Category: Ai Platforms

Dell Fiscal Q1: Agentic AI Creates Tailwind for Traditional Servers and Storage

Posted on by io-fund

Dell put up a massive beat this evening with analysts calling for growth of 51.3% compared to 87.5% reported for revenue of $43.8 billion. This evening, Dell’s management team admitted they did not foresee the incoming boom that agentic AI is causing in both traditional servers and their storage and services attach rates, stating: “I didn’t — we didn’t know this in October. This is a completely new marketplace. That's being driven by putting intelligence in every workflow and every part of knowledge work on the planet today, and we're just beginning.”

There were a few references back to October on the call as Dell’s management team had to substantiate why they originally offered a long-term annual revenue growth target of 7% to 9% with a long-term target for EPS growth of 15% or higher, yet are now offering a 1-year guide of 47% with EPS growth of 75%.

The report is being celebrated after hours – and for good reason. It’s not every day that you see a beat/raise of this magnitude, and at scale. To remain balanced, there were some concerns on the call that the current quarter could reflect a pull forward, to where some customers are buying ahead to secure supply and avoid future price increases. The answer to this concern is the pipeline exceeds historic norms, demand is broadening across many customers, and management repeatedly emphasized “We have a supply issue. It is not a demand issue for us.” My take is that what would have been a pull forward in the past, is now sheer scarcity in the AI economy.

See below for a few key discussions from one of the largest players in AI.

Agentic AI is Leading to a Surge in Traditional Servers and CPU-Based Infrastructure

Dell may not be the first company that comes to mind when thinking of the importance of CPUs handling orchestration for inference workloads, yet the surge in CPUs translates to traditional servers and CPU-based infrastructure. By sitting at the system layer, Dell benefits by selling the servers, racks, storage and services as the CPU boom broadens to also include more demand for OEMs like Dell, given Dell’s core business is to package CPUs into servers.

Per management commentary on the earnings call, agentic AI is creating a new market for traditional servers specifically because each GPU call requires more CPU resources, which results in enterprises and neoclouds needing more servers to run the orchestration layer. The additional bonus for Dell is this means their customers also need more storage to track what agents do and services to deploy the systems at scale.

Here is what was stated on the earnings call:

“But you have this work that has to be done around I/O, around branch, retries, managing state. They're very sequential. They're very serial in nature as a result of that. That's a workload that's for the CPU. So if you think about this notion, that's generally called the harness. So if you think about that harness, the CPU runs it. It's going to make those calls. It's going to manage memory. And it's in the loop and every decision that an agent makes. I didn't — we didn't know this in October. This is a completely new marketplace. That's being driven by putting intelligence in every workflow and every part of knowledge work on the planet today, and we're just beginning […] And if I go from the trifecta here, all of that stuff has got to be stored. It needs high-performance storage to be able to ultimately have a receipt of what the agent is doing. So it can be corrected. You can understand what it did. That's where we're at. I don't know how we would have predicted that in October. And today, I can't sit here and tell you how big the TAM is other than I know it's bigger, it's growing, and we're in the early innings of it.”

Earlier in the same comment, management offered a perspective that is important for to double click-on, as the statement confirms that AI infrastructure is quickly expanding beyond GPUs, and that historical models no longer apply. The emphasis made in the quote below is that there is an important shift as AI moves from “adviser” to “operator.”

Here is what was stated:

“[…] don't think applying historical models or historical views about the market and how it's going to act or appropriate today. we're finding new uses. I mean, the way that I get asked this old ask you this, is what's the value of adding intelligence into every workflow, every decision, every product every customer interaction. I would assert the value is pretty darn high. And that's what's been really, I think, the game changer since that October time is what's really happened in Agentic. And what you're seeing are new categories of TAM expanding, you had the 3 microprocessor leaders talk about an expansion of CPU TAMs. Why? It's driven by agentic.”

The important takeaway for investors is two-fold, as one of the management teams closest to the AI server market was unable to foresee the importance of CPUs to inference workloads. Secondly, TAM expanding is not merely theoretical, it’s happening very quickly in one earnings cycle.

Dell Pushes Back on Pull Forward Concerns; the Reasons are Important

It doesn’t hurt to pay attention when a deeply cyclical player offers discussions around why their surging sales are not cyclical. It’s one thing to listen to Nvidia or Broadcom, those with very fortunate positioning. Yet a player like Dell is offering rare visibility in this earnings call, and any resiliency at all into 2H is a hint toward the strength of AI demand.

For example, management called out memory constraints around DRAM and NAND, along with CPUs and hard drives, implying they are gated by component availability rather than customer pipelines. For example, even if memory components were readily available, Dell pointed to lead times on CPUs being a year out. This is leading to customers signing multi-year supply agreements. There was even a mention that customers are locking in servers without knowing what the prices will be.

Here is what management stated:

 “On the pricing side, Tim, we're repricing, it feels like every day. And I'm sure our customers feel that pain. Unfortunately, I don't see that changing given the world that we're living in today where you have an inflationary environment, whether it's fuel, whether it's raw materials, whether that's DRAM, whether that's NAND, CPUs, we are living in an inflationary environment that is changing at a rate that, obviously, we've never seen before. And everything that we see suggests that continues. There will be a point where some customers, it's enough and they'll wait it out. And we're seeing that in some cases. .

In other cases, we're seeing an acceleration, the notion of that was called out earlier, where folks are trying to secure that supply now and over multiple years because it's going to be more constrained.”

Perhaps most importantly, even though there is a nominal QoQ decline expected in AI server revenue next quarter of (3.7%) QoQ, management pulled the Q1 beat/raise through to the full year guide. This suggests 2H will be strong and that Q1 is not transient or cyclical.

Financials

Revenue Accelerates to 87.5% in Q1 FY2027

Overall, Dell reported one of the largest beat-and-raise quarters across the AI industry so far this quarter. Not only did the company beat Q1 estimates by nearly $8.5 billion and guide Q2 nearly $8 billion above, but it also boosted its FY27 revenue outlook by $27 billion.

Dell’s Q1 revenue surged 87.5% YoY and 31.3% QoQ to a record $43.84 billion, driven primarily by a strong acceleration in AI server deliveries and CSG revenue coming in well ahead of guidance. YoY growth accelerated by 48 points from 39.5% in Q4, while QoQ growth accelerated nearly 8 points from 23.6% QoQ. As noted above, this represented a massive $8.46 billion (23.9%) beat over consensus estimates for $35.38 billion.

For Q2, management provided guidance of $44.0 billion to $45.0 billion, implying 49.4% YoY growth and 1.5% QoQ growth at the midpoint of $44.5 billion. This again was a notable $7.92 billion raise (21.7% beat) to consensus estimates of $36.58 billion for 22.9% growth.

Dell also doled out a significant upward revision to its FY27 revenue guide, raising its forecast from the prior range of $138–$142 billion to $165–$169 billion. This represents a $27 billion raise at midpoint and implies YoY growth of 47.1%, a substantial ~24 point raise from its prior guidance of 23.3% YoY.

Management’s updated guidance for $167 billion is more than $22 billion above current consensus estimates for $144.9 billion. This implies perhaps a touch less visibility (or conservatism) into the second half of the fiscal year, considering Q1 and Q2 combined for nearly a $16.4 billion beat.

In other news, Dell won a $9.7 billion, five-year deal with the Department of Defense to help consolidate Microsoft software licenses across the military, and earlier this week it won a $1.6 billion deal from IREN for air-cooled Blackwell racks.

Key Segments:

ISG Grew 181%, Fueled by AI Servers

Dell’s Infrastructure Solutions Group (ISG) Q1 revenue grew 181% YoY and 48% QoQ to a record $29.0 billion, accelerating sharply from 73% YoY and 39% QoQ in Q4 and bucking the typical Q1 seasonal decline. To emphasize how strong Q1’s growth was, ISG recorded $9.4 billion in sequential growth this quarter, versus $5.5 billion in Q4 and a ($1 billion) decline in Q1 last year. This also marked the ninth consecutive quarter of double-digit growth for the segment.

ISG’s growth was driven by an explosion in AI server shipments, with AI-optimized server revenue reaching a record $16.1 billion in Q1, up 757% YoY and 80% QoQ; in dollar terms, AI server revenue increased $7.1 billion QoQ. This was substantially ahead of the $13 billion shipment guide management had set at the start of the quarter.

AI server orders in Q1 were $24.4 billion, moderating from Q4’s $34.1 billion, while AI server backlog increased to $51.3 billion exiting the quarter, up from $43 billion in Q4.

Management guided AI server revenue of approximately $15.5 billion in Q2, which would represent roughly 89% YoY growth but a (3.7%) QoQ decline. Dell also raised its FY27 AI-optimized server revenue expectation to $60 billion, up 144% YoY and a $10 billion raise to its prior guide for $50 billion.

Here was a pointed discussion around where the growth is coming from: “We had significant unit growth in traditional servers. And then we had the content growth. We are continuing to see on a year-over-year basis more cores, more DRAM, more NAND placed in each and every server. So you have the uplift of more content. And then obviously, that content is growing as well in terms of the inflationary side. So absolute growth in units, absolute growth in the content driven by modernization and consolidation as customers are looking to upgrade and modernize their fleets and then we had the inflationary part.”

Strength was evident outside of AI servers, as Traditional Servers & Networking revenue grew 92% YoY and 46% QoQ to $8.5 billion. Demand remained well ahead of supply with double-digit or better demand growth across every region. Data center modernization continues to drive a refresh cycle as enterprises rearchitect their infrastructure to support both AI and traditional workloads in parallel.

Storage revenue grew 8% YoY to $4.3 billion, representing the fifth consecutive quarter of Dell-IP demand growth above the market; sequentially, Storage declined (10%) QoQ, consistent with typical seasonal patterns after a strong Q4. Storage profitability also improved, supported by a higher Dell-IP mix.

Looking out to Q2, ISG revenue is expected to grow approximately 75% YoY, riding strength in both AI and traditional servers. This would project revenue to be roughly $29.4 billion, up just 1.4% QoQ.

For the full year, Dell guided for ISG revenue to grow ~80% YoY, implying revenue of roughly $109.5 billion for the segment, underpinned by AI-optimized servers guided to be up 144% YoY to $60 billion. Traditional Servers revenue was guided to increase 60%, while Storage was guided up mid-single digits.

CSG Revenue up 17% YoY, Well Ahead of 2% YoY Guide

Client Solutions Group (CSG) Q1 revenue grew 17% YoY and 8% QoQ to $14.6 billion, marking the seventh consecutive quarter of commercial revenue growth and the second consecutive quarter of PC share gain, per IDC data. This was a notable beat versus management’s guidance for just 2% YoY growth for CSG.

Commercial revenue grew 18% YoY and 12% QoQ to $13.0 billion, reflecting continued enterprise spend on PC refresh and the strength of Dell’s commercial premium positioning. Consumer revenue grew 9% YoY to $1.6 billion (down 15% QoQ on seasonality), representing the third consecutive quarter of demand growth supported by strength in gaming.

For Q2, management guided for CSG growth to accelerate further to 20% YoY, implying revenue of $15 billion or up 2.7% QoQ. For the full year, CSG growth was guided up low-teens, potentially implying a bit of moderation in 2H or a lack of visibility at present.

Margins

Despite gross margins falling to their lowest level in recent history, operating income tripled YoY, underscoring how efficiently Dell is scaling operating expenses relative to revenue. On a sequential view, however, operating margins moderated and were implied to moderate a bit more in Q2.

GAAP gross margin was 17.8% in Q1, down from 21.1% a year ago, while adjusted gross margin was 18.1%, down from 21.6% a year ago. The compression continues to reflect the higher proportion of AI server revenue, which carries structurally lower gross margins than storage or services.

GAAP operating income grew 214% YoY to $3.66 billion, driving GAAP operating margin expansion from 5% a year ago to 8.3% in Q1. Adjusted operating margin was 9.7%, up from 7.1% a year ago. Management’s Q2 guide implies adjusted operating income dollar growth of 80% YoY, projecting adjusted operating margin of 9.2%, up from 7.7% a year ago but down from Q1’s 9.7%.

For a quick view on segment margins, ISG operating margin was 10.5%, improving from 9.7% a year ago despite the higher AI server mix, while CSG operating margin was 8%, improving from 5.2% a year ago.

GAAP net margin was 7.8%, up from 4.1% a year ago and 6.8% in Q4, reflecting both revenue scale and a $631 million fair-value gain on equity investments. Adjusted net margin was 7.3%, up from 4.7% a year ago but moderating from 7.8% in Q4.

Q1 Adjusted EPS Grew 214% YoY

Dell’s Q1 adjusted EPS grew 214% YoY to $4.86, beating the analyst consensus estimate of $2.90 by approximately 68%, one of the largest EPS beats in Dell’s recent history. GAAP EPS was $5.24, up 282% YoY, beating consensus of $2.61 by over 100%. Both adjusted and GAAP EPS reached a record.

Management guided Q2 adjusted EPS to $4.70–$4.90, up approximately 107% YoY at midpoint $4.80. This also came in substantially above consensus estimates for $2.73 next quarter.

Similar to revenue, Dell also significantly raised its EPS guidance for the year, now projecting FY27 adjusted EPS of $17.65 to $18.15, up 74% at midpoint. This compares to prior guidance for $12.90 at midpoint, up 25% YoY. Dell also raised its GAAP EPS guidance to $17.06 to $17.56, up 99% YoY at midpoint, versus prior guidance for nearly 33% growth to $11.52.

Cash Flow and Balance Sheet

Operating cash flow margins held near double digits despite the higher working capital requirements of Dell’s AI server business, though cash flow margins contracted both YoY and QoQ.

Q1 operating cash flow was a record $4.08 billion or 9.3% of revenue. This compared to $2.80 billion or 12% in Q1 last year, and 14% in Q4.

Q1 adjusted free cash flow was $3.17 billion or 7.2% of revenue, compared to $2.23 billion or 9.5% a year ago and 15.2% in Q4. Free cash flow (before adjustments) was $3.12 billion for a 7.1% margin, down from 9.5% a year ago and 11.8% in Q4.

Dell ended Q1 with $14.1 billion in cash and investments, including $11.6 billion cash and $2.5 billion in long-term investments, up from $13.3 billion at the end of Q4. Total debt was $31.4 billion, slightly below the $31.5 billion at Q4 end. Core leverage declined to 1.2x, below the company’s 1.5x target, providing significant balance sheet flexibility.

Inventories rose 44% QoQ to $15.05 billion in Q1, up from $10.44 billion at Q4 end, primarily to support surging AI server demand and ensure Dell can fulfill its $51.3 billion backlog. Accounts receivable rose sharply to $25.85 billion, supporting the strong revenue ramp.

Conclusion:

Dell’s management team has a long track record of offering conservative commentary, yet this evening, the call was decisively bullish. It’s not only the beat/raise that stands out, but also who delivered it. For Dell to raise full year revenue by $27 billion following roughly two $8 billion beat/raise quarters for a combined $16 billion, is notable, because this is a management team that tends to undersell.

Perhaps most importantly, Dell was transparent that agentic AI is driving CPU demand they did not foresee a few months ago, and in turn, higher traditional server sales tied to a new TAM is already materializing.

One note, Dell is not an easy stock to own. Even with this blowout beat/raise, the company is guiding for a modest sequential QoQ decline on AI servers in Q2. The stock requires active management, a keen eye on the margins, and an investor that is okay with lumpy quarters. If that will smooth out for Dell remains to be seen, yet as it stands, this report shined on all accounts.

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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Dell Sees AI Servers Doubling to $50B in 2026 

Posted on by io-fund

Dell reported some of the strongest AI revenue numbers in the industry last quarter with AI server revenue up 342% YoY to $9.0 billion, orders up 1,906% YoY to a record $34.1 billion and backlog up 177% QoQ to a record $43 billion. This strong AI momentum in Q4 is underpinning Dell’s FY27 guidance for AI server revenue to more than double to $50 billion, which management believes they can achieve while maintaining margins in the mid-single digits.  

Driven by this AI strength, Dell guided for revenue to accelerate nearly five points to 23.3% YoY to $140 billion, emphasizing that they have the supply to achieve this guide in full for the entire year, despite supply constraints facing the industry, notably in memory. Dell also noted that the demand picture remains robust, and more supply would leave potential for more growth.   

Below, we look into Dell’s AI server metrics, key risks ahead for growth and margins, and potential headwinds on the PC side. 

Robust AI Server Growth, Backlog up 949% YoY 

It’s hard to deny that Dell’s AI server guidance and key metrics were the strongest parts of its Q4 report, with the company guiding for just over 100% growth to $50 billion in AI server revenue this year and both orders and backlog up well over 100% QoQ. However, the predominant question for Dell’s stock is server margins, which Dell stated will be in the mid-single digits. 

Starting with backlog and orders, perhaps the top two metrics this quarter, it’s hard to understate the strength of demand that Dell is seeing. Orders rose 1,906% YoY and 177% QoQ to a record $34.1 billion in the quarter, driving backlog up 949% YoY and 134% QoQ to a record $43 billion.  

Dell clarified that the majority of the backlog consists of Grace Blackwell servers, while Vera Rubin is taking a larger share in its five-quarter pipeline but is not yet appearing in orders, likely due to the system timing in the second half of the year along with potential rumors of slight delays. Management also expects a smoother transition from Blackwell to Rubin, letting them ramp “with more velocity and speed” into calendar 2027. Here is what was stated: “So on the $43 billion backlog, Samik, it is predominantly overwhelmingly Grace Blackwell. There is no Vera Rubin [indiscernible] pipeline. The largest percentage of our 5-quarter pipeline is a combination of Grace Blackwell and Blackwell where we're seeing a rise in x86 Blackwell in the 5-quarter pipeline, driven primarily by enterprise deployment, air being the #1 consideration.” 

Importantly, Dell noted that the dollar value of their five-quarter AI server pipeline has never been larger, despite the robust order activity and $34 billion in orders received, highlighting the breadth of demand from enterprises, CSPs and sovereigns.  

While these both add a large layer of confidence in Dell’s $50 billion AI server revenue guidance for FY27, up 103% YoY, the question moving forward is, what does this mean for growth?   

While Dell did guide for Q1’s AI server revenue to be $13 billion, up 620% YoY and 45% QoQ (some of the strongest growth across AI at the moment), its full year guide says this will be its max quarterly run rate. Management had explained at Morgan Stanley’s TMT Conference after earnings that they have “committed to $13 billion of Q1, which is effectively $1 billion a week of shipments going out the door.” Annualizing that gives $52 billion, which suggests there will be minimal QoQ growth moving forward as the max run rate, or that they will be some degree of lumpiness, potentially tied to the upcoming transition from Blackwell to Rubin.  

There is also potential for orders to normalize lower moving through FY27 – Dell is likely quite capable of handling a high degree of orders, yet its backlog exiting Q4 already represents more than 85% of its AI server revenue guide, meaning continuous orders at this level ($10-30B) each quarter could cause its backlog to grow faster than it can get servers out the door. 

Dell also has made clear that there isn’t enough supply to meet the level of demand they see: “If we were to look at some of the demand asks that we would see from customers today and replicate that for a full 12 months, there isn't enough supply to fulfill that.” While Dell emphasized that it has the supply to satisfy its entire guidance for the year (not just Q1), some of the constraints that we see on the memory side in particular may make it increasingly difficult to ramp server revenue much higher. 

It’s Not Only About the AI Server Margins, but Also Storage 

As mentioned above, Dell’s story mainly circulates around AI server margins, which the company is aiming to maintain in the mid-single digit range. Regardless of where mid-single digit is for Dell (whether it’s 5% or 7%), the fact is that AI servers lag its broader ISG segment on operating margins and could present a larger headwind as its share of revenue increases. However, Dell is offsetting this server drag via storage, its highest margin business where growth has been strong and attach rates are rising.  

COO Jeff Clarke explained that Dell has “operated throughout the quarter and over the course of the year in that mid-single-digit operating income [for AI servers]. With what we see in front of us, there's no reason to change that. That is our guidance of where we can operate this business, and we're going to continue to grow it.”  Clarke emphasized again in a later question that Dell believes it can maintain mid-single digit margins while transitioning from Blackwell to Rubin, noting that the current $43 billion backlog “will ship at mid-single digits” as well.  

Looking more acutely at margins, Dell’s ISG segment operating margin was 14.8%, down 3.3 points YoY, with AI servers accounting for nearly 46% revenue share in the segment, up from less than 18% a year ago; Dell said pricing efforts allowed server margins to stabilize despite higher input costs.  

For the entire fiscal year, ISG operating margin was 11.7%, down 1.1 points, with AI servers accounting for 41% of revenue, up from 21%. Based on management’s guide for $50 billion in AI server revenue and ISG growth of mid-40%, AI servers could exit the year at ~57% of ISG revenue, potentially creating a larger margin overhang by next Q4; quick back-of-napkin math assuming a 6% AI server margin roughly projects ISG operating margin dropping as low as 9.7% in FY27 all else unchanged.   

Another challenge with maintaining margins is that Dell faces intense AI server competition, not only from Super Micro, guiding to a similar $40 billion in revenue with operating margins currently at 3.7%, but also from Taiwanese ODMs. Dell faced a question on the latter at Morgan Stanley’s TMT: 

Erik Woodring, Morgan StanleyErik Woodring, Morgan Stanley 

How do you make sure that you protect yourselves against some of the lower-priced Taiwanese ODMs, making sure that you can defend what you've done and stay with the customers that you have and grow with them? 

David Kennedy, Dell CFODavid Kennedy, Dell CFO 

“Back to your second part of the question, look, again, our value as we look at the production cycle here from the L11 scale and beyond, those engineering standards, those activities, I'm sure we might touch on OpEx in our P&L later. But within our OpEx framework, we are making sure we're investing, investing in our go-to-market teams. So as AI opportunities expand in the enterprise, we're building out the right pod structures and the right capacity to go execute that. But also two, giving Arthur Lewis and his team, the engineering capability, the labs and the investment. So they're not working just on, let's say, Vera Rubin, but the next gen beyond that and beyond that. We're ahead of the game right now. Our job is to stay ahead. So we maintain the value that we can find in our P&L.” 

Dell’s answer here is incomplete without one other quote from management at BofA’s conference, where they explained that they “can deliver hundreds of these racks in a given week like clockwork and have them show up and within 24 to 36 hours, they're up and running and they're generating money for the customer,” where “competitors don't seem to be able to do that reliably.” 

This speed and reliability is key as the Taiwanese ODMs may beat out Dell when it comes to cost at scale, yet Dell’s advantage lies in delivering full rack-scale systems that can almost immediately be monetized by customers. It is also a key advantage in serving the enterprise customer pipeline, now extending to 4,000 customers in its installed base, up from 3,300 in Q3. This also may play a key role in helping Dell mitigate AI server margin erosion moving forward while serving enterprise customers, as competitive pressures on the cost side and potential undercutting to gain share are unlikely to let Dell drive margins higher at the time being.  

However, Dell is leaning on storage to help preserve ISG operating margins in the face of this growing AI-related margin pressure. Dell’s storage IP portfolio, including its PowerMax, PowerScale and PowerFlex, “is the biggest lever as to why we say our core margins, excluding AI, can show a bit of expansion” with ISG operating margin up 2.4 points sequentially to 14.8%. This was driven by storage revenue up 20% QoQ in its seasonally strongest quarter (a slight improvement versus the 18% QoQ last Q4) and 2% YoY, outperforming the market.  

Looking ahead, Dell expects storage to be a primary lever in helping keep margins strong in the face of headwinds from increased AI server share and rising memory costs. This is because Dell is seeing stronger storage attach rates for AI servers in enterprise customers, and strong demand for storage products as inference expands. Management also sees its IP portfolio growing mid-single digit YoY in FY27 and taking a larger mix this year:  

Benjamin Reitzes, Melius ResearchBenjamin Reitzes, Melius Research 

Nice execution here, guys. I'll echo that. My question is on storage. It sounds like it's turning a little bit. You beat the Street by a little bit, 2%. And then you said, I believe that it will grow in the mid-singles for the year, and it looks like it may outgrow servers in the back half of the year. So can you just talk about what's really going on with storage, your highest margin business? Is it really turning? Is it going to be a contributor to mix in the upcoming year that allows you to keep gross margins pretty flat for the year in a tough component environment? 

Jeffrey Clarke, Dell COO Jeffrey Clarke, Dell COO  

Sure, Ben. Look, we're excited about our storage business. Again, we're reporting that on an orders basis, our Dell IP portfolio grew double digits. That's the entire portfolio. PowerMax, PowerStore, PowerScale, ObjectScale and our data domain platforms all grew double-digit demand. Our all-flash grew double-digit demand. It grew in all regions, and we acquired new customers. PowerStore grew its 8th consecutive quarter, 7 of those — the last 7, double digit. 

Half of those new customers that we are winning are new to PowerStore and nearly 30% are new to Dell buying storage. We saw tremendous demand for our unstructured products as AI inference and AI continues to grow, grow, grow. Our Dell IP portfolio is now a greater percentage of the mix year-over-year. We expect it to grow FY '27 over '26, it will be a greater percentage of mix next year than this year. That's part of the profit contribution that David has outlined in our guidance. 

Memory Costs, PC Demand and Pull Ahead Dynamics 

We touched upon some of memory headwinds and potential significant PC unit volume shrinkage the market faces this year in our Silicon Motion analysis, Silicon Motion: Strong Consumer SSD Demand, Trying to Move into AI Enterprise Markets for 2027-2028, with Dell’s management similarly pessimistic on PC growth. 

Management explained that they foresee PC units declining in the range of (11%) to (12%) this year, at odds with the refresh cycle underway, though emphasized that they do “expect the back half of the year to be deeper, probably high teen double-digit negative growth.” To note, this is slightly more pessimistic than estimates from IDC and Gartner calling for (11.3%) and (10.4%) decline in unit volumes this year. Dell also outlined a bit of a pull ahead dynamic, with customers are beginning to understand that quotes tomorrow or next quarter are likely to be higher than price quotes today, spurring some purchasing activity.  

This challenging demand environment has the potential to weigh on CSG growth especially in 2H, though Dell expects its pricing activities to allow them to hit their CSG revenue guidance of 1% YoY even if price increase take unit growth even lower.  

Management pointed out that their price quotes “are valid for the shortest period of time they've ever been. And we're reducing promotions and all sorts of special pricing going forward. … In PCs, we purposely delayed implementing that price move to stay in the hunt to take share and to drive growth, which will serve us for the long run. And then when we made the change on January 6, it wasn't 90 days later, it was that day we stabilized margins.” Management had also clarified that CSG’s higher deal volumes means its repricing efforts take longer to flow through, meaning it will not have as immediate an impact as servers on growth.  

Dell shared a bit on memory costs, noting that Q2 is estimated to rise 20% to 50%, Q3 up 5% to 15%, and Q4 up 5% to 10% for combined DRAM and NAND. Management expects these industry estimates to be in the ballpark, explaining that they have LTAs and capacity agreements in place and that they have experience budgeting prices as needed. However, current forecasts point to conventional DRAM up 58-63% QoQ and NAND up 70-75% QoQ, far ahead of management’s expectations and suggesting that memory prices may still remain a tougher constraint through the summer and beyond. Even if Dell does have the ability within LTAs to avoid some of these increases, broader demand destruction may still occur and impact growth.  

Financials 

Revenue Growth Accelerates to 39.5% in Q4 

Dell’s Q4 revenue grew by 39.5% YoY and 23.6% QoQ to $33.4 billion driven primarily by outperformance in AI servers. Revenue growth accelerated by 28.7 percentage points from 10.8% YoY growth in the previous quarter and significant improvement from the (9.3%) QoQ decline in the previous quarter.  

Management also provided strong Q1 guidance of $34.7 billion to $35.7 billion, implying YoY growth of 50.6% and 5.5% QoQ at the midpoint. Analysts currently expect Q1 revenue to grow by 51.8% YoY to $35.5 billion and will moderate to 17.6% and 26.6% growth in the next two quarters.  

FY2026 revenue ending January grew by 18.8% YoY to $113.5 billion. Management provided a strong FY2027 guidance of $138 billion to $142 billion, implying YoY growth of 23.3%, with one analyst pointing out that Dell is “adding $30 billion more on top line with very little incremental OpEx.” Analysts currently expect FY2027 revenue to grow by 24.8% YoY to $141.7 billion and will decelerate to 6.9% and 4.5% growth in the next two years.  

Key Segments 

ISG Revenue Grew by 73%  

Infrastructure Solutions Group (ISG) Q4 revenue grew by 73% YoY and 39% QoQ to $19.6 billion primarily driven by very strong AI server revenue growth. It marked the eight consecutive quarter of double-digit revenue growth for the ISG segment. ISG revenue is expected to grow over 100% in Q1, primarily driven by strong AI server revenue. 

From Q4, the company has started to bifurcate servers and networking revenue into AI optimized server revenue and traditional servers & networking revenue. Q4 AI revenue grew by 342% YoY and 60% QoQ to $9.0 billion. While the traditional servers & networking revenue grew by 27% YoY to $5.85 billion and storage revenue grew by 2% YoY and 20% QoQ in its seasonally strongest quarter to $4.8 billion.  

Management expects Q1 AI revenue to be $13 billion, implying a YoY growth of about 620% and 45% QoQ. FY2026 AI revenue grew by 166% to $24.68 billion, and management expects AI revenue to grow 103% YoY to about $50 billion in FY2027.  

AI orders grew by 1906% YoY and 177% QoQ to a record $34.1 billion in Q4. While AI shipments grew by 352% YoY and 70% QoQ to $9.5 billion. The company’s AI server backlog grew by 949% YoY and 134% QoQ to a record $43 billion. 

CSG Revenue grew by 14% 

Client Solutions Group (CSG) Q4 revenue grew by 14% YoY and 8% QoQ to $13.5 billion. Commercial revenue grew by 16% YoY and 9% QoQ to $11.6 billion. It was the sixth consecutive quarter of growth and demand up for the eighth quarter. The company is witnessing growth across geographies, with strong large enterprise demand and traction in the lower end of commercial markets. Consumer revenue was flat YoY and up 1% QoQ to $1.88 billion with demand up for the second consecutive quarter, supported by strength in gaming. Management expects CSG revenue to be up roughly 2% YoY in the next quarter. 

Margins 

The market was growing concerned that rapidly rising memory costs would squeeze on Dell’s margins (“you're supposed to miss numbers, by the way, when memory prices go up”), yet Dell’s margins are among the highest they’ve been since we began tracking the stock. This is quite impressive given the AI server and memory headwinds, with storage being a key piece of this margin strength despite being a much smaller portion of revenue at $4.8 billion this quarter.  

  • Q4 gross profits were $6.7 billion or 20.2% of revenue compared to $5.7 billion or 23.7% in the same period last year. The lower margins reflect higher proportion of AI revenue mix.  
  • Q4 operating income grew by 43.2% YoY to $3.1 billion primarily driven by operating leverage. Operating margin was 9.3% compared to 9% in the same period last year.   
  • Q4 net income was $2.3 billion or 6.8% of revenue compared to $1.5 billion or 6.4% of revenue in the same period last year.  

Q4 Adjusted EPS grew by 45.1% 

The company’s Q4 adjusted EPS grew by 45.1% YoY to $3.89 primarily driven by operating leverage. Analysts expect Q1 adjusted EPS to grow by 89% YoY to $2.93 and will decelerate to 27.8% and 20.5% in the next two quarters.  

Looking ahead, FY2027 adjusted EPS is expected to grow by 24.5% YoY to $12.82 and 13.8% in FY2028. 

Cash Flow and Balance Sheet

Similar to margins, Dell’s cash flows were equally as strong, with operating cash flow margin expanding by double digits and free cash flow following. Cash flow margins were also around the highest they’ve been over the last three years. 

  • Q4 operating cash flow was $4.7 billion or 14% of revenue compared to $585 million or 2.4% of revenue in the same period last year.  
  • Q4 adjusted free cash flow was $5.1 billion or 15.2% of revenue compared to $474 million or 2% of revenue in the same period last year. 
  • The company had a high debt of $31.5 billion and cash & investments of $13.3 billion at the end of Q4. The company repurchased shares worth $1.85 billion and paid dividends of $346 million in Q4. 
  • The company’s inventories rose 50.2% QoQ to $10.4 billion in Q4 primarily to support the strong AI demand.  

Conclusion 

Dell’s Q4 saw some of the strongest AI revenue growth across the AI industry with AI server revenue up 342% YoY to $9 billion, while orders surged 1,906% YoY to a record $34.1 billion. This order momentum drove Dell’s AI server backlog to a record $43 billion, with it consisting primarily of Grace Blackwell systems, which could be quite helpful if the upcoming Vera Rubin generation sees a delay. Importantly, Dell also has supply secured to satisfy its guidance in full for the entire year, a key advantage considering the memory and component shortages persisting across the industry. 

Moving down the line, Dell’s margins and cash flows stand out as they both approached the highest levels over the last three years, despite AI server margin headwinds and rising memory costs, with Dell leveraging its IP storage portfolio growth to keep margins strong. Growing storage attach rates through FY27 provides a large lever to keep margins strong through the rest of this year even with AI servers guided to grow >100%.

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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Alibaba Stock: China Has Low AI Revenue Compared to United States

Posted on by io-fund

Alibaba is one of the hottest AI stocks in the market in 2025, with shares up more than 60% year-to-date. The surge in price is due to Q3 results showing Cloud revenue accelerated with AI revenue up triple-digits for a sixth quarter in a row. Notably, the triple digit growth is on much lower revenue than what United States Big Tech companies are reporting, with leader Microsoft at 13X higher AI revenue. AI is also not meaningfully contributing to revenue nor earnings despite six consecutive quarters of triple digit growth. 

Despite the advancements that Alibaba is making in AI and tens of billions it is committing to invest in AI infrastructure, AI remains but a small portion of Cloud revenue, far below the scale of US-based peers. An ultra-competitive Chinese AI market engaging in a pricing war likely is hindering the country’s  AI growth potential, as Alibaba is touting tens of thousands of users and millions of downloads with small dollar growth to show for it. I break this down and more below. 

Alibaba has Made Visible AI Advancements 

Alibaba remains committed to its dual-prong strategy of e-commerce and AI + cloud. The company has recently highlighted multiple advancements on the AI front, with a handful of its models showing “industry-leading” performance. Shares rose again on Tuesday as Alibaba struck a partnership with Manus AI to roll out a Chinese version of Manus’ rapidly popular AI agent.  

China’s AI market is rapidly heating up with fierce competition from Alibaba, DeepSeek, Baidu, Tencent and Bytedance, among others. Alibaba is aiming to take a leading position in the AI market and announced recently that its Qwen2.5-Max mixture-of-experts model outperforms DeepSeek’s V3, Meta’s Llama 3.1 and OpenAI’s GPT-4o. In Q3’s earnings call, Alibaba teased the release of a new deep reasoning model built on Qwen 2.5 Max. 

Alibaba is strengthening its AI strategy with cloud innovations and partnerships, including a collaboration with Manus AI. Its Qwen2.5-Max model outperforms competitors like DeepSeek V3, Meta’s Llama 3.1, and OpenAI’s GPT-4o, positioning Alibaba as a key player in China’s competitive AI landscape.

Alibaba says its Qwen model outperforms DeepSeek’s V3 and Llama 3.1-405B across major benchmarks. 

Last week, Alibaba announced a new 32 billion parameter reasoning model, QwQ-32B, that it says outperforms DeepSeek’s R1 reasoning model, with 1/20th the parameters. QwQ-32B is the latest iteration of QwQ, which was first launched in November 2024 and “designed to enhance logical reasoning and planning by reviewing and refining its own responses during inference,” which a report from VentureBeat says allowed it to outperform OpenAI’s o1 on math benchmarks AIME and MATH, and scientific reasoning tasks. 

Alibaba is committed to expanding access to its AI models and tools, with its Qwen-2.5 series of models available via APIs as well as its genAI development platform Model Studio. Developers also can access Alibaba’s family of multimodal models – its vision understanding model Qwen-VL, its visual generation model Wanx2.1, its audio language model Qwen-Audio, and its coding assistance model Qwen-2.5coder.  

In Q3’s earnings call, Alibaba’s management highlighted that this approach is paying off, with more than 90,000 Qwen-based derivative models developed globally at the end of January, which made Qwen “the most popular among developers across the major model families.” Management added that more than 290,000 companies and developers accessed Qwen APIs through Alibaba Cloud's Bailian platform. 

Alibaba Outlines Significant Capex Outlay to Support AI 

To support its growth in AI and become a competitive global player, Alibaba outlined a plan to “aggressively invest in AI infrastructure,” with planned capex over the next three years exceeding what it has spent over the last decade. Management’s plan calls for spending of 380 billion yuan, or ~$52.4 billion, over the next three years predominantly for AI.  

Management first discussed increasing capex in the June 2024 quarter, when expenditures nearly doubled YoY to ~12 billion yuan, or $1.6 billion. Management noted in the June quarter that confidence in this level of investment was driven by strong demand, and expected to stay around this level for the next few quarters. 

However, capex quickly accelerated — in the September 2024 quarter, capex rose more than 310% YoY to 16.9 billion yuan, or $2.4 billion, and in the December 2024 quarter, capex rose 330% YoY to 31.4 billion yuan, or $4.3 billion. For the nine months of this fiscal year, capex totaled 60.3 billion yuan, or $8.3 billion, rising more than 246% YoY. 

Capex Plans Well Below US Big Tech 

This 30 billion yuan/quarter rate is a bare minimum of what’s needed to come close to management’s spending targets, signaling heightened capex will continue for the foreseeable future. However, at $52.4 billion over the next three years, Alibaba is spending only a fraction of what US Big Tech firms are spending, which could impact its competitive positioning.  

For 2025, Amazon, Microsoft, Meta and Alphabet outlined plans for approximately $320 billion in capex, predominantly for AI, which is 6x more than what Alibaba is spending. Of the four, Meta has earmarked the least towards capex, at $60-65 billion, but even at the low end, Meta’s one-year spending is more than 15% higher than Alibaba’s 3-year plan. 

In 2024 and 2025, Big Tech is on track to spend more than $550 billion in capex, or more than 10x higher than Alibaba’s plan in just two years as opposed to three. So while Alibaba’s AI spending commitment looks high compared to its historical investments, it’s spending just a mere fraction of what Big Tech is. The US is not likely to back down when it comes to AI dominance, which we covered in the article “DeepSeek Creates Buying Opportunity for Nvidia Stock.” 

Alibaba Remaining Competitive on AI Pricing 

China’s AI market is engaged in much fiercer competition than in the US, and this is evident within the pricing structures of AI models. Alibaba and rivals are pricing models at mere fractions of the cost of US-based competitors, in an effort to win over customers from each other and remain ahead in the broader global AI race.  

China’s AI market has been in a pricing war since early 2024 – Alibaba had cut prices by up to 97% in May 2024. ByteDance further intensified the price war in December 2024, when it slashed prices for its new Doubao model with vision understanding capabilities to $0.00041 per 1,000 tokens, 85% lower than the industry average. Alibaba mirrored this move within two weeks, matching Doubao’s $0.00041 price for its Qwen-VL Max model. 

Graph of AI models pricing, from Alibaba, OpenAI, Anthropic, Google, Meta, Mistral and others

Alibaba’s Qwen models are priced much cheaper than leading models from OpenAI and Anthropic as China engages in an AI pricing war. 

Alibaba’s Qwen2.5 Max is priced at $0.0016 per 1,000 input tokens and $0.0064 per 1,000 output tokens, while its Qwen Plus is offered at $0.0004 per 1,000 input tokens and $0.0012 per 1,000 output tokens. Qwen Turbo is priced at $0.00005 per 1,000 input tokens and $0.0002 per 1,000 output tokens. 

For comparison, ByteDance’s Doubao 1.5 Pro is priced at $0.00011 per 1,000 input tokens and $0.00028 per 1,000 output tokens. DeepSeek’s V3 model is priced $0.00014 per 1,000 input tokens and $0.00029 per 1,000 output tokens, while its R1 models is priced higher at $0.00057 per 1,000 input tokens and $0.00227 per 1,000 output tokens. Baidu recently announced that it is aiming to make Ernie free for all users by the start of April this year.  

This pricing structure is allowing Alibaba to remain quite competitive in the Chinese AI market and more so on the global market, as China’s models are significantly cheaper than OpenAI, Anthropic and others, with Meta and Mistral two of the lower-cost competitors.  

OpenAI’s GPT 4.5 is currently one of the most expensive models available, at $0.075 per 1,000 input tokens and $0.15 per 1,000 output tokens – that’s up to almost 50x more expensive that Qwen2.5 Max. OpenAI’s o1 is priced at $0.0015 per 1,000 input tokens and $0.06 per 1,000 output tokens, while the much smaller GPT 4o mini is priced comparatively to Chinese rivals. 

Pricing is Alibaba Stock’s Achilles Heel for AI 

However, it is this pricing structure and ongoing price war in China’s AI model market that is Alibaba’s Achilles heel. While the low-cost structure is enabling Alibaba to remain extremely competitive in the face of rising competition both domestically and globally, it’s serving as a bit of a hindrance to growth, with AI revenue likely still quite below the $1 billion mark, where US tech giants are touting multi-billion dollar AI revenue streams.

Alibaba first outlined the growing demand for AI model training and AI infrastructure services in its June 2023 quarter. The following quarter in September 2023, Alibaba laid out a two-pronged strategy for driving AI growth in the cloud. 

Management said that they will aim to “build the most open cloud in the AI era, providing stable and efficient AI infrastructure for all industries and enabling all sectors to go intelligent,” and “build an open and prosperous AI ecosystem.” This was underscored by its Qwen family of models, its model application development platform Bailian, and its open-source platform ModelScope. The September quarter saw ModelScope’s cumulative downloads more than double sequentially, from 45 million in July 2023 to 100 million, attracting more than 2.8 million developers. 

Discussing the March 2024 quarter results, CEO Eddie Wu explained that AI is serving as a primary driver for the revenue growth that is being seen in the broader Cloud segment: 

“If you look at the overall revenue growth of the Cloud business today, most of that is already being driven, I would say by AI and AI-related new products. So going forward a lot of the incremental growth we can expect to see in the Cloud business will be related to investments the customers are making in AI. But also there is a complementary effect because the more that customers invest in and make use of AI the more demand they will also have for other of our various cloud offerings.”  

For the December 2024 quarter, Cloud Intelligence revenue accelerated 6 points sequentially to 13% YoY to  ¥31,742 million, or $4.35 billion, up from 7% growth in the September quarter. This marks the steepest sequential increase in what has been a rather gradual acceleration from 2% YoY growth in the September 2023 quarter.  

Graph of Alibaba stock's quarterly Cloud Intelligence revenue and YoY growth showing acceleration to 13% in December 2024 quarter

Alibaba stock’s Cloud revenue growth accelerated to 13% YoY in the December quarter, aided by AI. 

In its December 2024 quarter results, Alibaba noted that AI product revenue “maintained triple-digit year-over-year growth for the sixth consecutive quarter,” starting in the September 2023 quarter. AI helped drive an acceleration to the double-digits for Cloud Intelligence revenue growth.  

There are a handful of stats that support increasing adoption of Alibaba’s AI products – more than 90,000 Qwen-based derivative models had been developed globally at the end of January, while more than 290,000 companies and developers have accessed Qwen APIs through Alibaba Cloud's Bailian platform. Qwen’s models have been downloaded more than 7 million times, and ModelScope has attracted more than 4,000 AI models and 5 million developers.

The I/O Fund specializes in covering lesser-known AI stocks on our research site with trade alerts and weekly webinars. Learn more here.The I/O Fund specializes in covering lesser-known AI stocks on our research site with trade alerts and weekly webinars. Learn more here.Learn more here.

Yet despite this and six quarters of triple-digit growth, Cloud revenue is only growing in the low-double digits, implying that AI’s contribution to revenue remains quite small. A rough estimate places AI’s contribution in the mid-single digit percentage of Cloud revenue, with revenue possibly around the $200-275 million range as of the December quarter. This would put Alibaba’s AI run rate between $800 million to $1 billion.   

Compare this to Microsoft, where its AI run rate on Azure surpassed $13 billion last quarter, up 175% YoY. Microsoft is also showing rapid growth for AI platforms and tools – the number of Azure OpenAI apps running on Azure databases more than doubled YoY last quarter, while Azure AI Foundry reached 200,000 MAUs within two months. Microsoft’s Phi family of small language models have been downloaded more than 20 million times, nearly 3x more than Qwen. 160,000 organizations have used Microsoft’s Copilot Studio, creating 400,000 custom agents last quarter, up 2x QoQ. 

AI’s Impact on Alibaba’s Cloud Margins 

Alibaba noted last quarter that a shift to higher-margin cloud products, including AI, has aided EBITA growth in its Cloud segment. For the December quarter, adjusted EBITA rose 33% YoY to  ¥3,138 million, or $430 million, decelerating dramatically from 89% YoY and 155% YoY growth in the prior two quarters.  

Adjusted EBITA margin was 9.9% in the December quarter, up from 9% in the prior quarter. It’s hard to argue against the beneficial impact of AI on EBITA margin for Cloud, with margins beginning to expand significantly as AI embarked on its six-quarter stretch of triple digit growth in the September 2023 quarter, aside from a hiccup in the March 2024 quarter. Since that point, margin have risen nearly 5 points and are knocking on the double-digit range. 

Graph of Alibaba stock's quarterly Cloud Intelligence adjusted EBITA margin showing margin expansion to 9.9% in December 2024 quarter

Alibaba stock’s Cloud adjusted EBITA margins have expanded as AI drives a shift to higher-margin products.  

Despite the margin expansion and strong EBITA growth from a shift in product mix towards higher-margin cloud offerings and AI products, Cloud’s share of consolidated adjusted EBITA is still quite small. For the last four quarters, Cloud’s share has hovered between 5% to 6.6% of consolidated adjusted EBITA. While this was an improvement from 0.9% in the June 2023 quarter and 3.3% to 4.5% in the second half of 2023, segment adjusted EBITA growth has decelerated sharply to the lowest level in the past seven quarters, suggesting EBITA contribution may follow and plateau.  

Graph of Alibaba stock's quarterly Cloud Intelligence adjusted EBITA YoY growth showing sharp deceleration to 33% in December 2024 quarter

Alibaba’s Cloud Intelligence adjusted EBITA growth has decelerated more than 120 points in two quarters to 33% YoY. 

What this means is that despite the six-quarter string of triple-digit growth for AI revenue, there’s minimal impact to the bottom line from this AI revenue surge at the moment. Earnings estimates for this fiscal year and next were relatively unchanged through much of the second half of 2024, within a 3% range, only rising in February following a 10% earnings beat in the December quarter.  

Graph of Alibaba stock's EPS estimates for current and next fiscal year, source YCharts

Alibaba’s EPS estimates for this fiscal year and next were relatively unchanged through most of 2024 despite AI growth. Source: YCharts 

AI revenue is not yet at the scale where it is meaningfully contributing to revenue or earnings, though Alibaba’s commitment to spend significantly on AI after witnessing six quarter of triple-digit growth is more positive for the long-term rather than the short term.  

Valuation Reaching a Peak 

Because AI is not driving the revenue scale or profits that we are seeing here with US Big Tech, Alibaba’s valuation is getting pricey, trading at peak levels from the past three years. Alibaba not only is facing tough competition from Big Tech but also from within domestic peers, with Tencent and Baidu both reporting strong AI growth.  

Graph showing Alibaba stock’s valuation reaching its highest levels in the past three years, reflecting recent market trends and investor sentiment.

Alibaba is trading at peak valuation levels from the past three years. Source: YCharts 

Alibaba is currently trading at 15.1x forward earnings and 2.35x forward revenue, both at or just below peak valuations since early 2022. This rapid rerating has likely been driven predominantly by AI enthusiasm, given that a majority of the multiple expansion occurred following DeepSeek’s rout in late January.  

For comparison, Baidu trades at a 40% discount to Alibaba on both metrics, at 9x forward earnings and 1.7x forward revenue, with its AI Cloud revenue rising 26% YoY, double the rate of Alibaba’s. Baidu’s Ernie handled 1.65 billion daily API calls in December 2024, with external API calls up 178% QoQ. Baidu’s Wenku platform reached 94 million MAUs, up 216% YoY and 83% QoQ.  

There’s also risk that China remains behind the US when it comes to AI and monetization, with  Tencent VP Martin Lau laying out three reasons why it lags behind US peers despite AI revenue reaching 10% of Cloud revenue. He explained that China does not have nearly as large as an enterprise market as the US, and within that, the SaaS ecosystem “is not really that vibrant in China.” He added that fewer AI startups in China are purchasing less compute, another reason the US leads. These three reasons are why Lau believes that AI revenue is starting to scale, but not exploding as it is in US.  

Conclusion

Alibaba is one of AI’s top winners so far in 2025 with shares rising more than 60% YTD on AI enthusiasm as the giant has released highly-competitive Qwen models and struck partnerships with leading Chinese AI firms. However, the rally is likely front-running AI revenue to a significant degree, as Cloud’s low growth and management’s comments about AI revenue imply that AI is still growing off quite a small base. 

Alibaba is quickly ramping AI investments to better compete on the global scale, but its AI run rate far lags that of US peers, with Microsoft recently reporting 175% YoY growth to a $13 billion AI run rate and Amazon and Google both reporting in the multi-billion dollars. Alibaba has a lot of ground to cover to get into the same realm as Big Tech on AI, as its AI run rate is still likely below the $1 billion mark. 

The I/O Fund has recently added five new small and mid-cap positions poised to benefit from the ongoing AI spending war. Join us every Thursday at 4:30 p.m. for our exclusive 1-hour webinar, where we cover market entries, exits, and key insights on the broader market. Take advantage of our limited time monthly promotion for up to $110 off Pro. Learn more here.The I/O Fund has recently added five new small and mid-cap positions poised to benefit from the ongoing AI spending war. Join us every Thursday at 4:30 p.m. for our exclusive 1-hour webinar, where we cover market entries, exits, and key insights on the broader market. Take advantage of our limited time monthly promotion for up to $110 off Pro. Learn more here.here.

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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AI Spending To Exceed A Quarter Trillion Next Year

Posted on by io-fund

This article was originally published on Forbes on ForbesForbes on Nov 14, 2024, 05:29pm EST

Big Tech’s AI spending continues to accelerate at a blistering pace, with the four giants well on track to spend upwards of a quarter trillion dollars predominantly towards AI infrastructure next year.

Though there have recently been concerns about the durability of this AI spending from Big Tech and others downstream, these fears have been assuaged, with management teams stepping out to highlight AI revenue streams approaching and surpassing $10 billion with demand still outpacing capacity.

Below, I take a look at the growth in AI spending from Big Tech this year and yet, as it quickly approaches the quarter-trillion mark, and next week, I’ll discuss exactly what this means for the market’s biggest beneficiary.

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AI Capex Accelerating

Big Tech’s AI-fueled capital expenditures serve as a barometer for the broader AI industry, as Microsoft, Meta, Alphabet and Amazon are among the first to recognize multi-billion dollar revenue streams from AI and generative AI offerings. The four are also leading the charge by pouring billions each quarter towards AI infrastructure, signaling that they are still attempting to catch up to AI demand and invest more aggressively in AI come 2025.

To better understand the trajectory of AI spending, let’s take a step back to 2023, where the rapid ascent of ChatGPT at the beginning of the year set the stage for AI to quickly step into the spotlight.

In the first half of 2023, Big Tech spent ~$74 billion on capex. Through Q3, that sum had moved up to ~$109 billion.

In the first half of 2024, Big Tech spent nearly $104 billion, a 47% YoY increase. Through Q3, that sum had surged to $170 billion, up 56% YoY.

So far in 2024, Big Tech has spent nearly $171 billion on capex, predominantly for AI infrastructure, up 56% from 2023.

Big Tech Capex

Source: I/O Fund

To understand why these four are accelerating spending this year and laying the groundwork for even higher spend in 2025, consider this: why is Big Tech spending billions on AI infrastructure globally? Why is Big Tech procuring GPUs en masse or building out custom silicon to deliver AI services in the cloud to millions of enterprise customers?

The answer is three-fold:

1) AI is expected to have a multi-trillion dollar economic impact globally, with a recent estimate from IDC placing AI’s cumulative potential impact through 2030 at $20 trillion. The mobile economy, which sprouted a handful of the trillion-dollar tech behemoths of today, added approximately $5.7 trillion to the economy in 2023. Big Tech’s leaders are well aware of how critical it is to capture and capitalize on an opportunity of this magnitude, and will not miss it.

2) Developing larger models and doubling model sizes requires massive computing power that only Big Tech can afford to develop, meaning a majority of genAI progress is likely to be made primarily in the hyperscalers’ clouds.

3) Big Tech is already realizing AI-related gains, with three of the four saying AI revenue is at least in the mutli-billion dollar range. With millions to billions of users for products to either enhance with AI integrations or target with AI features in subscriptions, the long-term revenue opportunity could dwarf some of their leading revenue streams of today.

I had said in May this year that Big Tech “will likely commit upwards of $200 billion, maybe even $210 billion, combined in capex this year, predominantly for AI infrastructure – from data center construction and expansion, to GPU procurement and custom silicon efforts and more.”

However, that figure is already likely too small, given the pace of acceleration seen in Q3 and commentary for Q4 and full-year spending. Combined, Big Tech spent $64.9 billion in Q3, up 11% QoQ. This increase was driven primarily by Amazon, which boosted capex by ~$5 billion sequentially.

Big Tech Quarterly Capex

Big Tech spent $64.9 billion on capex in Q3, up 11% QoQ and accelerating to 68% YoY. Source: I/O Fund

Microsoft and Amazon combined for $42.6 billion in capex in the third quarter, with Alphabet maintaining its ~$13 billion/quarter rate and Meta beginning to accelerate its spending.

Amazon signaled in Q3 that it was expecting to spend $75 billion on capex this year, with Meta tightening and raising its capex guide to $38 billion to $40 billion – alone, the two are expecting to spend nearly $115 billion in 2024. To meet that target, combined capex from the duo will need to be nearly $35 billion.

Alphabet is expecting Q4’s capex to be relatively in-line with Q3’s as it maintains its pace for ~$50 billion in full year spend, while Microsoft did not lay out a concrete picture for capex this year. Assuming spend is flat sequentially for Microsoft, the two would be spending ~$33 billion in Q4.

Putting this all together, Big Tech could spend another $70 billion in Q4, overwhelmingly for AI infrastructure, putting full year capex at ~$240 billion, or nearly 15% higher than the level they were tracking for at the start of the year.

The I/O Fund will spell out what this means for the biggest beneficiary of this trend in next week’s newsletter – make sure you don’t miss it.

Come 2025, this AI-driven capex surge is set to stay, with executives foreseeing lasting AI demand and a need to still invest to capture growth and meet demand.

Executives Signal AI Demand is Lasting, Requiring More Spend

I want to reiterate this quote from May’s newsletter, Big Tech Q1 Earnings: AI Capex Increases As AI-Related Gains Continue, as it continues to remain relevant for investors: it is no surprise that Big Tech is boosting spending by more than 50% versus 2023 “given positive outlooks on AI’s potential to drive revenue growth in the billions and how demand continues to outstrip GPU supply.”

This theme was evident across Big Tech’s Q3 earnings calls. Listen to what executives had to say:

Microsoft: Microsoft spent close to ~$10 billion this most recent quarter on GPU and CPU servers, primarily to meet cloud demand, with management signaling that “demand continues to be higher than our available capacity.”

CFO Amy Hood explained that Microsoft expects capex “to increase on a sequential basis, given our cloud and AI demand signal,” as they aim to stay aligned with demand signals. Microsoft also “announced new cloud and AI infrastructure investments in Brazil, Italy, Mexico, and Sweden as we expand our capacity in line with our long-term demand signals.”

Hood further clarified that Microsoft has confidence that as they “get a good influx of supply across the second half of the year, particularly on the AI side that we'll be better able to do some supply-demand matching and hence, while we're talking about acceleration [in Azure] in the back half.”

Amazon: Amazon CEO Andy Jassy said that AWS has “more demand that we could fulfill if we had even more capacity today,” and that “pretty much everyone today has less capacity than they have demand for, and it's really primarily chips that are the area where companies could use more supply.” He explained that AWS is growing rapidly in AI, but he believes “the rate of growth there has a chance to improve over time as we have bigger and bigger capacity.”

What Jassy is saying is that AWS and Microsoft are not the only supply-constrained firms, with Alphabet, Oracle, and others all struggling to meet demand because they cannot purchase enough GPUs or deploy enough custom accelerators alongside GPUs to meet demand.

Jassy also dropped a big clue on long-term demand and AWS’ need for rapidly increasing AI investments. He said that he thinks AI is at an “earlier stage [and] more fluid and dynamic than our non-AI part of AWS,” and customers not “showing up for 30,000 chips in a day. They're planning in advance. So we have very significant demand signals giving us an idea about how much we need.”

It’s interesting that this comment comes as Amazon has significantly ramped capex over the past two quarters, from $14.6 billion in Q1 to $22.6 billion in Q3. Jassy’s comment implies that AWS is seeing much larger demand than what they were expecting at the beginning of the year, hence the need to spend much more on AI infrastructure, from data centers to servers to GPUs to custom silicon.

Alphabet: The Search giant was a bit more obscure on AI demand in the cloud, but executives signaled spending to increase in 2025. CFO Anat Ashkenazi said that realizing growth opportunities and innovating in AI “requires global reach, which we have through our products and platforms, as well as continued meaningful capital investment.” Ashkenazi explained that Alphabet thinks that “into 2025, we do see an increase coming in 2025, and we will provide more color on that on the Q4 call, likely not the same percent step-up that we saw between '23 and '24, but additional increase.”

Meta: Though Meta is positioned primarily in advertising as opposed to the cloud, executives still signaled long term opportunities and a need to continually invest in AI. CEO Mark Zuckerberg said that it is “clear that there are a lot of new opportunities to use new AI advances to accelerate our core business that should have strong ROI over the next few years,” while Meta’s “AI investments continue to require serious infrastructure, and I expect to continue investing significantly there too.”

CFO Susan Li added that Meta is “growing our infrastructure investments significantly this year, and we expect significant growth again in 2025.” For Q4, she clarified that Meta foresees the large QoQ jump in part from “increases in server spend and to a lesser extent data center capex” due to delivery and cash recognition dynamics.

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more hereLearn more here.

AI Revenue Streams Emerging

AI revenue streams are emerging as Big Tech continues to spend prolifically on AI, with Microsoft among the leaders as it sees AI revenue soon to be double digits.

Microsoft: CEO Satya Nadella pointed out that “monetization from these [AI] investments continues to grow, and we're excited that only 2.5 years in, our AI business is on track to surpass $10 billion of annual revenue run rate in Q2. This will be the fastest business in our history to reach this milestone.”

At a closer look, AI contributed 12 points to Azure’s growth in the recent quarter, implying that Azure’s AI run rate has already surpassed $6 billion, with other gains coming from Microsoft’s product suite, with Power Platform seeing 4x YoY growth to 600,000+ users utilizing AI capabilities and 70% of the Fortune 500 using Microsoft 365 Copilot.

Azure AI Quarterly Run Rate

Azure’s AI run rate is estimated to have already surpassed $6 billion. Source: I/O Fund

To read more about how AI could drive the $100 billion in revenue for Microsoft by 2027, read more here: Microsoft – AI Will Help Drive $100 Billion In Revenue By 2027.Microsoft – AI Will Help Drive $100 Billion In Revenue By 2027.

Amazon: Amazon did not provide an exact number for AI revenue, but said that “AWS's AI business is a multibillion-dollar revenue run rate business that continues to grow at a triple-digit year-over-year percentage ,and is growing more than 3 times faster at this stage of its evolution as AWS itself grew.”

For comparison, it took AWS ~2 years to scale from ~$500 million in revenue in 2010 to over $2 billion in revenue in 2012, and then another 3 years to grow to nearly $8 billion. To have AI growing at triple this rate in the multi-billion dollar level already speaks volumes about the magnitude of the AI opportunity ahead and the demand that exists that still can’t be met in the market today.

Alphabet: Alphabet did not provide a new update for AI revenue, with the latest update from Q2 noting that “AI infrastructure and generative AI solutions for Cloud customers have already generated billions in revenues and are being used by more than 2 million developers.”

Management provided a few additional points about the swift uptake of AI across its products, saying that “Gemini API calls have grown nearly 40x in a 6-month period,” while AI Overview in Search “will now reach more than 1 billion users on a monthly basis.”

Meta: Unlike the other three, Meta’s path to monetizing AI in the billion-dollar scale is less clear, as AI’s primary role in operations is driving better ROI and conversions for advertisers, thus driving advertising revenue higher.

Management said that “Meta AI now has more than 500 million monthly active improvements to our AI driven feed and video recommendations have led to an 8% increase in time spent on Facebook and a 6% increase on Instagram this year alone. More than a million advertisers used our Gen AI tools to create more than 15 million ads in the last month and we estimate that businesses using image generation are seeing a 7% increase in conversions and we believe that there's a lot more upside here.” What’s not as clear is the direct impact to revenue growth stemming from these AI-fueled increases, but management has faith in the longer-term of driving strong ROI from AI investments.

Conclusion

Big Tech’s AI spending is only set to surge through the end of 2024 and into 2025, with management teams reiterating the need to invest more to meet demand and build out AI infrastructure. Microsoft leads the pack with AI on the cusp of surpassing a $10 billion run rate, while Amazon and Alphabet see AI revenue in the billions.

In next week’s free newsletter, the I/O Fund will discuss what this surge in spending to more than a quarter trillion will mean for one of AI’s largest beneficiaries. The I/O Fund is also closely tracking the next sectors to benefit from AI, regularly sharing our research on the biggest growth opportunities. We also share our buy and sell plans with real-time alerts for our premium members. Learn more here.

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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This Stock Is Crushing Salesforce, MongoDB And Snowflake In AI Revenue

Posted on by io-fund

This article was originally published on Forbes on Updated Oct 17, 2024, 09:02pm EDTForbesForbes on Updated Oct 17, 2024, 09:02pm EDT

Palantir has been one of the top-performing AI software stocks this year with a 156% YTD return, thanks to accelerating revenue growth and strong business momentum from its Artificial Intelligence Platform (AIP) released last year.

AIP sets Palantir apart from the rest of the SaaS universe, driving visible AI-related growth and acceleration in multiple different metrics – at this time, other leading AI favorites such as Snowflake or MongoDB can’t say the same. Outside of the cloud hyperscalers, Palantir is one of the rare few that sees AI drive both real returns for its business and real value for its customers due to AIP.

Below, I break down how Palantir’s AIP is putting it a step above peer Salesforce, MongoDB and Snowflake with visible AI growth, and its undeniable ‘secret sauce’.

Palantir’s AI Growth is Visible

AIP has driven tremendous growth for Palantir’s business since its release, with primary impacts arising in the commercial segment. A clear inflection point in Palantir’s growth is visible following AIP’s release, while other ‘AI’ cloud peers can’t say the same about AI-driven growth.

Palantir said that “US commercial continues to accelerate in Q2 2024 alongside [the] AIP revolution” with “unprecedented demand”, and the numbers to back this up:

  • 55% YoY revenue growth in US commercial to $159 million, accelerating from 40% YoY in Q1.
Palantir US Commercial Revenue

US Commercial revenue growth accelerated to 55% YoY in Q2 as revenue rose to $159 million.

Source: I/O Fund

  • 83% YoY growth in US commercial customers to 295 and 98% YoY growth in US commercial deals closed to 123.
  • 103% YoY growth in US commercial remaining deal value and 152% YoY growth in US commercial total contract value to $262 million. Chief Revenue Officer Ryan Taylor explained that “one of the most notable indicators of our delivery is the volume of existing customers who are signing expansion deals, many of which are a direct result of AIP.”

Here’s what the growth in US commercial customers looks like:

US Commercial Customer Count

Palantir's US Commercial customer growth has reaccelerated over the past few quarters thanks to AIP.

Source: I/O Fund

US commercial customer growth began to stagnate through late 2022 and early 2023, but following AIP’s release in Q2 2023, customer count re-accelerated. There is a clear inflection point from where QoQ customer additions were decelerating – from 12 net adds in Q1 2023 to six net adds in Q2 2023. Following the AIP-driven acceleration, net adds rose to 20 QoQ in Q3 2023, then 40 QoQ in Q4 2023.

This matches a similar acceleration in commercial customer growth as Palantir quickly became a market darling following its IPO, which was seen as a way to drive growth in the commercial sector. From Q4 2020 to Q4 2021, commercial customers grew nearly 5X. Now, as a stock market darling once more with a unique and unbeatable AI offering, Palantir is seeing commercial growth resume.

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Palantir is King of AI Among Cloud SaaS Stocks

Other leading cloud ‘AI’ stocks are struggling to put up AI-driven growth numbers like Palantir.

Salesforce reported 8% YoY revenue growth in Q2, decelerating from 11% YoY in Q1, as subscription revenue growth decelerated to 9% YoY, down from 12% YoY in Q1. Salesforce sees Q3 revenue growth of 7%, another deceleration. The full-year revenue growth of just 8% to 9% translates to the SaaS giant struggling to realize AI gains. Furthermore, Salesforce’s more AI-aligned offerings, MuleSoft and Tableau, decelerated sharply in Q2, from 27% YoY to 13% YoY for MuleSoft and 21% YoY to 11% YoY for Tableau.

MongoDB witnessed a much steeper deceleration in Q2, as Atlas and new workload wins struggled at the start of the year. In Q1, MongoDB reported 22% YoY growth with Atlas growth of 32% YoY, and this decelerated to 13% YoY revenue growth in Q2 as Atlas declined 5 percentage points QoQ to 27% YoY. For the full year, MongoDB guided to about 14.6% YoY growth in Q2 as it slightly boosted its outlook, a steep deceleration from 31% YoY growth in fiscal 2024.

Snowflake’s product revenue growth decelerated from 34% YoY in Q1 to 30% YoY in Q2, and while this was ahead of its guidance by 3 percentage points, growth is set to decelerate further in Q3. Management guided for 22% YoY growth in product revenue for the third quarter, a steeper QoQ deceleration rate, with the full year product revenue guide of 26% YoY. Despite management saying that they see “great traction” in early stages of AI products, there’s no visible inflection or acceleration in growth.

In sharp contrast, AIP has helped Palantir drive a significant topline acceleration over the past four quarters.

Palantir Quarterly Revenue Growth, YoY

AIP's strong momentum has helped drive quarterly revenue growth to 27.2% YoY in Q2 2024, up from 12.7% in Q2 2023.

Source: I/O Fund

Palantir reported 27.2% YoY revenue growth in Q2, aided by strength in US commercial stemming from AIP as well as government revenue accelerating significantly. Palantir’s YoY revenue growth bottomed in Q2 2023 at 12.7%, the same quarter as AIP’s release, with revenue growth now 15 points higher. Despite guiding for a slight 2 percentage point deceleration in Q3 to 25.2% YoY growth, Palantir would only need to beat its guide by 1.5% to keep this revenue acceleration intact.

Fundamentally, what’s most critical for shares is maintaining a revenue growth rate above 20% for the foreseeable future – analysts currently estimate fiscal Q2 2025 to be the one quarter of the next eight with revenue growth just below that threshold. Given AIP’s strength just one year following its launch, with clear inflections in customer and revenue growth, it will be the telling sign of Palantir’s AI status if it can maintain these revenue growth rates as it scales.

Palantir’s AIP Separates it From the SaaS Universe

Palantir’s standout performance so far in 2024 against SaaS peers can be attributed to the success of AIP, which, at its core, is a comprehensive AI platform that lets enterprises lever Palantir’s AI and machine learning tools and harness the power of the latest large language models (LLMs) within Foundry and Gotham.

Gotham was the company’s first product and is built for government operatives in defense and intelligence sectors. The platform enables users to identify patterns hidden deep within datasets using semantic, temporal, geospatial and full-text analysis, with mixed reality capabilities to allow operations to be run in virtual environment as well. Graph allows data objects to be seen as nodes and edges, while Map track geo-located objects, run searches and display key data.

Foundry was built for the commercial sector, and is centered around the three-layer Ontology Core, integrating semantic, kinetic, and dynamic layers for real-time data analytics and AI-powered decision making capabilities:

  • The Semantic layer brings volumes of data into one place, and lets users generate detailed object properties
  • The Kinetic layer brings operations and business behaviors into a real-time graph linked back to the Semantic layer, creating the basis for AI-driven analytics, real-time monitoring, identification of inefficiencies, and ability to optimize workflows
  • The Dynamic layer connects models to objects and actions, reasoning across both the Semantic and Kinetic layers for AI-powered automation and AI-driven decision making, alongside multi-step simulations with AI predictive analytics to explore possibilities of changing actions or events

AIP combines with Foundry’s data operations suite and Apollo’s autonomous software deployment capabilities as part of Palantir’s ‘AI Mesh’, providing enterprise and government customers with a full suite of AI products from the web to mobile to the edge. With the Ontology, linking data and logic into an AI-accessible environment, Palantir brings generative AI directly to an enterprise’s operations, delivering real-time AI-driven operational decision-making abilities.

Palantir describes Gotham and Foundry as the “ability to construct a model of the real world from countless data points.” AIP links this all together, and this is what separates Palantir as a standout in the SaaS space — outside of the cloud hyperscalers, Palantir is one of the rare few that sees AI drive both real returns for its business and real value for its customers due to AIP.

What further sets AIP apart is its scalability, interoperability and versatility. With AI Mesh, organizations can integrate AI across different operations and applications, while its design facilitates interoperability with existing enterprise software and systems. AIP is also extremely versatile, having been successfully and seamlessly integrated into enterprises spanning a wide range of industries from tech to healthcare to aerospace, while still driving value to customers.

The uniqueness of Palantir’s AIP and value that it can quickly provide has driven growth for the company. CEO Alex Karp said in Q2 that “growth across the commercial and government markets has been driven by an unrelenting wave of demand from customers for artificial intelligence systems that go beyond the merely performative and academic.”

Essentially, there is constant strong demand for an applicable, scalable, versatile AI platform that can drive real-time results with an instant value-add for an organization. Chief Revenue Officer Ryan Taylor added that Q2’s “exceptional results are a reflection of a market that is quickly awakening to a reality that our customers have already known, we stand alone in our ability to deliver enterprise AI production impact at scale.”

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more hereLearn more here.

Government is Palantir’s Secret Sauce

While Palantir is undoubtedly seeing strong business momentum in the commercial sector, the government sector remains Palantir’s bread and butter, being that the government sector has funded the company and allowed it to aggressively invest in AIP while expanding margins, with a recent growth acceleration

In Q2, US government revenue accelerated to 24% YoY growth, up 12 percentage points from 12% YoY growth in Q1. Overall, government revenue growth was 23% YoY, up 7 percentage points from 16% YoY in Q1. Management noted that Palantir was “selected for several notable awards in Q2, which led to the strongest US government bookings quarter since 2022, reflecting the growing demand for our government software offerings.”

This included a production contract from the DoD, Chief Digital and Artificial Intelligence Office (CDAO) for an AI-enabled operating system for the DoD, with an initial $153 million order and additional awards for up to $480 million over a 5-year period.

The acceleration in the government segment aided overall revenue growth in the quarter, as the government continues to remain Palantir’s primary revenue source, accounting for nearly 55% of total revenue. This is why the government segment is vital for Palantir, and is its ‘secret sauce’ – these long-term, high-value government contracts provide consistent and recurring revenue and financial stability, allowing the company to venture and invest to scale AIP while expanding margins and increasing its profitability.

Conclusion

Palantir has been on a tear this year, and is outperforming major cloud competitors, thanks to the strength and uniqueness of its AIP offering. Palantir has the best of both worlds in government contracts and AI exposure, as well as accelerating enterprise AI adoption and strong customer and revenue growth.

The one caveat is Palantir’s valuation, at 34x FY24 revenue and 29x FY25 revenue, is increasingly challenging to sustain. In the past, the low 20x revenue multiple range has tended to be the level that even the industry’s leading SaaS names have struggled to break past over the last few years.

Given the outsized valuation, the I/O Fund is looking for a lower entry in Palantir before adding the stock to our portfolio. Join the I/O Fund’s next webinar on Thursday, October 24th where Knox Ridley, Technical Analyst, will discuss the firm’s buy zones and targets for AI leaders. Learn more here.

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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4 Things Investors Must Know About AI

Posted on by io-fund

This article was originally published on Forbes onForbesForbes on Sep 20, 2024, 12:44am EDT

Last week was quite an important week for tech and AI investors, with Goldman Sachs hosting its Communacopia and Technology Conference featuring executives from the largest tech and semiconductor companies. Rarely have so many tech CEOs gathered to discuss their thoughts on AI, where the industry currently stands, and what lies ahead.

To have the CEOs of trillion-dollar companies speaking in unison on AI’s potential and investing in AI is either a staggering coincidence — or they have important insights pointing to the same conclusion, which is that AI’s primary risk is for companies who are not early enough to capture it.

We’re still in the early innings of AI, but the pace of transformation that AI is driving is unlike any other technology seen before, and that was evident at Communacopia. Below, I dig in to the four things that investors must know about AI.

1) Tech CEOs Agree the AI Revolution is Here

The AI revolution has arrived, sparked in full-scale by Nvidia’s Hopper series GPUs and OpenAI’s release of ChatGPT in late 2022. Not even two years later, Nvidia continues to sell GPUs at an unbelievable clip, with Big Tech unable to procure enough GPUs to meet internal project needs and external enterprise demand in the cloud.

AWS CEO Matt Garman explained that he truly believes AI “is a technology that over time is going to completely change almost every single industry that all of us focus on and think about and work on every single day to some level.” Garman added that the early AI use cases we’re seeing proliferate at the moment are just scratching the surface. ServiceNow CEO Bill McDermott agrees, stating that he also believes “AI is the well spring of opportunity in the global economy.”

Nvidia CEO Jensen Huang echoed this, saying that “we're now in this computer revolution. … Generative AI is not just a tool, it is a skill. And so this is the interesting thing. This is why a new industry has been created. And the reason for that is, if you look at the whole IT industry, up until now, we've been making instruments and tools that people use. For the very first time, we're going to create skills that augment people. And so that's why people think that AI is going to expand beyond the trillion dollars of data centers and IT, and into the world of skills.”

Despite the immense potential AI holds, in the present, the AI industry is only just at the nascent stages of this revolution. Snowflake CFO Mike Scarpelli explained that he thinks “it's still in the very early innings,” but “the reality is that very few are using it en masse today.” Bringing AI to the masses, when adoption of AI is commonplace, is when the industry will unlock things previously seen as impossible or extremely costly, according to Microsoft CTO Kevin Scott. Scott believes we could be 5 to 10 years out from seeing what developers are capable of and what applications can be created.

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2) AI to Have a $10 Trillion Impact on the Economy

By heralding in a new wave of innovation and unlocking endless possibilities to advance technology currently available today, AI is expected to have a multi-trillion-dollar impact on the global economy in the coming decades.

ServiceNow CEO Bill McDermott discussed AI’s profound potential at Communacopia: “There are researchers that independently have said it will have an $11 trillion impact on the economy in the next handful of years. I believe that may be true. Maybe it's [$10 trillion], maybe it's [$9 trillion], maybe it's [$8 trillion], but it's going to be big.

And the reason for that is there is so much inefficiency. There is so much waste. There is so much human potential that can be activated by taking the soul crushing work away from people and unleashing them to do things that really matter that can help companies grow and prosper. And that has never been factored into the equation as people think about technology on a day-to-day basis, that's why we're working so hard to tell them the story.”

For context, the mobile economy, which delivered a handful of the trillion-dollar tech behemoths of today, added approximately $5.7 trillion to the global economy in 2023, up from $5.2 trillion in 2022, according to GSMA. McDermott sees AI having up to double the economic potential of mobile, though other industry forecasts point to a much larger long-term impact from AI.

According to McKinsey, generative AI is estimated to add up to $7.9 trillion to the global economy annually when combining new generative AI use cases and gen-AI related productivity gains, according to research from McKinsey, Overall, McKinsey estimates the AI economy could add $25.6 trillion to global GDP over the next couple of decades.

AI's Potential Impact on the Global Economy, $Trillion

Source: I/O Fund

Through 2030, AI’s cumulative economic impact is projected to be nearly $20 trillion, according to IDC – with every new dollar spent on AI services and solutions expected to generate $4.60 in “indirect and induced effects.” This is a massive technological shift and value add globally to be realized only five years from now and eight years following AI’s breakthrough moment with ChatGPT.

For a closer look at AI’s potential and how to invest in this mega-trend, read Investing In AI with Beth Kindig: 1-Hour Video Interview.Investing In AI with Beth Kindig: 1-Hour Video Interview.

3) Productivity Gains are Already Being Seen

Even with the view that AI is still in the early stages of its growth curve and barely scratching the surface of its potential, companies are already discovering and showcasing productivity gains, a cornerstone of how AI can quickly become a multi-trillion dollar economic force.

Google Cloud CEO Thomas Kurian explained how Google is leveraging generative AI features in Google Workspace to drive significant productivity gains for customers: “For example, if you're in a hospital, as a hospital company, nurses are the critical path. Because nurses determine how many hospital beds you can have, they control the revenue of the organization. So we work with nursing staff, for example, to do live hand-off of patients. It saves about 6 hours in a 24 hour day. And one of the leading hospitals was talking at a conference today that they estimate when rolled out, it will save them $250 million.”

Kurian also discussed how AI is improving efficiency and productivity in the insurance industry, highlighting a use case for Germany’s largest health insurer. He explained that on average, the company’s representatives “need to read 800 policy documents to determine if the claim is valid or not. They use our technology. It helps take 23 to 30 minutes down to 3 seconds. So productivity in these specific places are extremely high value.”

AWS’ Garman shared other ways AI is dramatically altering what’s possible. He said that there are pharmaceutical companies “using AI to actually invent new proteins [and] new molecules that may be able to help cure cancer or cure other diseases and things like that. And at a rate that's tens of thousands or hundreds of thousands more times than a person sitting there with a computer trying to guess what the next protein could look like to solve a particular disease. That is just a fundamentally different capability than ever existed before and has massive implications for health care.”

Garman also mentioned how bullet train operators in Japan are using AWS’ SageMaker and “built AI models to predict where they're going to have maintenance issues, [and] actually proactively predict weeks in advance where they might see components fail. And then using generative AI, they actually pull from a bunch of different data sources actually give the technician advice as to how they can go address that.”

As the industry continues to build more powerful models to advance capabilities and unlock new use cases, productivity gains, and reasoning abilities, the amount of AI accelerators needed will continue to rise exponentially. Per Barclays, for the development of three frontier AI models with 50 trillion parameters by 2027, 20 million AI accelerators would be needed to simply train each model, for a total of 60 million accelerators. This is more than 15x higher than Nvidia’s AI GPU volume from 2023, where it shipped an estimated 3.76 million GPUs.

AI can have a profound impact across multitudes of roles and industries, and this is only the tip of the iceberg in terms of how AI can boost productivity and increase efficiency – this is the larger cornerstone of AI's potential multi-trillion economic impact.

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more here.

4) AI’s Technological Progress is Moving at the Speed of Light

The AI industry is progressing exponentially fast, much faster than previous technological breakthroughs, and this is being spearheaded by Nvidia.

Nvidia has radically changed the game when it comes to progress in AI, quite essentially by breaking Moore’s Law and supercharging GPU performance in an undeniably rapid annual release cycle. As Nvidia CEO Jensen Huang put it at Communacopia, the “benefit of performance at the scale that we're doing, it directly translates to TCO [total cost of ownership].”

This is driving substantial acceleration downstream in the data center industry. Cloud providers such as Microsoft, Amazon, Alphabet and Meta not only can establish new data centers with the newest accelerators for faster performance, but also upgrade existing data centers and retire previous chip generations to significantly accelerate computing performance while realizing lower operational costs. Nvidia’s newest architecture, Blackwell, is also necessitating the adoption of liquid cooling, forcing new data centers to be reinvented from the ground up while being set up at much quicker rates.

Here’s what Microsoft CTO Kevin Scott said about data center and related infrastructure buildouts: “Everybody in the [AI] ecosystem is moving materially faster right now than they were 3 or 4 years ago, materially faster. … So far, demand for the infrastructure has materially outpaced our ability to supply it. … Do I wish it were faster? Yes, I wish it were faster. [But] it's so much faster than it was like 4 years ago.”

Not only does Nvidia not have enough chip supply to meet demand from its largest customers, but major cloud service providers Amazon, Microsoft, Alphabet, and Oracle, as well as startups such as CoreWeave, do not have enough GPU or custom silicon supply to meet enterprise and rental demand in the cloud and simultaneously utilize GPUs for internal AI R&D and product development.

The CSPs also do not have nearly enough infrastructure to support demand, especially as demand rises as the industry shifts towards real-time use cases. Shifting from today’s world of model development and training to inference, where these AI models will make predictions and draw conclusions in real-time on new data, still requires massive amounts of AI accelerators and infrastructure to support it, aside from the millions needed to train larger models.

This is why data center construction is rising so rapidly – capacity under construction in North America soared more than 70% YoY to 3.87 GW in the first half of 2024. For comparison, construction in all of 2023 totaled less than 3.1 GW.

Putting this all together, Big Tech is estimated to spend north of $210 billion of capex this year, predominantly for AI accelerators and infrastructure, with cumulative spending projected to surpass $700 billion by 2027. Nvidia’s GPU supply still lags behind demand, while Big Tech is working to build data centers as quickly as possible to house these millions of future GPUs.

While $700 billion in three years is a massive sum, one that has sparked fears of an inability to generate enough of an ROI to justify such spending, productivity gains are already arising not even two years after AI’s big spark, and the long-term economic growth potential from AI-enabled productivity gains is as much as $3.5 trillion per current projections. AI spending is not set to slow, and Big Tech has left many breadcrumbs pointing out exactly why they’ll continue to spend heavily on AI.

Conclusion

Communacopia was ripe with information about the current and future state of AI and what to expect as the industry emerges from its nascent stages of growth to an expected multi-trillion-dollar economic force. Big Tech’s executives see that the AI industry is moving much faster than anything before, with physical data center buildouts speeding up to meet both demand and infrastructural upgrades to handle more powerful and power-hungry GPUs.

While Wall Street debates on if AI is a bubble, we think it’s wise to closely track what highly successful management teams are saying about AI and why it’s a trend to not miss or ignore. At this time, it’s nearly unanimous among tech CEOs that AI offers investors a rare opportunity to get onboard in the early stages of one of the largest economic and transformational trends in tech.

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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Dell Q2: AI Server Shipments Rise 82% QoQ; Pipeline Preparing for Blackwell

Posted on by io-fund

Dell reported a strong Q2 as AI server demand remained robust with shipments rising 82% QoQ to $3.1 billion, an AI server backlog of $3.8 billion and a five-quarter pipeline that is “several multiples of our backlog.” Dell’s revenue beat by nearly $1 billion as servers and networking revenue rose 80% to a new record at $7.7 billion. Dell said that Q2 saw “exceptional AI optimized server demand” as its order pipeline expanded again sequentially.

However, Q3’s guide came up short, as Dell forecast revenue between $24 to $25 billion, or a single-digit sequential decline. The very large pipeline refers to Dell waiting for Blackwell’s GPUs, which was discussed on the call. Therefore, the fiscal year will end higher than previously guided, making Q3 inconsequential.

ISG’s growth this quarter was driven by servers and networking, with revenue accelerating to 80% YoY and 40% QoQ to $7.67 billion, a record for the segment. This was a 3700 bp sequential acceleration in the YoY growth rate, from 42.5% in Q1 to 79.5% this quarter.

Another pertinent point discussed on the call was the surprising margin expansion in the ISG segment of 300 bps QoQ. Dell explained the expansions is party because enterprise server margins are higher than cloud service providers (CSPs).

Revenue

Q2 revenue was $25.03 billion, beating estimates by $910 million. Revenue growth was 9.1%, accelerating from 6.3% YoY growth in the previous quarter, with servers and networking revenue growth accelerating significantly this quarter.

For Q3, Dell guided for revenue between $24 billion to $25 billion, with the midpoint of $24.5 billion coming up just short of analysts' expectations for $24.6 billion. Despite the implied miss, the guide still points to revenue growth accelerating by 100 bp QoQ to 10.1%; analysts were expecting growth of 10.6% in Q3.

Despite the lighter Q3 guide, management boosted its full-year revenue outlook, now seeing revenue between $95.5 billion and $98.5 billion, or $97 billion at midpoint for YoY growth of 10%. Management’s prior guidance called for $93.5 billion to $97.5 billion, (midpoint of $95.5 billion for 8% growth), so this represented a healthy $1.5 billion raise on strong momentum in AI servers and networking.

Key Segments

Infrastructure Solutions Group (ISG):

Revenue in Dell’s Infrastructure Solutions Group (ISG) accelerated significantly in the quarter and easily topped management’s forecast for mid-20 percent growth this quarter. ISG revenue grew 38% YoY to $11.65 billion, accelerating 1600 bp sequentially from 22% YoY growth in Q1. Management guided for ISG growth to be in the low-30% range for Q3, pointing to a slight deceleration sequentially. For the full-year, ISG’s growth is expected to be approximately 30% driven primarily by AI and growth in traditional servers.

ISG’s growth this quarter was driven by servers and networking, with revenue accelerating to 80% YoY and 40% QoQ to $7.67 billion, a record for the segment. This was a 3700 bp sequential acceleration in the YoY growth rate, from 42.5% in Q1 to 79.5% this quarter.

AI servers were a primary driver in the quarter, with orders revenue of $3.2 billion, up 23% QoQ from $2.6 billion in Q1 as Tier 2 cloud service providers and enterprise customers increased. AI server shipments rose more than 82% QoQ, from $1.7 billion in Q1 to $3.1 billion in Q2. Growth also extended beyond AI to traditional servers, as traditional server demand rose YoY for the third consecutive quarter and rose QoQ for the fifth consecutive quarter.

Dell continues to see AI servers driving growth in Q3, adding that its “AI optimized server pipeline again expanded Q/Q across both Tier 2 cloud service providers and enterprise and has now grown to several multiples of our backlog.” For context, AI server backlog remained at $3.8 billion, flat QoQ.

ISG’s adjusted operating margin also expanded 300 bp QoQ to 11% in Q2, easing some concerns about AI servers weighing on segment margins. Management maintained its full year view for 11% to 14% adjusted operating margins for ISG, suggesting more upside to margins in the back half of the year. Dell also expects operating margin to improve in Q3 as a result of improved ISG profitability.

Client Solutions Group (CSG):

Turning to Dell’s Client Solutions Group (CSG), growth was muted, declining (4%) YoY but rising 4% QoQ to $12.41 billion. Commercial revenue was flat YoY at $10.55 billion, while Consumer revenue declined (22%) YoY to $1.86 billion. Management said they saw “modest Commercial PC demand growth in the quarter.”

Dell is expecting growth in CSG in the second half of the year, with growth more concentrated in Q4. Q3 is expected to see flat to low single-digit growth, with management believing the “coming PC refresh cycle and the longer-term impacts of AI will create tailwinds for the PC market.” For the full-year, CSG is expected to also be “flat to low single digits for the year.”

CSG’s adjusted operating margin was 6.2%, increasing only 10 bp sequentially and contracting 130 bp YoY. Full-year operating margin is expected to be 5% to 7%, implying there will be little change as the year progresses.

Margins

Overall, Dell’s margins down the line remained resilient despite gross margin contracting, as Dell faces some competitive pressure and headwinds from increased AI server mix.

  • GAAP gross margin was 21.4%, contracting 40 bp QoQ and 230 bp YoY as AI server mix rose and due to a more competitive pricing environment. Adjusted gross margin was 21.8%, contracting by the same amounts QoQ and YoY.
  • Management guided for gross margin to decline 180 bp for the fiscal year due to “inflationary input costs, the competitive environment and a higher mix of AI optimized servers. We will continue to drive efficiencies in the business and expect operating expense to be down low single digits for the year.”
  • GAAP operating margin was 5.4%, improving by 30 bp QoQ and 130 bp YoY. Adjusted operating margin was 8.1%, increased 150 bp QoQ but decreasing 50 bp YoY.
  • GAAP net margin was 3.4%, down 90 bp QoQ but up 130 bp YoY. Adjusted net margin was 5.5%, up 140 bp QoQ but down 10 bp YoY.

Dell topped EPS expectations as adjusted margins improved quite significantly down the line in Q2.

  • GAAP EPS of $1.17 beat expectations for $1.01.
  • Adjusted EPS of $1.89 beat expectations for $1.71.
  • For Q3, Dell sees adjusted EPS of $2.00, +/- $0.10, short of the consensus estimate for $2.18.
  • For the full-year, Dell sees adjusted EPS of $7.80, +/- $0.25, slightly higher than the $7.72 estimate and indicative of a stronger Q4.   

Cash Flows and Debt

Cash flows declined significantly YoY, but perked up sequentially.

  • Operating cash flow was $1.34 billion in Q2, down (58%) YoY but up more than 28% QoQ. OCF margin was 5.4%, improving from 4.7% last quarter but down substantially from 14.0% in the year ago quarter.
  • Adjusted cash flow was $1.28 billion in Q2, once again down (58%) YoY but up more than 106% QoQ. Adjusted FCF margin was 5.1%, up from 2.8% last quarter but down sharply from 13.3% in the year ago quarter.
  • Cash and equivalents totaled $5.85 billion, as Dell repaid approximately $1 billion in debt during the quarter along with $712 million in shares repurchased and $316 million in dividends paid.
  • Debt totaled $24.5 billion. The company stated their core leverage ratio was 1.4x.
  • Inventory rose more than 24% QoQ to $5.95 billion, with the QoQ increase likely driven again by AI servers as was the case in Q1.

Earnings Call:

ISG Margins 300 Bps Expansion:

Questions on how Dell was capable of expanding ISG margins were abundant, as analysts were clearly impressed. In addition to the Q&A excerpt below, buried a bit into the call, Dell’s CEO also stated the enterprise servers come with higher margins than cloud service providers (CSPs) later in the call: “And I think we've said each of the last several calls and we'll say this call again, the margin selling to enterprises are better than the margins selling to our largest customers.”

Question
Amit Daryanani (Analysts)

I guess my question is really around ISG margins to really step up from 8% in Q1 to 11% in this quarter despite the [80%] sequential growth in [indiscernible]. So can you just talk about what's enabling this kind of margin expansion because really a lot of peers on the AI server side are struggling with trying to — are struggling with the margins, I feel right now.

So I'd love to understand kind of what's enabling this margin expansion? And then critically, as we think about this 11% to 14% target for the full year, what are the key inputs of building blocks together in the back half of the year?

Yvonne McGill (Executives)

Thanks, Amit. I will get started on that one. So we were very pleased with the operating income rate we saw in the second quarter of 11%, up 300 basis points quarter-over-quarter. That was really driven by improvement across the entire portfolio. I mean first, revenue was up quarter-over-quarter, 26%, which helped drive scale within the P&L. And as expected, the headwinds we saw in Q1 did not persist into Q2. 

In storage, we had scale. We're price disciplined. We mixed more towards our own Dell IP storage offerings, which was very helpful and saw strength in North America enterprise. 

In the traditional server space, the demand environment continued to improve, although we're still seeing some competitive pressures. And in AI servers, we had strong shipments with improved profitability and growing enterprise customers in that portfolio mix. I'd say, we do expect ISG operating income to finish FY '25 within our long-term framework that 11% to 14% and — and do expect as we move through the second half of the year that we'll continue to see that as we mix more towards our storage portfolio as we do each year.

-End Quote

Preparing to Ship for Blackwell

An analyst asked why Q3 would be down sequentially in the guide yet servers would end the year above previous guidance, to which the CFO answered: “I would say if we have the GPUs and the customers are ready, we're fully motivated and ready to ship more AI servers in the third quarter, but that is what's embedded in our guidance.”

Later, Blackwell was asked about more directly to which the CEO stated: “So when I think of the backlog limbs, I think at an opportunity of deliveries for customers next quarter and then in Q4 and then clearly into next year, and that implies Blackwell. We have sold our most advanced architecture aligned to Blackwell to a number of customers. We have sold H100 and H200s and availability. More importantly, customer availability to take the product, which is what Yvonne is reflecting in our guidance. She didn't make a demand statement. She made a shipment statement. 

So demand with that 5-quarter pipeline that I described that is now multiples of our backlog is converting the backlog or converting that into orders as quickly as we can. That opportunity is in all sorts of architectures, the vast majority with NVIDIA, H100, H200 and Blackwell as well as a couple of other opportunities around AMD and Intel. But the vast majority is NVIDIA.”

-End Quote

The readthrough is that any lull from Q3 will be made up for in Q4, which obviously implies Blackwell.

CEO Remains Bullish on AI PCs

Q4 is also expected to be strong on CSG. Per the CFO opening remarks: “We expect growth in the second half of the year, particularly in the fourth quarter. The coming PC refresh cycle and the longer-term impact of AI will create tailwinds for the PC market.”

During the call, the CEO stated: “I know all of you have done your supply-based exit would indicate the same thing that refresh is heading towards end of '24, into '25. And what's important about that is as the refresh takes longer to start, history suggests it steps back faster because the Windows 10 end-of-life date is not moving. So we have a Windows 10 end-of-life date. We have an aging installed base of machines bought during the COVID era, all mounting to be refreshed with exciting new products built around AI and more AI applications are coming.”

Conclusion:

Dell looks to have some room in its valuation, and the report justifies us seeing if the roughly 25% upside in valuation will materialize. I do foresee the market going through a period of doubt on Blackwell before it arrives in volume. We have a strategy for this, which is to trim at key levels and buyback at lower levels. Regardless, Dell is one we want to own and be steadfast about as the signals are fairly clear it’s shaping up to be a major Nvidia supply partner on Tier 2 cloud service providers and enterprise AI.

Recommended Reading:

Dell Q2 Earnings Preview: Looking for Growth in AI Servers and AI PCs

Posted on by io-fund

Dell will release its Q2 FY2025 results on August 29th. The management revenue guide is $23.5 billion to $24.5 billion, representing YoY growth of 4.7% at the midpoint. The company also raised the FY2025 revenue guidance from $91 billion to $95 billion to a new range of $93.5 billion to $97.5 billion due to strong AI server demand.

Margins will be a key area of focus in the upcoming earnings and was the primary reason for the post-Q1 sell-off. Recently, Super Micro also witnessed a sell-off due to lower margins. Dell’s margins are under pressure due to inflationary cost increases, competition, and a higher mix of AI-optimized servers. The company forecasted adjusted gross margins to decline by 150 basis points for FY2025.

This report hinges on progress on AI PCs and the market will also want to see growth in AI servers, which reported 113% QoQ last quarter.

Revenue

  • Q1 revenue grew by 6.3% YoY to $22.24 billion. This is an acceleration from a (-10.9%) decline in Q4. Next quarter is expected to slightly taper off to growth of 5.2% YoY for $24.12 billion in revenue, and then accelerate again to 10.6% growth in Q3.
  • The Q1 revenue growth was helped by strong demand for AI servers and a return of growth in the commercial PC business.
  • Analysts expect FY2025 revenue to grow 9.1% YoY to $96.49 billion. This compares to an acceleration from a (-13.6%) decline in FY2024.
  • Analysts expect FY2026 revenue to grow 7.9% YoY to $104.15 billion.

Key Operating Segments

Revenue rebounded in the Infrastructure Solutions Group after four quarters of negative growth. Revenue grew by 22% YoY to $9.2 billion, primarily helped by strong server and networking revenue growth of 42% YoY to $5.5 billion. Storage revenue was flat YoY to $3.8 billion. Management has guided ISG revenue to grow by mid-twenties percent in Q2 and the combined ISG and CSG revenue to grow by 8% at the midpoint.

Infrastructure Solutions Group’s adjusted operating margin was 8%, down from 9.7% in the same period last year and 15.3% in the previous quarter. Margins were lower due to the increasing AI server revenue and seasonal low revenue for the storage segment. Management expects margins to improve, guiding the adjusted operating margin within the long-term target of 11 to 14% for FY2025.

Client Solutions Group’s revenue was flat at $12 billion. Commercial revenue grew by 3% YoY to $10.2 billion and consumer revenue declined by (-15%) YoY to $1.8 billion. Commercial PC demand stabilized, and management is optimistic about the PC refresh cycle and the long-term benefits of AI on the PC market.

CSG’s adjusted operating margin was 6.1%, down from 7% last year and 6.2% in the previous quarter due to competitive pricing. Management expects to be within the long-term target of 5 to 7% for FY2025.

Management expects ISG revenue to grow more than 20%, driven by strong AI demand, and CSG revenue to grow in the low single digits for FY2025. ISG and CSG combined are expected to grow 11% at the midpoint.

Margins

Margins are under pressure due to competition and a higher proportion of AI-optimized server revenue mix. The lower proportion of storage revenue seasonally also negatively impacted margins. As the year progresses, margins are expected to improve with a higher proportion of storage revenue and higher margin services revenue, offset by inflationary cost increase. The company is focused on reducing costs and has recently reduced the sales team.

  • Q1 gross margin was 21.6%, down from 24% in the same period last year and 23.8% in the previous quarter. Adjusted gross margin was 22.2%, down from 24.7% in the same period last year and 24.5% in the previous quarter. The lower gross margin was due to the competitive pricing environment and higher AI-optimized server revenue mix.
  • Management has guided adjusted gross margins to decline by about 150 basis points for FY2025 from 24.3% for FY2024 due to inflationary cost increases, competition, and a higher mix of AI-optimized servers. Previously, the guide given during Q4 results showed a decline of about 100 basis points.
  • The operating margin was 4.1%, down from 5.1% in the same period last year and 6.7% in the previous quarter. The adjusted operating margin was 6.6%, down from 7.6% last year and 9.6% in the previous quarter. The drop in operating margin was due to lower gross margin and was partially offset by lower operating expenses due to cost cuts.
  • Net income was $955 million or 4.3% of revenue compared to $578 million or 2.8% of revenue last year. The higher net income was due to the one-time tax benefit in the recent quarter.
  • Adjusted net income was $923 million or 4.1% of revenue compared to $963 million or 4.5% of revenue last year.

EPS

The company missed the adjusted EPS estimates by 1.9% due to a competitive pricing environment, a lower proportion of storage revenue, and a higher mix of AI-optimized server revenue mix.

  • GAAP EPS grew by 67.1% YoY to $1.32, helped by a one-time tax benefit. Adjusted EPS declined by (-3.1%) YoY to $1.27 and missed estimates by 1.9%.
  • Management Q2 adjusted EPS guide is $1.65, +/- $0.10. Analysts expect adjusted EPS to decline by (-2.8%) YoY to $1.69 and then accelerate to 15% growth to $2.16 in Q3.
  • Management FY2025 adjusted EPS guide is raised from $7.50 to $7.65, +/- $0.25. Analysts expect FY2025 adjusted EPS to grow 8.1% YoY to $7.71 and 20.9% growth in FY2026 to $9.32.

Cash Flow and Balance Sheet

The trailing twelve months adjusted free cash flow was $5.5 billion, which is higher than the five-year average of $4.8 billion. We would like to see the cash flow improve, particularly since the company has high debt.

  • Operating cash flow was $1.04 billion or 4.7% of revenue compared to $1.78 billion or 8.5% of revenue in the same period last year.
  • Adjusted free cash flow was $623 million or 2.8% of revenue compared to $687 million or 3.3% of revenue in the same period last year.
  • The company returned $1.1 billion to the shareholders through $722 million in share repurchases and $336 million in dividends.
  • The company had cash and investments of $7.1 billion and debt of $25.48 billion, compared to $8.68 billion and $26 billion in the previous quarter. The core leverage ratio has been maintained within the company’s target of 1.5x.
  • During Q1, the company issued $1.0 billion of 5.4% senior notes due 2034. It used the proceeds to prepay a portion of the outstanding 6.02% senior notes due 2026, thereby increasing the maturity and decreasing the interest expenses.
  • Inventory was $4.8 billion compared to $3.6 billion in the previous quarter due to higher inventory related to the AI server business.

Other Key Points to Watch

AI-Optimized Server and Backlog

The company’s AI-server optimized orders increased to $2.6 billion and AI shipment grew strongly increasing 113% sequentially to $1.7 billion. AI-server backlog increased to $3.8 billion from $2.9 billion in the previous quarter. However, was lower than the consensus estimates of $4 billion to $5 billion.

Jeff Clarke, COO and Vice Chairman, said in the earnings call, “In ISG, our AI-optimized servers orders increased to $2.6 billion, with shipments up more than 100% sequentially to $1.7 billion. We have now shipped more than $3 billion of AI servers over the last three quarters. Our AI server backlog is $3.8 billion, growing sequentially by approximately $900 million. Our AI optimized server pipeline grew quarter-over-quarter again and remains a multiple of our backlog.”

Storage revenue

Storage demand stabilized as revenue was flat in Q1 and accelerated from a (-10%) decline in the previous quarter. Storage revenue is expected to recover from the seasonal low quarters and benefit from the strong AI server demand. Management previously mentioned that storage recovery typically lags servers by a couple of quarters and also previously mentioned that “for every $1 of AI server, there's $2 of services, storage and other higher-margin things that come.”

AI PCs

Management remained optimistic about the coming PC refresh cycle. Jeff Clake said in the earnings call, “The PC installed base continues to age, Windows 10 will reach end of life later next year and the industry is making significant advancements in AI-enabled architectures and applications. We will continue to focus on commercial PCs, high-end of consumer, and gaming, driving a strong attach motion, a strategy that has served us well across various economic cycles.”

Earlier in May this year, the company announced new AI PCs during the Dell Technologies World.

Valuation

Dell is trading at a P/E ratio of 22.3 and a forward P/E ratio of 14.3, higher than the 5-year average P/E ratio of 12.5. Similarly, it trades at a P/S ratio of 0.9 and a forward P/S ratio of 0.8, above its average of 0.43. The P/S ratio peaked at 1.47 prior to the announcement of Q1 results and bottomed out at 0.72 on August 07th.

Conclusion

Dell is a beneficiary of AI servers, the new upgrade cycle coming for PCs, and AI PCs. Another catalyst is that the company might be included in the S&P 500 Index. Commercial PC and storage demand stabilized in Q1. At the same, margins are to be monitored in the upcoming quarter.

Many AI semis have stretched valuations. Dell does not have a stretched valuation yet went quite low on the last drawdown in sympathy with AI peers. Our goal is to de-risk the position at higher levels.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

Additional Reading:

Big Tech Battles On AI, Here’s The Winner

Posted on by io-fund

This article was originally published on Forbes on Updated Aug 8, 2024, 09:24pm EDTForbes on Updated Aug 8, 2024, 09:24pm EDT

The major theme over the past month in Big Tech and AI semiconductors has been the durability of demand: essentially, what is Big Tech’s return on more than $150 billion in capex over the last twelve months (primarily for AI infrastructure), and if the companies can generate a substantial enough return from AI products to continue catalyzing GPU demand and revenue for Nvidia.

Though Big Tech’s June quarter earnings were met mostly with rather gloomy reactions, management teams reiterated positivity on the long-term potential of generative AI products and services, and the need for continual investment in AI infrastructure.

Microsoft stands out as the clear leader with multiple different monetization pathways from generative AI, whether through Azure or GitHub Copilot, while AWS has seen growth reaccelerate as AI’s revenue contribution reaches a multi-billion-dollar run rate.

Alphabet has touted billions in AI related revenue, while Meta is seeing an in-house effect with AI playing an increasingly large role in engagement and ad delivery across Meta’s family of apps.

The Quest for ROI

Sequoia Capital recently raised an alarm on Big Tech’s massive AI investments, and whether companies will be able to realize large enough returns to justify these expenditures, calling it “AI’s $600B Question,” in a follow up to their September 2023 analysis and the $200B question. Sequoia’s analysis suggests that based on Nvidia’s annualized $150B data center run rate by Q4, the revenue required for payback on capex would be $600B, based on a 50% software margin for CSPs and 50% operating cost from GPUs.

This sparked fears as Big Tech is not yet able to convince investors or analysts that these investments will pay off. This has led to analysts pressing management over monetization and potential overinvestment in capacity in earnings calls.

Lead Tech Analyst Beth Kindig recently discussed this with Bloomberg Asia following Alphabet’s earnings, saying that investors are looking for an ROI from Big Tech in terms of quarter-over-quarter revenue accelerations from AI in the cloud, and if these accelerations are enough to justify the amount of capex spent.

Sign up for I/O Fund's free newsletter with gains of up to 2600% because of Nvidia's epic run – Click here.Click here.

Capex Growth Continues

We recapped Big Tech’s capex and commentary following Q1’s earnings in mid-May for our newsletter readers, saying at the time that Big Tech “will likely commit upwards of $200 billion, maybe even $210 billion, combined in capex this year, predominantly for AI infrastructure – from data center construction and expansion, to GPU procurement and custom silicon efforts and more.

It’s no wonder the four are boosting capex by more than 35% YoY, given positive outlooks on AI’s potential to drive revenue growth in the billions and how demand continues to outstrip GPU supply.”

Following the recent Q2 reports, Big Tech did, indeed, commit $210 billion to capex.

In the first half of 2024, Alphabet, Amazon, Meta and Microsoft spent nearly $104 billion in capex, up 47% YoY, with more than half of that total coming in Q2. Microsoft and Alphabet saw the largest YoY increases among the four, driving capex 78% and 91% higher for the first half of the year, respectively.

Big Tech Capex Growth

Big Tech spent nearly $104 billion in capex in the first half of 2024, up 47% YoY, with more than half of that total coming in Q2.

Source: I/O Fund

Microsoft: Capex this quarter was $19 billion, an increase of nearly 78% YoY from $7.8 billion in the year ago quarter, and a QoQ increase of almost 36% from $14 billion last quarter. Microsoft’s fiscal 2024 (ending June) capex was $55.7 billion, up nearly 75% YoY, and management is guiding for a YoY increase in capex in FY’25.

Meta: Capex was almost $8.5 billion in Q2, up more than 33% YoY and 26% QoQ. Meta’s first half capex totaled $15.2 billion, with management raising the lower-bound of their 2024 capex guidance range by $2 billion, from a prior view for $35 to $40 billion to $37 to $40 billion. This would imply ~37% YoY growth at midpoint for the full year, and indicate a significant acceleration in the back half, with more than $23 billion in capex projected at midpoint. Meta also expects “significant” capex growth in 2025 to support AI initiatives.

Alphabet: Capex totaled $13.2 billion in Q2, up 91% YoY and approximately 10% QoQ. Management said the surge in Q2 was “driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers.” For the year, management expects quarterly capex to be flat or above Q1’s $12 billion figure, implying capex of $50 billion or more.

Amazon: Capex was $16.5 billion in Q2, with Amazon the second-largest spender in the quarter after Microsoft. Amazon projected capex in the back half to be higher, suggesting 2024’s capex will come in well above $60 billion, with management saying the majority will go to support AWS infrastructure to meet high demand for both generative AI and non-generative AI services.

Big Tech’s capex is a barometer for the AI semiconductor industry, one that we closely track as we have a heavy allocation of stocks in this booming industry. Learn more about the I/O Fund’s holdings and consistent deep dive research on AI stocks, crypto and more here.here.

Analysts Pressing Big Tech Over ROI

Given this significant spending through 2023 and 2024, analysts are questioning whether monetization is going to match the level of investment, and grilled management teams over ROI timelines and AI capacity.

The management teams offered similar responses – which is that the predominant risk in AI is for those arrive late. Note, that it’s quite rare to have management teams from this many different companies agree (on anything really); and they are not only saying it in words, rather are showing us the seriousness of what is being stated in their budgets. Due to the sheer amount of capex, plus the unanimous agreement we are seeing across companies with $1T+ market cap on the importance of this capex, we are quoting the management teams directly.

Amazon:

Eric Sheridan (Analyst): “There's been a theme during the last couple of weeks of earnings of the potential to over-invest as opposed to under-invest in AI as a broad theme. I'm curious, Andy, if you have a perspective on that in terms of thinking about elements of capitalizing on the theme longer term against the potential for pace or cadence of investment on AWS as a segment.”

Amazon CEO Andy Jassy: “We also are getting a lot of signals from customers on what they need. I think that it's — the reality right now is that while we're investing a significant amount in the AI space and in infrastructure, we would like to have more capacity than we already have today. I mean we have a lot of demand right now. And I think it's going to be a very, very large business for us.”

Jassy also discussed the challenges in managing a business of AWS’ scale, and delivering too little or too much capacity, saying AWS understands the balance and how to manage capacity “reasonably well” to ensure AWS deploys the “right amount of capacity."

Alphabet:

Ross Sandler (Analyst): “Just two questions on the AI CapEx. So it looks like from the outside at least, the hyperscaler industry is going from kind of an under bill situation this time last year to better meeting the demand with capacity right now to potentially being overbuilt next year if these CapEx growth rates keep up. So do you think that's a fair characterization? And how are we thinking about the return on invested capital with this AI CapEx cycle.”

Alphabet CEO Sundar Pichai: “I think the one way I think about it is when we go through a curve like this, the risk of under-investing is dramatically greater than the risk of over-investing for us here, even in scenarios where if it turns out that we are over investing. … But I think not investing to be at the frontier, I think definitely has much more significant downsidethe risk of under-investing is dramatically greater than the risk of over-investing for us here, even in scenarios where if it turns out that we are over investing. … But I think not investing to be at the frontier, I think definitely has much more significant downside.”

Meta:

Brian Nowak (Analyst): “You have a lot of CapEx priorities from building new infrastructure for next-generation models, compute capacity. Just walk us through again on the CapEx philosophy and any guardrails you have around ensuring you generate a healthy return on invested capital for investors from all the CapEx.”

Meta CFO Susan Li: “On the ROI part of your question, I’d broadly characterize our AI investments into two buckets; core AI and Gen AI. And the two are really at different stages, as it relates to driving revenue for our businesses and our ability to measure returns. On our core AI work, we continue to take a very ROI based approach to our investment here. We are still seeing strong returns as improvements to both engagement and ad performance have translated into revenue gains and it makes sense for us to continue investing here.And the two are really at different stages, as it relates to driving revenue for our businesses and our ability to measure returns. On our core AI work, we continue to take a very ROI based approach to our investment here. We are still seeing strong returns as improvements to both engagement and ad performance have translated into revenue gains and it makes sense for us to continue investing here.

Gen AI is where we are much earlier. … We don't expect our Gen AI products to be a meaningful driver of revenue in 2024. But we do expect that they are going to open up new revenue opportunities over time that will enable us to generate a solid return off of our investment while we are also open sourcing subsequent generations of Llama. And we've talked about the four primary areas that we are focused here on the Gen AI opportunities to enhance the core ads business, to help us grow in business messaging, the opportunities around Meta AI, and the opportunities to grow core engagement over time.Gen AI is where we are much earlier. … We don't expect our Gen AI products to be a meaningful driver of revenue in 2024. But we do expect that they are going to open up new revenue opportunities over time that will enable us to generate a solid return off of our investment while we are also open sourcing subsequent generations of Llama. And we've talked about the four primary areas that we are focused here on the Gen AI opportunities to enhance the core ads business, to help us grow in business messaging, the opportunities around Meta AI, and the opportunities to grow core engagement over time.

… So while we do expect that we are going to grow CapEx significantly in 2025, we feel like we have a good framework in place in terms of thinking about where the opportunities are and making sure that we have the flexibility to deploy it, as makes the most sense.”So while we do expect that we are going to grow CapEx significantly in 2025, we feel like we have a good framework in place in terms of thinking about where the opportunities are and making sure that we have the flexibility to deploy it, as makes the most sense.”

CEO Mark Zuckerberg said he would “rather risk building capacity before it is needed rather than too late,” rather risk building capacity before it is needed rather than too late,” as the “people who bet on those early indicators tend to do pretty well,” in a reference to Meta AI’s early success and it being “on track to achieve our goal of being the most used AI assistant by the end of this year”.

Microsoft:

Keith Weiss(Analyst): “Right now, there's an industry debate raging around the CapEx requirements around Generative AI and whether the monetization is actually going to match with that. Is CapEx still an appropriate leading indicator for cloud growth? Or does the shift in gross margin profile change that equation? Or said another way, maybe can you give us a little bit more help in understanding the timing between the CapEx investments and the yield on those investments?”

Microsoft CEO Satya Nadella: “So I would say – and obviously, the Azure AI growth, that's the first place we look at. That then drives bulk of the CapEx spend, basically, that's the demand signal ,,, we will only be scaling training as we see the demand accrue in any given period in time. So I would say it's more important to manage to capture the opportunity with the right product portfolio that's driving value.”the Azure AI growth, that's the first place we look at. That then drives bulk of the CapEx spend, basically, that's the demand signal ,,, we will only be scaling training as we see the demand accrue in any given period in time. So I would say it's more important to manage to capture the opportunity with the right product portfolio that's driving value.”

“The asset, as Amy said, is a long-term asset, which is land and the data center, which, by the way, we don't even construct things fully, we can even have things which are semi-constructed, we call [cold] (PH) shelves and so on. So we know how to manage our CapEx spend to build out a long-term asset and a lot of the hydration of the kit happens when we have the demand signal.”we don't even construct things fully, we can even have things which are semi-constructed, we call [cold] (PH) shelves and so on. So we know how to manage our CapEx spend to build out a long-term asset and a lot of the hydration of the kit happens when we have the demand signal.”

CFO Amy Hood:

“[…] when we did this last transition, the first transition to the Cloud, which seems a long time ago sometimes, it rolled out quite differently. We rolled out more geo by geo and this one because we have demand on a global basis, we are doing it on a global basis, which is important. We have large customers in every geo. And so hopefully, with that sort of shape of our capital expense, it helps people see how much of that is sort of near-term monetization driver as well as a much longer duration.”because we have demand on a global basis, we are doing it on a global basis, which is important. We have large customers in every geo. And so hopefully, with that sort of shape of our capital expense, it helps people see how much of that is sort of near-term monetization driver as well as a much longer duration.”

Microsoft reiterated that capacity was and will continue to be the primary constraint for AI and Azure’s growth. They noted the need to invest ahead of demand with respect to land and data centers on a global basis, which necessitates an elevated level of capex to maintain growth over the long-term. However, they noted that they are waiting to fully outfit data centers to align with demand and thus the first clue to when capex might slow down likely will be seen in a QoQ stagnation in AI-driven Azure revenues from Microsoft.

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Microsoft Leads in AI Monetization, Amazon Close Behind

When it comes to Big Tech’s ability to monetize AI features and services, Microsoft leads the pack, with multiple different AI revenue streams and multiple billions in revenue. Amazon follows closely behind with AWS, while Meta and Google are both improving revenue generation and profitability via AI integrations in core products.

For Microsoft’s Azure, AI services contributed 8 percentage points of growth in the quarter, up from 7% in the prior quarter. Azure AI Services revenue run rate is estimated to be ~$5 billion, up 900% YoY, with 60% YoY growth in customers to more than 60,000. Though management guided for slightly softer Azure growth next quarter (fiscal Q1’25), demand continues to outstrip capacity, and management expects an acceleration in the second half of fiscal 2025 as AI capacity increases.

Microsoft is also seeing strong AI growth via Copilot offerings in GitHub and Office. GitHub’s ARR has reached $2B, with GitHub Copilot accounting for over 40% of GitHub’s revenue growth this year. GitHub Copilot has been adopted by over 77,000 companies, up 180% YoY. Copilot for Microsoft 365 continues to gain traction in just its second quarter of availability, with the number of people using Copilot daily at work nearly doubling QoQ. Copilot customers increased 60% QoQ and the number of customers with over 10,000 seats more than doubled QoQ. Copilot Studio, a low-code tool for creating and maintaining copilots, saw a 70% QoQ increase in organizations using it to 50,000.

Amazon has not provided a clear-cut breakdown of what percentage of AWS’ growth is being driven by AI, but management pointed out that Amazon has “a multibillion-dollar revenue run rate already in AI, and it's so early.” Management also noted that AWS “has launched more than twice as many machine learning and generative AI features into general availability than all the other major cloud providers combined.”

Amazon continues to roll out AI services and features across its businesses, recently unveiling its AI-powered shopping assistant Rufus, to assist customers with e-commerce purchases. Amazon believes Amazon Q is the “most capable generative AI powered assistant for software development,” while it is also deploying AI and computer vision in fulfillment centers to optimize deliveries and uncover product defects.

Alphabet similarly has two core businesses where it can integrate and monetize AI at a large scale, in cloud and advertising, with management seeing AI generating “billions in revenue.” Alphabet said it sees “tremendous ongoing momentum in Search and great progress in Cloud with our AI initiatives driving new growth,” with Cloud driving billions in AI revenue year-to-date.

In addition, Alphabet’s developer tools and Gemini are witnessing strong adoption, with more than 2 million developers using its AI tools, and more than 1.5 million developers utilizing Gemini. Alphabet added that a “majority of [its] top 100 customers” are adopting its generative AI solutions. For Search, AI features are improving profit optimization for advertisers – when “paired with Search or PMax,” Alphabet’s new AI-powered DemandGen ad campaigns deliver “an average of 14% more conversions,” more efficient cost-per-click rates, and profit uplifts.

Unlike Microsoft and Amazon, Meta’s AI monetization is not as visible, with AI aiding in engagement and advertising. CEO Mark Zuckerberg noted that AI is already enabling increased engagement and better targeting across the business, as its unified AI systems have “already increased engagement on Facebook Reels more than our initial move from CPUs to GPUs did.” For advertising, Meta says that it has “seen promising early results since introducing our first Generative AI ad features, image expansion, background generation, and text generation with more than 1 million advertisers using at least one of these solutions in the past month.”

However, Meta said that it does not “expect [its] Gen AI products to be a meaningful driver of revenue in 2024” with Mark Zuckerberg referencing his philosophy of maximizing engagement first before focusing on monetization “I think you all know this from following our business for a while, but we have a relatively long business cycle of starting a new product, scaling it to something that reaches 1 billion people or more and only then really focusing on monetizing at scale…before we are really talking about monetization of any of those things [Meta AI or AI Studio] by themselves, I mean I don't think that anyone should be surprised that I would expect that — that will be years”, implying that the timeline for fully recognizing real revenue tailwinds will take more than just a few quarters.

Conclusion

We’ve seen concerns rise recently that Big Tech may be overspending on AI capacity, with not enough revenue to justify this level of expenditure. However, comments from the largest four management teams highlighted one crucial similarity – demand remains above capacity, and they would rather risk overbuilding than underbuilding when it comes to AI capacity.

The weight of four Big Tech CEOs speaking in unison on this topic is either a staggering coincidence —- or they have important insights that are leading to the same conclusion, which is that AI’s primary risk is for those companies that are not early enough to capture it. It’s interesting Big Tech CEOs feel that way, as the I/O Fund’s stance is similar for investors, which is that the primary risk to a portfolio over the next 3-5 years is not being early enough to capture the powerful trend of AI.

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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AI PC Stocks: Emerging 2024 And 2025 Story

Posted on by io-fund

This article was originally published on Forbes on Jun 27, 2024,04:25pm EDTForbesForbes on Jun 27, 2024,04:25pm EDT

AI-capable PCs are expected to be an explosive trend through 2025 and beyond. The trajectory of AI will increase when more people can access AI-powered applications, which in turn, will help AI developers build a bigger ecosystem. Currently, there is a major bottleneck right now for AI applications to where client devices are not powerful enough or energy efficient enough to leverage AI capabilities at the edge.

We’ve discussed the PC rebound in late 2023 for our premium members with executive commentary on how AI PCs will accelerate the PC market’s growth rate. Industry research organizations similarly see strong growth in AI PCs, with some forecasting annual AI PC shipments to more than triple by 2028. In other words, AI-capable PCs are projected to rise from ~19% of total PC shipments this year to more than 70%, even up to 80% by 2028. The rapid adoption curve will be driven “with a strong inclination towards commercial adoption.” There is indication the early majority will adopt AI PCs in 2025, and the late majority in 2026. This leaves time for consumers to participate, which thus far has been a challenge for AI, as it's been predominately driven forward by Big Tech.

Refresher on AI PCs

With the rapid ascent of generative AI over the past year and a half, the term ‘AI PC’ may be self-explanatory but there are nuances to each release. Microsoft has adopted a new definition for AI PCs that underpins the launch of its Copilot+ PCs on the market, which launched in mid-June.

According to Microsoft’s definition, an AI PC will contain a CPU, a GPU, and an NPU (neural processing unit), as well as its Copilot key and Copilot software onboard. NPUs are highly efficient at parallel processing for AI and ML workloads by running matrix multiples. Essentially, NPUs offer a very power-efficient way of running localized AI on devices such as PCs and smartphones without draining battery life by operating in the background. Per Microsoft, AI PCs must be capable of 40 TOPS or greater performance on the NPU.

Meeting Microsoft’s Copilot+ requirement calls for at least 16GB RAM and 256GB storage alongside the 40+ TOPS NPU performance. This is currently only met by Qualcomm’s Snapdragon X Elite chips, but will soon be met with Intel’s Lunar Lake chips, AMD’s Strix Point chips, and others.

AMD and Intel define the AI PC more broadly – AMD defines an AI PC as “a PC designed to optimally execute local AI workloads across a range of hardware, including the CPU, GPU, and NPU.” Intel’s definition says an AI PC “has a CPU, a GPU and an NPU, each with specific AI acceleration capabilities.”

Intel believes the AI PC “promises to be a huge improvement for everyday PC usages,” as it “represents a fundamental shift in how our computers operate.” AI PCs meeting the TOPS and memory requirements set forth by Microsoft will allow AI models and workloads to be built and deployed directly at the edge, without transferring data to and from the cloud, offering an extra layer of security and privacy.

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Strong Growth Forecasts

Shipments of AI-capable PCs are forecast to grow at a rapid rate over the next four years, while also boosting broader PC market growth. HP believes that as AI PC commercialization accelerates, the “overall PC category growth rate can double over the next three years.”

Canalys is projecting AI PC shipments to rise at a 44% CAGR from 2024 to 2028, from an estimated 48 million PCs this year, before doubling to more than 100 million in 2025 and rising to over 205 million by 2028. Cumulative shipments of AI PCs are projected to surpass 600 million over the next four years.

Gartner is slightly more optimistic on the near-term growth of AI PC shipments, forecasting shipments to more than double from 24 million in 2023 to 54.5 million in 2024, nearly 14% higher than Canalys’ estimate. Gartner’s 2025 forecast calls for shipments more than doubling once more to 116 million units, or 43% of total PC shipments, up from just 10% in 2023 and 22% this year.

IDC is projecting 50 million shipments in 2024, with 3-year growth of 234%, reaching 167 million annual shipments in 2027. Here’s what the three projections look like:

AI Capable PC, Forecasted Annual Shipments

Source: I/O Fund

While there are some nuances in the growth projections, especially in the next twelve to eighteen months, the longer-term growth trends remain intact, with shipments projected to increase more than 200% by 2027.

Much of the growth through 2025 is expected to be in the premium (or high-end) laptop segment, with ASPs rising due to the NPU. For example, the first Copilot+ PCs equipped with Qualcomm’s Snapdragon X Plus chips start at $999, and the Snapdragon X Elite PCs at $1,249.

In addition, while the growth in AI PC shipments is expected to be felt across both the consumer and commercial end markets, commercial adoption is forecast to be higher, at approximately 60% by 2028 versus 40% for consumer. This is due to the productivity gains that AI PCs can enable via powerful on-device AI as well as benefits to software developers and related roles. For example, Dell’s XPS and Latitude 7455, equipped with the Snapdragon X Elite, “can support 13 billion-plus parameter models which means customers can run popular models like Llama 3 directly on their PCs.”

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PC Market Growth

A look at the broader PC market shows that the industry finally inflected back to growth after a challenging two-year stretch of declines; however, this came against an easy comp of a nearly (29%) YoY decline in Q1 2023, per IDC.

Counterpoint Research and Canalys both reported 3% YoY growth for the PC market in Q1, with Lenovo leading the way with nearly 8% YoY growth. In addition, IDC noted that “global PC shipments finally returned to pre-pandemic levels as 1Q24 volumes rivaled those seen in 1Q19 when 60.5 million units were shipped.”

For the full year, the market is expected to see approximately 2% to 3% growth, with annual shipments in the 265 million and 270 million range. This is still a far cry from the ~340 million shipments seen in 2021, due to the challenging landscape the industry navigated through 2023.

An Ultra-Competitive Landscape

Competition in AI PCs is quickly heating up, with Intel forecasting a surge in its PC chip shipments, while Nvidia, AMD and others line up powerful Arm-based CPUs to take on Qualcomm’s Snapdragon X chips once its exclusivity deal with Arm expires at the end of 2024. Apple is rumored to be planning an M4-powered Mac refresh either by the end of this year or early 2025.

The four are competing on NPU performance, alongside efficiency:

  • Qualcomm’s Snapdragon X NPU offers 45 TOPS of AI performance, while CEO Cristiano Amon “claiming a performance-per-watt 2.6 times better than AMD and 5.4 better than Intel's Core Ultra 7 chips.”
  • Intel’s upcoming Lunar Lake chip offers up to 48 TOPS on the NPU, and Intel is claiming “1.4x AI performance over the Snapdragon X Elite running the Stable Diffusion tool in a GIMP plugin; faster overall core performance versus Ryzen and Qualcomm competition; and a 1.5x improvement over its previous generation in the performance of the integrated GPU.”
  • AMD’s upcoming Ryzen AI 300 series chips (Strix Point and Strix Halo) offer up to 50 TOPS performance from the NPU, the highest on the market so far.
  • Apple’s M4 chip offers up to 38 TOPS performance on the NPU, with the chip originally deploying on the iPad lineup with the Mac refresh rumored for this year or next.

Nvidia does not have an NPU competitor yet, as it believes its GeForce RTX GPUs offer significantly higher TOPS and more AI performance: “Performing 40 TOPS is sufficient for some light AI-assisted tasks, like asking a local chatbot where yesterday’s notes are. But many generative AI tasks are more demanding. NVIDIA RTX and GeForce RTX GPUs deliver unprecedented performance across all generative tasks — the GeForce RTX 4090 GPU offers more than 1,300 TOPS. This is the kind of horsepower needed to handle AI-assisted digital content creation, AI super resolution in PC gaming, generating images from text or video, querying local large language models (LLMs) and more.” However, Nvidia and MediaTek are reportedly working on an Arm-based AI PC chip for a 2025 launch following the expiration of Qualcomm’s exclusivity deal.

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Industry Commentary on PCs, AI PCs

Industry commentary on the AI PC outlook is optimistic over the longer-term, with vendors and chipmakers alike seeing growth through 2026. Management teams are broadly bullish on the upcoming refresh cycle and the potential for AI PCs to not only boost growth but also to improve ASPs.

Let’s break down some recent industry commentary:

Hewlett-Packard:

HPQ’s management is expecting to see stronger AI PC demand as 2024 closes with larger impacts in 2025 and 2026. Management said that “in the second half, we expect to see the introduction of AI PCs accelerate demand, over-and-above the anticipated PC refresh cycle and Windows 11 roll out.”

CEO Enrique Lores said that HP believes the “penetration of AI PCs is going to be growing over time,” with its first AI PCs representing “around 10% of the shipments for the second half. That's how we are quantifying that. But really, the impact will be more relevant in 2025 and in 2026. In fact, we expect that AI PCs, and at that point will be our new generation, will be between 40% and 60% of our sales three years after launch. … And as we have discussed before, we continue to believe that they will drive an improvement in average selling price of between 5% and 10%”

He further clarified that of the new AI PC products, HP expects “a stronger traction in consumer because commercial requires some evaluation done by customers. That takes some time. But over time, we expect the penetration in commercial to grow and to be more relevant in 2025 and in 2026.”

Dell:

Despite have one of the largest AI PC lineups in the industry, Dell’s management has been a bit more opaque about the opportunity, though they remain bullish on AI PCs.

Management said in Q1’s earnings call that the “commercial PC demand has also stabilized and we saw an improving demand environment as we move through the quarter. … We expect commercial PCs to continue to improve as the year progresses. We remain optimistic about the coming PC refresh cycle, driven by multiple factors. The PC installed base continues to age, Windows 10 will reach end of life later next year and the industry is making significant advancements in AI-enabled architectures and applications.”

This return to growth in commercial PCs and stabilization in demand is a positive sign, and also echoes HP’s view that the commercial space may need more than a quarter or two to fully embrace AI PCs and for shipment growth to accelerate.

Qualcomm:

Qualcomm sees AI redefining the PC, and its understandable management would be outwardly very optimistic about the opportunity given the Arm exclusivity this year and partnership with Microsoft.

CEO Cristiano Amon said at Computex that “the PC is truly reborn. It's a new era for the PC and that is happening with the combination of Snapdragon X Elite and Copilot Plus,… it's one of the most significant transitions in Windows. Personally, I believe is as significant as Windows 95. It is changing the experience, delivering groundbreaking AI capabilities, fundamentally changing how we interact with our PCs.” Amon added that the AI PC “will become indispensable for both personal and business applications. One thing is going to be different about this new PC. Unlike the past, your Windows PC will get better over time.”

Despite the optimism, Qualcomm said that “in our June quarter guidance, there isn't material PC volume forecasted in our numbers,” with more of the impacts coming from the back-to-school season and into 2025.

AMD:

AMD is arguably one of the more bullish companies in the industry regarding the impact that AI PCs will have on the upcoming refresh cycle.

CFO Jean Hu mentioned that AMD’s “PC client business are performing really well. We're gaining share. And primarily, they are driven by our most recent generation of processors, Ryzen 8000.” She added that the company believes the “AI PC is a very significant inflection point. It will potentially help the refresh the PC market. … [And] we think generation over generation technology and product leadership will help us both on the commercial side and the consumer side to continue to gain share.”

This echoes statements from CEO Lisa Su in AMD’s Q1 earnings call: “We see clear opportunities to gain additional commercial PC share based on the performance and efficiency advantages of our Ryzen Pro portfolio and an expanded set of AMD-powered commercial PCs from our OEM partners. Looking forward, we believe the market is on track to return to annual growth in 2024, driven by the start of an enterprise refresh cycle and AI PC adoption. We see AI as the biggest inflection point in PC since the Internet with the ability to deliver unprecedented productivity and usability gains.”

Q1 had already seen rather strong demand for AMD’s latest Ryzen series, as “Ryzen desktop CPU sales grew by a strong double-digit percentage year-over-year and Ryzen mobile CPU sales nearly doubled year-over-year as new Ryzen 8040 notebook designs from Acer, Asus, HP, Lenovo and others ramped.” If anything, this could be seen as a strong indicator of demand for the upcoming Ryzen AI 300 series.

Intel:

Intel has had the most to say about AI PCs, given that their positioning in the x86 versus Arm-based processor competition is most at risk if Arm-based PCs really start to see strong adoption over the next few quarters to years. We previously discussed the outlook for Arm-based PCs for our premium readers, saying that “if Arm-based PCs stick this time, it will mark a massive shift in edge devices. X86 dominates PCs as it stands today, yet AI leaders have their roadmaps loaded with Arm-based releases over the next year.” For more on Arm-based PCs, reference our analysis “Arm-Based PCs and AI Edge Devices”.

However, Intel has made it crystal clear that they don’t see Arm as much of a threat. Management explained that “Arm and Windows PC is not a new dynamic. This is something that was a big concern of the investment community as far back as 2011. And so there's been 14, 15 years of trying to break Arm into the Windows PC market with very little success in large part because we had a very strong road-map in large part because we had a strong ecosystem and in large part x86 PCs not only make us a profitable, it makes the OEMs profitable as well.

And so we kind of feel like the dynamic really hasn't changed all that much from the 2011 time period. Clearly, Microsoft is throwing more weight behind this. They've done an exclusivity with a single vendor in Qualcomm and that is up at the end of the year. And we fully expect to see other potential Arm suppliers come into the market when that exclusivity is up. But in general, there's been one successful Arm PC vendor in the market, and that's been Apple. And they've had 25 plus years in the market and they've got about a 10% market share.”

Turning to AI PCs, Intel is one of the most bullish on the long-term potential, seeing up to 80% of annual PC shipments being AI PCs by 2028.

Intel also believes revenue in Q1 was the “bottom and we expect sequential revenue growth to strengthen throughout the year and into 2025, underpinned by, one, the beginnings of an enterprise refresh cycle and growing momentum for AI PCs.” Management also hinted that the weaker Q2 revenue guide in part boiled down to supply constraints for its Core Ultra chips: “Q2 client revenue is constrained by wafer-level assembly supply, which is impacting our ability to meet demand for our Core Ultra-based AI PCs.”

Management further explained that the ramp of Core Ultra (Meteor Lake) “continues to accelerate beyond our original expectation with units expected to double sequentially in Q2, limited only by our supply of wafer level assembly. Improving second half Meteor Lake supply and the addition of Lunar Lake and Arrow Lake later this year will allow us to ship in excess of our original 40 million AI PC CPU target in 2024.” As a reminder, Intel is aiming to ship more than 100 million AI PC chips by the end of 2025, with a target of 40 million or more in 2025, and 50% growth to 60 million or more in 2025. Supply constraints will certainly pressure this target if wafer supply takes longer to improve, but at the moment, the demand is present, aided by the enterprise refresh.

As a whole, management teams from both chipmakers and PC vendors alike are projecting strong growth for AI PCs. Qualcomm is leading the push for the Arm-based PC, while Intel is targeting a huge growth in shipments for its x86-based Core Ultra lineup over the next six quarters.

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more here.

Conclusion

We see AI PCs as the next wave of growth in the budding AI industry, following GPU hardware and memory as professionals and consumers alike both stand to benefit from the ability to run on-device AI efficiently. AI PCs are projected to spearhead growth in the broader PC industry over the next few years, while adoption rates of AI PCs are estimated to soar, from less than one-fifth of total shipments this year to nearly four-fifths of annual shipments by 2028.

In terms of unit growth, AI PCs are expected to more than triple from approximately 50 million units this year to north of 200 million units by 2027, a rapid growth curve for the industry. We’re keeping a close eye on the major players and in the space as we work to identify the top beneficiaries of this trend, recently sharing a downstream beneficiary with our premium members.

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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