composition is relatively healthy and is not loaded with idle finished goods inventory, which is at a higher risk of being written off. As shown below, finished goods were just 20% of total inventory, well below the five-year average of 31%.
A key risk that should be noted is the way Marvell sells its inventory. Marvell does not have agreements in place that guarantee sale to its customers. Marvell explained in its 10K that it must maintain large inventory balances because the “semiconductor industry is characterized by short lead time orders and quick delivery schedules”. If demand for its products declines, Marvell will be left with a very large inventory balance that will likely need to be discounted to turnover.
Another risk is that Marvell has now had to enter into manufacturing supply capacity reservation agreements with foundries to secure supply. This means that Marvell now has to prepay for inventory (unfavorable) and also must pay a fee to cancel its reserved capacity. Marvell has $2 billion of supply commitments signed through 2032 and prepaying for future supply increases Marvell’s risk of taking on too much inventory, which could pressure margins in the future. This is a relatively new development and is a direct result of the current supply chain shortage. However, this is broader trend in the semiconductor industry and is not isolated to just Marvell. Furthermore, securing supply in a tight market should be awarded a premium.
The key takeaway is that elevated inventory can be a concerning trend, but we think it is actually a favorable trend given the expectations for surging demand in the near term and supply-constrained environment. Furthermore, inventory composition is healthy with low levels of idle finished goods. We should expect to see Marvell’s inventory balance normalize going forward as the 5G and COLOR II ramp get underway.
Trends on the horizon: DPUs and customization
With datacenter and 5G taking center stage in 2022, there is a new trend gaining momentum that promises to be a significant driver of growth going forward that should offset the eventual decline in 5G spending. The rising trend is ‘customization’, which is being driven by hyperscale customers that are increasingly developing their own custom, optimized silicon for the cloud environment.
Marvell’s recent acquisition of Innovium was driven to improve the company’s reach in the cloud-optimized market. Innovium developed a leading cloud-optimized switching technology that is used in cloud data centers. Innovium is expected to report $150 million in sales in FY2023 after being selected as a supplier for a Tier 1 cloud customer. Marvell also disclosed that it has a strong pipeline of cloud-optimized silicon, with $400 million of contract wins in the pipeline that will turn into revenue in FY2024 which is expected to double to $800 million by FY2025.
Since the cloud environment is inherently different than the legacy on-prem environment, prior architectures developed long before the cloud was around are outdated and are not optimized for the cloud. It makes sense that new silicon solutions will be optimized specifically for the cloud, and Marvell is positioning itself to benefit from this rising trend.
For instance, Marvell disclosed in its 10K that it is transitioning its product offering “from standard server processors to the broad server market to focus only on customized server processors for a few targeted customers”, adding that “the demand for optimized solutions has been increasing as our customers seek greater customization and differentiation for their products and services”.
Customized silicon for the cloud will be a material contributor to Marvell’s topline in a few years, and will help offset the expected decline in 5G spending after the ramp in 2022. During the year, Marvell won “over a dozen cloud optimized programs across multiple Tier 1 cloud customers. A significant number of these designs are for custom DPU implementations, reflecting the increase in the attach rate of DPUs inside cloud data centers”. We had mentioned that DPUs would be a tailwind for Marvell, stating that Marvell will be a major player here and this trend will be a future bull thesis for Marvell.
Marvell is well-positioned to benefit from the rise in edge computing driven by 5G and datacenter growth, and new trends such as custom, cloud-optimized silicon. We expect to hold onto Marvell through the concurrent ramp in 5G and datacenter spending but will monitor the company closely heading into H2 2022 for a possible lull in growth as spending peaks. however, we expect datacenter, edge computing and AI tailwinds to drive topline growth for the foreseeable future.
Valuation and conclusion
Marvell trades at a 10x forward P/S multiple, down from its peak multiple of 17x in December 2021, but a premium to peers such as Broadcom (8x), AMD (7x), Qualcomm (4x) and Cisco (4x). Marvell also trades at a 30x forward PE multiple, down from its peak of 57x in December 2021 but also above the peer median of 17x. Importantly, Marvell’s Q4 earnings grew 72% YoY and are expected to accelerate to 76% YoY growth in the upcoming quarter. The company’s long-term guide for 40% operating margins going forward, coupled with its LT guide for ~25% topline growth, highlights that earnings growth will be significant going forward, a trend that supports a premium PE multiple. While Marvell trades at a premium relative to semiconductor peers, the company is well-positioned to benefit from strong secular tailwinds such as 5G, datacenter, AI and customized silicon, which warrants a premium multiple.
We believe that the upcoming year will be a breakout year for Marvell’s top and bottom-line as both 5G and COLORZ II are ramping this year. Marvell also has the inventory on hand to meet this demand and is positioning itself to benefit from new trends such as customized silicon. While we believe that Marvell will be strong, we will be monitoring growth expectations closely heading into H2 2022 as sales growth may slow as 5G spending peaks. however, we expect this to be a temporary trend that will be offset from the secular tailwinds from datacenter and edge computing infrastructure spending.
Additional Reading:
- Inphi: Premium Analysis
- Marvell Technology: 2019 Analysis
- Marvell and Inphi: Acquisition Analysis
- AI Accelerator and 5G Chips: Connecting the Dots
Disclosure: Bradley Cipriano and the I/O Fund own shares in Marvell and have no plans to change their respective positions within the next 72 hours. You can access the I/O Fund’s positions here. The above article expresses the opinions of the author, and the author did not receive compensation from any of the discussed companies.Disclosure: Bradley Cipriano and the I/O Fund own shares in Marvell and have no plans to change their respective positions within the next 72 hours. You can access the I/O Fund’s positions herehere. The above article expresses the opinions of the author, and the author did not receive compensation from any of the discussed companies.