Nvidia, Mag 7 Flash Warning Signs For Stocks

Posted on October 15, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Oct 10, 2024,10:58pm EDTForbesForbes on Oct 10, 2024,10:58pm EDT

The Fed surprised the market with an aggressive 50 bps cut recently, which has pushed the S&P 500 back to new all-time highs. However, not all markets are celebrating this move. Bond yields and mortgage rates, for example, have been in an uptrend since this decision, which is not normal to see at the onset of a rate cutting cycle.

Also, the bull market leaders – the Mag 7 and AI focused semiconductors – are making a series of lower highs, not confirming this move in the S&P 500. This divergence between the market leaders and the broad market has been the consistent theme of the I/O Fund’s broad market reports in 2024. More times than not, the bull market leaders will lead on the way up, as well on the way down. So, when my firm sees the primary beneficiaries of a bull market start to make lower highs while the broad market makes higher highs, it tends to be a warning.

In this report, my team will address the risks brewing in the market. The strange behavior in the bond market could be signaling that the FOMC has made a policy error. This coupled with key tech stocks trending lower against the S&P 500’s advance, has my firm cautious for the time being.

What Big Tech and AI Stocks Are Telling Us

In 2023 we saw these market leaders trending higher with the broad market. This was a powerful trend that lasted into late 2023. As a result, the collective Mag 7 returned around 90% in 2023 vs. the S&P 500 returning 24%. However, this trend is not continuing into 2024, as we are beginning to see cracks in market leadership.

This year, the Mag 7 are up ~30% compared to the S&P 500’s ~20%. Though this year has been excellent for investors, it’s concerning the relative strength between the bull market leaders and the broad market is narrowing, which has been a constant theme in our broad market analysis throughout all of 2024.

“When the cycle leaders start to underperform, it tends to mark the start of a trend change. The FAANGs have been the undoubted leaders of this bull run, and we are now seeing them start to trend lower against the indexes. More times than not, the leaders on the way up, tend to be the leaders on the way down.”

More importantly, the Mag 7 is making a lower high, while the S&P 500 makes a higher high. In other words, the bull market leaders are not confirming this push higher in the broad market. This is a rare pattern that has only shown up one other time in this bull market – July of 2023, just before we saw an almost 11% correction in the broad market.

A rare pattern observed in the bull market, similar to July 2023, preceding an 11% correction in the broad market. – I/O Fund

This divergence is not only happening with the Mag 7, but it’s also happening with the most important sub-sector within tech due to AI – semiconductors.

Since the current bull market began on October 13th of 2022, the Mag 7 has returned over 102% vs. the S&P 500’s 61%. During the same period, semiconductors have returned over 174%. The leading stock, Nvidia, is up over 967% over the same period. So, while the Mag 7 are the popular market leaders, the true market leaders of the current bull cycle are semiconductors, and specifically, Nvidia. This is a trend that the I/O Fund positioned for in 2022, making NVDA our largest position, as we rotated out of cloud stocks and into AI.

Performance of the Mag 7, S&P 500, and semiconductors since October 13, 2022: The Mag 7 returned over 102%, the S&P 500 returned 61%, and semiconductors returned over 174%, with Nvidia up over 967%. – I/O Fund

Semiconductor Index (SMH)Semiconductor Index (SMH)

SMH has a history of leading market swings in the broad market. Since 2021, every time the S&P 500 made a new high without SMH, it preceded a period of volatility. Today’s divergence is one of the largest on record. The Semiconductor Index topped in July at $283, and is still well below this high, compared to the S&P 500 that just pushed to new a new high this week at 5796.

Chart illustrating the semiconductor sub-sector’s corrective pattern, featuring a 3-wave drop since June followed by a bounce from the August 5th low, suggesting a potential final drop targeting $190 to $165. – 123

When digging deeper into this key sub-sector, we can see that a clear corrective pattern is playing out. Since the June top, there is a clear 3 waves down. This has been followed, so far, by a symmetrical 3 wave bounce off the August 5th low. This pattern best fits a standard corrective patten. This implies that a final drop is still needed, which is targeting between $190 – $165.

The advance seen today is poking above the downtrend line from the July top. However, this is happening on less volume and less momentum. Note the momentum indicator below the chart. It has given three lower highs while price provided three higher highs. This is a rare pattern that tends to precede a trend reversal.

Chart depicting the current market advance above the July downtrend line, showing decreasing volume and momentum. The momentum indicator reveals three lower highs, while the price shows three higher highs, suggesting a potential trend reversal. – I/O Fund

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Nvidia (NVDA)Nvidia (NVDA)

Nvidia topped in June at $140, and failed to make a new high in July with the rest of the Semiconductor Index. This was a warning that semis, and the broad market, were heading lower.

This same relative weakness is still present today. While most semiconductors have broken out above their August high, NVDA remained below it. This week, it has moved above the August high, which appears to be the final move in this bounce which is happening on less momentum and less volume. This lines up with the I/O Fund’s game plan, which was to sell a quarter of our NVDA position in June around $129, and attempt to buy it lower in the coming months, which was discussed in detail on my recent interview.

Chart illustrating NVDA’s incomplete corrective pattern, indicating potential drops below $114 and $108, which could lead to a decline toward the $90 – $70 region, completing a multi-month correction. – I/O Fund

Like SMH, NVDA appears to be tracing an incomplete corrective pattern. A move below $114 and then $108 will signal that the stock is heading toward the $90 – $70 region, which would complete this multi-month correction.

NVDA remains weaker than the broad market, as well as SMH. Considering the importance of this stock, as long as it remains below its June high, it is a warning to the current broad market advance.

Are New Leaders Developing?

Some have argued that the market is taking gains in the AI leaders and spreading that money out into beaten down sectors. In other words, there is a healthy broadening out of the market, which typically exhibits strength.

The narrative that supports this idea is that the FOMC just offered a surprise 50 bps rate cut into a seemingly healthy economy. The cheaper cost of borrowing should propel more economically sensitive sectors to play catch-up as the economic expansion continues.

As plausible as this sounds, it’s just not showing up in data, yet. Since the Fed cut rates on September 18th, we are not seeing money flowing into your beaten down sectors that should do well if this narrative is playing out.

Sectors like, transportation, small caps, retail sales, consumer discretionary and high beta are still under their 2021 highs. These are the sectors that would benefit from a soft-landing. As you can see below, aside from consumer discretionary, they are all underperforming the S&P 500.

Chart illustrating the market dynamics where AI leaders are gaining, but beaten down sectors like transportation, small caps, retail sales, consumer discretionary, and high beta are still lagging behind the S&P 500, showing no significant investment flow after the FOMC’s 50 bps rate cut. – I/O Fund

While Nvidia and Semiconductors are making a lower high, there is more money flowing into defensive and inflationary markets, like, Energy, Apple, Utilities and even the US dollar is doing better than the markets that would support the broadening out narrative.

What the Bond Market is Telling Us

Another unusual development since the Fed cut rates is that bonds are not acting as they should at the onset of a rate cutting cycle. Historically, the relationship between long-dated bonds and the Fed cutting rates has been an inverse relationship. As the Fed cuts rates, it is usually in the face of a weakening economy. If prices are going down due to demand collapsing, then a fixed yield is desirable in that environment, meaning that we should see bonds going higher.

This is not what is happening today. The day the Fed cut rates, the 10-year government bond began a sharp decline and is currently down nearly 4% from its high. This is a big move for the 10-year bond.

Chart showing the 10-year government bond’s sharp decline after the Fed’s rate cut, highlighting an unusual trend where bond prices typically rise in a weakening economy. The bond is down nearly 4% from its high. – I/O Fund

This is unusual behavior, as the above chart shows. Bonds should be going higher, not lower, based on historical comparisons. The popular narrative for this behavior in the bond market is that this is evidence that the FED accomplished a soft landing.

If we were going into a slowing economy, which could lead to a deflationary event, then bonds would be catching a bid. So, the fact that we are not must mean that the economy is strong, and the economic expansion will only continue. This will then propel asset prices higher, as well as inflation, making the need for fixed yields a poor investment.

As we just saw, the market is not buying this narrative, as money is not flowing into the sectors that would support this thesis. So, what could be going on?

It’s important to understand that the Fed does not control the 10-year yield; this is controlled by the bond market’s expectations for future growth and inflation. The Fed’s reasoning for aggressively dropping rates on September 18th was that inflation is heading to 2% and the employment market is starting to show weakness.

Since then, the ISM non-manufacturing PMI posted its hottest reading since February of 2023. Twelve out of the 18 segments of this report stated that prices are rising, not falling.

Chart highlighting the ISM non-manufacturing PMI’s highest reading since February 2023, with 12 of 18 segments reporting rising prices. Additionally, the labor market added 107,000 more jobs than expected, revising September figures up by 17,000, causing the unemployment rate to drop from 4.22% to 4.05%. – YCharts

This was accompanied with a labor market that is much stronger than expected. The most recent jobs report showed that the US added 107,000 more jobs than expected, while September’s report was revised higher by 17,000 jobs. This caused the unemployment rate to drop back to 4.05% from 4.22%.

This is further confirmed with current mortgage rates. Everyone was expecting mortgage rates to drop with the Fed Funds Rate. However, since the cut, there has been a sharp increase in average mortgage rate from 6% to 6.32%.

Current mortgage rates defy expectations, rising sharply from 6% to 6.32% following the Fed’s rate cut, contrary to the anticipated decrease. – YCharts

The reason for this is because mortgage rates are not determined by the Fed. Instead, they are the result of an equation that includes the 10-year yield and the borrower’s credit score. So, the 10-year getting sold, means yields are going up.

This happening on the day of the FED’s rate cut policy means the bond market is not convinced inflation is heading to 2%, which is pushing mortgage rates higher. This means that we could be getting signals that the FED made a policy error, and dropped rates too soon, as yields continue to climb in the weeks after this decision.

Interesting enough, at the Grant’s Annual Fall Conference, Druckenmiller stated that his largest bet is shorting the US bond market.

His reasoning is not because the Fed achieved a successful soft landing, which the consensus believes, but it is because “bipartisan fiscal recklessness is on the horizon.” In other words, the larger our deficits become, the more money will need to be borrowed to cover interest payments. As more and more debt gets created, yields will have to go up to attract more buyers, which will put pressure on fiscal budgets, and therefore creates a vicious cycle.

To put this into perspective, the budget deficit for the fiscal year 2024 is going to come in around $1.9 Trillion, or 6.7% of GDP. There is no other year in US history where the budget deficient was this large outside of a major war, like WW I & WW II, or dealing with a major recession, like 2008. It is unheard of to have fiscal spending this high, in an expanding economy, with historically low unemployment. This makes you wonder what the deficit will look like in the face of a contraction.

This was an issue that the market has been aware of for decades but was able to ignore due to historically low interest rates. With rates low and trending lower, this fiscal recklessness was allowed to go on. However, we are seeing for the first time in 30 years, bond yields are starting a new uptrend.

Since 1981, the 10-year yield has been in a classic downtrend, making a series of lower highs. This trend made borrowing easier, as low rates made the cost of borrowing affordable. However, in 2021, yields broke this downtrend and made their first higher highs in 30 years. Today, yields are higher than they were in 2008, making the cost of borrowing higher than most investors are used to in over 20 years.

Diagram illustrating the market’s awareness of excessive debt and low interest rates enabling fiscal recklessness. Since 1981, the 10-year yield has followed a downtrend until breaking the trend in 2021, resulting in the highest borrowing costs seen in over 20 years. – I/O Fund

If this uptrend in yields continues, which looks likely, it would become problematic for inflation expectations, as well as the Fed’s ability to lower rates. It will also become problematic for the cost to service government debts, as more debt will be issued at higher rates to cover current service requirements. And, it will become problematic for stocks, specifically high beta stocks that need to borrow to fund operations, as estimates on future cash flows will have to account for a higher cost to borrow. In short, the last +20 years have built on the idea that inflation will not happen, and the FED can keep rates close to zero.

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Broad Market Analysis

The bull market pattern off the 2022 low has taken the shape of a messy diagonal pattern. This is a 5 wave pattern where the internal waves are 3 waves in all directions. It is also marked with large, overlapping swings. Note how wave 4 went into wave 1 territory – this is typical of diagonals. The 5th wave in this pattern is a blow off, and from what I can tell, we are in the final swing of this pattern.

If SPX can breakout above 5825, then it can likely push into the 6000 – 6185 region. If instead, it breaks down below 5675 this will be your first indication of a potential trend change. Below 5500 and then 5115 will be the final confirmations.

Chart illustrating a messy diagonal pattern in the bull market since the 2022 low, consisting of 5 waves with overlapping swings. Key breakout points are at 5825, while downtrend confirmations are at 5675 and 5500, indicating potential trend changes. I/O Fund

In conclusion, as the economic expansion continues, the odds of a recession remain low. However, money is not flowing into the beaten down sectors that would benefit from this reality. Instead, defensive and inflationary names are getting more flows than transportation, small caps, high beta and retail sales. The market leaders continue to make lower highs while the broad market pushes higher, and bonds are getting sold as if the FED stopped cutting rates, not started. The warning signs are high, and my firm remains defensive until these signals reverse, or the market corrects.

If you want to track the potential top in equities, join I/O Fund next Thursday, October 17th at 4:30 pm EST, for our premium webinar. We will go over the levels that need to hold and the specific AI stocks we are targeting for the next leg higher.

Knox Ridley, Portfolio Manager of the I/O Fund, contributed to this analysis.

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

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TSMC Q3 2024 Earnings Preview: Strong HPC Growth Likely

Posted on October 12, 2024June 30, 2026 by io-fund

TSMC released its September monthly revenue, which grew 39.6% YoY and 0.4% MoM to NT$251.87 billion. The third quarter revenue grew 39% YoY to NT$759.69 billion, beating the LSEG estimates of NT$750.36 billion.

In US dollar terms, Q3 revenue grew by 36.2% YoY to $23.53 billion using the average exchange rate of $1=NT$32.28. We will get the official USD figures when the company releases its full results on October 17th. The company handsomely beat the upper end of the guidance of $22.4 billion to $23.2 billion.

The strong September results suggest surging demand for AI chips and with more details on full quarter performance coming this week. Due to its technological leadership, the company has over 90% market share in the manufacturing of advanced AI chips. TSMC's customer base includes leading companies like Apple, Nvidia, AMD, Qualcomm, Marvell, and Intel.

TSMC is the leading global foundry in terms of revenue. It has a market share of 62.3% in Q2 2024. Samsung ranks a distant second with a market share of 11.5% in Q2 2024. WSJ reported TSMC’s global foundry revenue share to hit about 64% in 2024, up from 51% in 2019 and Samsung’s share to drop to 10% from 16% in 2019.

Revenue

Strong revenue growth is expected in the coming quarters due to the robust demand for AI and smartphone chips. Revenue estimates have gone up over the past few quarters, 4.7 points for the current quarter and estimates have risen 7.6 points for Q1 of next year indicating analysts’ confidence in the company’s ability to maintain growth.

Management’s guide for the third quarter is between $22.4 billion and $23.2 billion. This represents year-over-year growth of 31.9% at the midpoint. Based on the monthly TWD figures, Q3 revenue grew by 36.2% YoY to $23.53 billion using the average exchange rate of $1= NT$32.28. We will get the official USD figures when the company releases its full results on October 17th.
Q2 revenue grew by 32.8% YoY and 10.3% QoQ to $20.82 billion, primarily driven by strong AI demand and partially offset by smartphone seasonality. Q2 reported a remarkable 19.9% acceleration from 12.9% growth in Q1.

During the Q2 earnings call, management increased full-year 2024 revenue guidance from low to mid-20% to slightly above mid-20% in US dollar terms as strong AI and high-end smartphone demand will lead to an increased capacity utilization for the 3-nanometer and 5-nanometer process technologies in the second half of the year.

Margins

While many companies struggle with rising costs, TSMC has successfully navigated these challenges by controlling costs and negotiating better prices with its customers. Due to reducing costs during a growth phase, referred to as “economies of scale,” and its leadership position in the foundry industry, the company has been able to report strong profitability.

According to DigiTimes, TSMC has notified its clients that prices for its 3-nanometer and 5-nanometer process products will increase by 3 to 8% in 2025. In the last earnings call, management hinted that prices will increase due to cost escalation.

Management has guided Q3 gross margin to increase 1.3 percentage points sequentially to 54.5% at the mid-point due to better capacity utilization, cost improvements, and productivity gains compared to 54.3% in Q3 last year. The margin is expected to be partially offset by the N3 ramp, N5 to N3 tool conversion costs, and higher electricity prices in Taiwan. Electricity prices in Taiwan increased by 17% last year and another 25% in April this year. Management is confident of achieving a long-term gross margin of 53% and higher.
Operating margins are expanding, helped by operating leverage. Management guide for Q3 is 43.5% at the midpoint compared to 41.7% in Q3 2023.

Net income was $7.66 billion or 36.8% of revenue which is lower than usual. This margin trends in the high 30% range and into the 40% range. Return on equity was 26.7% compared to 23.2% in the same period last year.

EPS

EPS is projected to rise significantly. Analysts expect Q3 GAAP EPS to grow 36.4% YoY to $1.76. For next quarter, EPS is expected to grow 34.7% YoY to $1.94 in Q4.

Compare this to Q2 GAAP EPS of $1.48, up 29.8% YoY, which beat estimates by 4.2% due to better capacity utilization, cost improvement and operating leverage. More importantly, analysts expect Q3 EPS to grow 18.9% sequentially.

Analysts expect 2024 GAAP EPS to grow 26.4% YoY to $6.55.
For FY2025, they expect GAAP EPS to grow 29.9% YoY to $8.51.

Cash Flows and Balance Sheet

The company’s financial stability is evident due to its strong operating cash flows, which have more than doubled in Q2. The foundry industry is capital-intensive and this is why you will notice a wide difference between operating cash flows and free cash flows for the company.

Operating cash flow was $11.68 billion or 56.1% of revenue compared to 35% of revenue in the same period last year and 73.6% in Q1.
Free cash flow was $5.32 billion or 25.5% of revenue compared to (-17%) of revenue in the same period last year and 43% in Q1. The company had negative free cash flows last year due to the income tax payment of $3.85 billion.
Management expects strong AI demand to continue and raised the midpoint of the capex for 2024 to $31 billion from the previous $30 billion, up 1.8% YoY. About 70% to 80% of the capex will be allocated to the advanced process technologies.
According to a report from Economic Daily News, Institutional Investors expect the capex to remain within the updated guide for this year. They also expect management to announce an increase in capex for next year during the January results due to the expected strong demand for 2 nm process technology.
Cash and marketable securities were $63.05 billion and debt of $30.4 billion compared to $60 billion and $30.25 billion in Q1. The company paid $2.8 billion in dividends in Q2.

Revenue by Platform

As the leading foundry for AI accelerators, TSMC is riding the enormous wave of demand from Big Tech. The chipmaker’s high-performance computing (HPC) revenues rose 28% QoQ to $10.8 billion and accounted for 52% of Q2 revenue, up from 46% of revenue in Q1. The HPC segment is above the 50% mark for the first time.

We can also notice in the below chart that the HPC revenue (which are mainly AI-related) reached a record $10.8 billion in Q2.

Smartphone revenues declined (-1%) QoQ due to seasonality and accounted for 33% of revenue compared to 38% of revenue in Q1. In the Q2 earnings call, management mentioned that they are witnessing strong AI and high-end smartphone-related demand in Q3. We will get the exact mix this week.

Internet of Things revenue grew by 6% sequentially and accounted for 6% of revenue.

Automotive revenue increased 5% sequentially and accounted for 5% of revenue. Digital Consumer Electronics increased 20% sequentially accounting for 2% of revenue. Other revenue increased 5% and accounted for 2% of revenue.

Revenue by Technology

The Advanced nodes are defined as 7-nanometer and below. We discussed in our editorial on the advanced nodes and AI-related revenue reaching fresh records. Most of the AI chips produced by the company utilize 5-nanometer and 4-nanometer process technology. 3-nanometer revenue is expected to triple this year and Apple usually gets the preference for the most advanced node in production. Volume production for 2-nanometer is expected in 2025 and should have a meaningful revenue contribution in the first half of 2026.

In Q2 2024, 3-nanometer process technology contributed 15% of wafer revenue, while 5-nanometer and 7-nanometer accounted for 35% and 17%, respectively.
In Q1 2024, 3-nanometer process technology contributed 9% of wafer revenue, while 5-nanometer and 7-nanometer accounted for 37% and 19%, respectively.

Advanced Packaging

The AI wave has also boosted the company’s advanced packaging business, particularly Chip-on-wafer-on-substrate (CoWoS). Morgan Stanley expects CoWoS capacity to reach 80,000 to 90,000 wafers per month by the end of 2025, up from a prior estimate of 70,000. The 2025 production capacity would suggest an over 430% increase from 15,000 at the end of 2023.

Management said in the Q2 earnings call Q&A that supply is expected to continue to be tight next year. They also mentioned that they are working with OSAT (Outsourced Semiconductor Assembly and Test) partners to increase production capacity.

Valuation

The company trades at a P/E ratio of 34.4 and a forward P/E ratio of 29.1. The P/S ratio is 13 and a forward P/S ratio of 11.4. In the last five years, the P/E ratio peaked at 41.8 in February 2021 and hit a low of 10.3 in November 2022. The stock is now trading above its five-year average P/E ratio of 24.1.

Conclusion

Due to technological leadership, TSMC can capture a significant portion of AI business and is the common denominator to the biggest AI winners as it supplies to Nvidia, Apple, AMD, Marvell, and Qualcomm. The company is negotiating better prices with its customers, is making cost improvements, and is maintaining strong margins and cash flows. Since TSMC generates strong cash flows, it has the scale to invest for future growth, and barriers of entry are high as the foundry industry is capital-intensive. We look forward to adding this stock to our portfolio in the coming months and will provide the play-by-play for our entries and adds to Essentials Members.

Pro premium members receive deep-dive research on the stocks in the portfolio and quarterly earnings kickoff webinars. In addition, the Advanced Market Signals Members receive regular technical and broad market analysis and weekly webinars from our Portfolio Manager, Knox Ridley. We have also recently discussed with the Advanced Market Signals members an AI stock that is up 415% in the last three months. Learn more here.here.

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

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Lumen Technologies – AI Turnaround Fuels Its Future

Posted on October 8, 2024June 30, 2026 by io-fund

Since July, Lumen Technologies is up over 500% and most of this rise occurred following the company’s Q2 earnings report. Given the exceptional and sudden performance, we looked at Lumen more closely.

The company provides fiber connections for high-speed transmission between data centers. Generative AI demands at least ten times more fiber connections within data centers, along with a strong fiber network to enable fast information transfer between these data hubs.

With the largest intercity fiber network in North America, Lumen is positioning itself as a key fiber provider for data centers and recently secured $5 billion in new contracts from clients, including Microsoft and the US Defense Information Systems Agency.

After suffering years of declining revenue and profits, Lumen is undergoing a turnaround as its fiber network provides the backbone for the AI economy. With that said, other segments weigh on Lumen and the company will not return to growth for some time.

Company Overview

Lumen Technologies is a telecommunications company that provides communications and data services to businesses, government agencies, and residential customers. Its business can be split into two sales channels: its business segment and its mass markets (primarily residential) segment.

The business segment operates under the flagship Lumen brand while the mass markets segment operates under Quantum Fiber for fiber-based broadband services and CenturyLink for copper-based broadband services. Lumen’s business segment has grown to 79% of revenue in FY’23, up from 72% in 2021.

The CenturyLink brand has been around since 1930, and was renamed Lumen Technologies in 2020 to reflect the shift away from the shrinking copper-based CenturyLink broadband business.

Largest Intercity Fiber Network

Lumen’s primary advantage comes from its scale with over 450,000 route miles of fiber optic cable globally that make it the largest ultra-low-loss intercity fiber network in North America.

It is further investing to more than double its intercity fiber miles by 2026, signing an agreement with fiber optic manufacturer Corning to reserve 10% of its global fiber capacity for each of the next two years.

Some of its key advantages include its use of a multi-conduit system which allows it to deploy fiber quickly and more economically than competition, and having 25% less optical loss than competition which decreases equipment costs.

The scale of Lumen’s fiber optic network was one of the key reasons it was able to secure $5 billion in new deals for its Private Connectivity Fabric (PCF) service, including with hyperscaler Microsoft. PCF is a custom network that includes dedicated access to existing fiber in the Lumen network, the installation of new fiber on existing and new routes, and the use of Lumen’s new digital services. Lumen notes that it is in talks to secure an additional $7 billion in AI-related sales opportunities and sizes the market as $50 to $60 billion, growing 4% to 5% annually.

The announcement of additional AI-related sales opportunities, as well as significantly raising its FY’24 free cash flow guidance from $100 to $300 million to $1.0 to $1.2 billion has contributed to Lumen’s outsized 3-month stock returns.

Business Segment (79% of FY’23 revenue)

As stated, Lumen is going through double-digit declines in revenue and it will be some time before the company returns to growth.

The business segment is comprised of four product and service categories denoting their stage of investment: Grow (a focus on new investments), Nurture (more mature offerings), Harvest (generating cash), and Other.

The Grow segment is the largest, comprising 41% of business revenue in Q2’24. If we back out international revenue, which experienced a (-70.5%) YoY decline due to the divestiture of Lumen’s EMEA business in November 2023, then Grow grew 1.5% YoY in Q2.

Nurture experienced the largest revenue decline at (-12.1%) YoY and is the second largest segment, comprising 29% of business revenue. The Nurture segment is comprised of mature offerings that are ex-growth where the focus is on improving margins.

Finally, the Harvest segment includes legacy services that have grown out of the Nurture phase and are managed to maximize cash. This segment experienced a (-10.6%) YoY revenue decline and comprises 22% of business revenue.

The Harvest segment has experienced the largest decline as a percentage of revenues over the last year, although all segments have seen revenue decline in absolute terms.

Mass Markets Segment (21% of FY’23 revenue)

The mass market segment is comprised of Lumen’s services for residential, small business, and government customers. This segment is split into three categories dependent on the type of service provided.

The Fiber Broadband (Quantum Fiber) segment serves high-speed internet through fiber infrastructure and is the fastest growing segment in the company at 14.6% YoY growth in Q2, comprising 26% of total Mass Markets revenue, up from 21% in the previous year’s quarter.

The Other Broadband (CenturyLink) segment uses slower, copper-based infrastructure under the legacy CenturyLink brand. This segment is rapidly shrinking as customers switch to fiber, seeing a (-16.1%) YoY decline in Q2.

Finally, the Voice and Other is comprised of phone services and government programs. This segment also saw an (-11.7%) YoY decline in Q2.

Financials

Lumen has seen years of declining revenues as the company failed to diversify itself away from its declining CenturyLink segment. Although revenue is expected to continue to decline in the coming quarters and years, Lumen’s Quantum Fiber business is growing and partially offsetting the decline in CenturyLink.

The over $5 billion in AI-related Private Connectivity Fabric (PCF) deals is also expected to reignite growth in the Business segment, with management guiding for the public sector to return to sustainable growth later this year, followed by mid-market then large enterprise. However, the overall business is not expected to return to growth until 2027 according to consensus estimates.

The cash flow from the AI-related PCF deals are also expected to close any FCF deficit between now and when the company reaches sustainable positive FCF, assuaging liquidity concerns despite the high debt load and decreasing margins.

Revenue

Q2 revenue fell by (-10.7%) YoY to $3.27 billion, beating expectations by 0.58%. This compares to Q1 revenue decline of (-12%) for revenue of $3.29 billion. Next quarter is expected to decline further at (-11.5%) YoY to $3.22 billion
2023 revenue fell by (-16.7%) YoY to $14.56 billion. This compares to 2022 revenue decline of (-11.2%) for revenue of $17.48 billion. In 2024, the revenue decline is expected to narrow to (-10.9%) YoY to $12.97 billion and (-4.3%) YoY in 2025 to $12.41 billion
The majority of the $5 billion in Private Connectivity Fabric solution sales is expected to be recognized over the next 3 to 4 years

Margins

While Lumen has consistently generated positive adjusted EBITDA, its margins have consistently declined. The company has reported large one-time GAAP losses stemming from goodwill impairments in Q4’23 and Q2’23.

Management expects the trend to continue and guided for adjusted EBITDA to fall further in 2025 as they pull forward some expenses due to their improved liquidity profile. However, this is part of their goal to take out $1 billion in costs from the business by the end of 2027 by unifying four enterprise networks into one. As a result, they expect a significant rebound in adjusted EBITDA in 2026, followed by YoY growth.

Q2’24 gross profit declined (-39%) YoY to $1.62 billion. Q2 gross margin was 49.4%, decreasing from 52.5% in the same quarter last year and 49.8% in the previous quarter
Q2 operating income increased to $135 million from loss of (-$8.42) billion in the year ago quarter which was affected by goodwill impairment charges. Q2 operating margin was 4.10%, up from (-230%) in the same quarter last year when there was a loss of $8 million, but up from 1.40% in the previous quarter

Adjusted EBITDA declined (-17.7%) YoY to $1.01 billion, representing a 30.9% margin, down from 33.6% last year but up from 29.7% last quarter.

Management guide for FY’24 adjusted EBITDA is in the range of $3.9 to $4.0 billion, slightly down from their previous guide of $4.1 to $4.3 billion issued in Q1 as Lumen pulled forward some investments associated with its business transformation.

Lumen management guided for 2025 adjusted EBITDA below 2024 levels, with a significant rebound in 2026 and growing thereafter, they note that they will provide more detailed guidance in their Q4’24 call in February 2025.

Net income was (-$49) million or (-1.5%) of revenue compared to (-$8.736) billion or (-238.6%) of revenue in the same period last year due to a non-cash goodwill impairment charge of $8.793 billion
Adjusted net income was (-$124) million or (-3.8%) of revenue compared to $98 million or 2.7% of revenue in the same period last year

EPS

Lumen is expected to remain unprofitable on a GAAP and adjusted EPS basis due to its interest expense burden.

Q2 GAAP EPS improved to ($0.05) from ($8.88) last year and beat estimates of ($0.11). Adjusted EPS fell from $0.10 last year to ($0.13) and missed estimates of ($0.04)
Analysts expect adjusted EPS to grow 4.6% YoY to ($0.09) in Q3 and to ($0.06) in Q4
Analysts expect 2024 adjusted EPS to decline from $0.20 in 2023 to ($0.32)

Cash Flow and Balance Sheet

One of the primary risks to Lumen has been its high debt load, with debt of $18.6 billion, for a debt-to-equity ratio of 39.9x.

However, Lumen has seen a significant improvement in cash flow and liquidity recently. Since Q2’23, it has addressed over $15 billion of debt and extended $10 billion of maturities as well as securing access to $2.3 billion in new liquidity.

With the company guiding for free cash flow guide of $1.0 billion to $1.2 billion for FY’24, liquidity is not much of a near-term concern.

The management guide for FY’24 FCF is in the range of $1.0 to $1.2 billion, significantly improved from their previous guide of $100 to $300 million issued in Q1.

Operating cash flow was $511 million or 15.6% of revenue compared to (-$100) million or (-2.7%) of revenue in the same period last year
Adjusted free cash outflow was (-$156) million or (-4.8%) of revenue compared to (-$896) million or (-24.5%) of revenue last year
Capex was $753 million compared to $796 million in the same period last year. The management guide for FY’24 capex is in the range of $3.1 to $3.3 billion, up from their previous guide of $2.7 to $2.9 billion issued in Q1

The company had cash of $1.5 billion and debt of $18.6 billion compared to $1.58 billion and $18.68 billion in the previous quarter. The company is guiding for net cash interest of $1.15 to $1.25 billion in 2024

Valuation

Due to the stock being up over 500% in three months, Lumen is trading at its historic averages, which reflect revenue declines, unprofitability, and liquidity concerns with its high debt load. It currently trades at a P/S multiple of 0.42x and a forward P/S ratio of 0.46x which is below its 5-year average of 0.44x. Notably, telecom companies such as AT&T are trading at 1.3x and Verizon at 1.4x.

Lumen trades at a forward EV/EBITDA multiple of 6.0x. While Adjusted EBITDA is expected to decline further in 2025, management guided for a “significant rebound” in 2026, followed by growth thereafter as previously mentioned.

Risks

Lumen’s largest risk stems from its declining revenues in combination with the interest burden from its debt. The stock went through a 98% peak-to-trough drawdown as liquidity became a key concern prior to the large AI-related contracts it recently landed.

However, the details around the $5 billion of AI-related PCF contracts remain high-level and the contribution is front-loaded, meaning the majority of the revenue and cash flow associated with these contracts will be recognized in the next 3-4 years, so Lumen needs to continue to win new business to extend its growth.

Finally, Lumen operates in a very competitive industry with large competitors like AT&T and Verizon that are investing heavily in their own fiber networks. Both companies are much larger than Lumen and thus pose a significant threat to Lumen’s ability to land more contracts and continue to pay off debt.

Technical Analysis

Lumen is up over 600% since July. This is an unusually large move in such a short amount of time. To understand if this is the start of a new, multi-year uptrend, we will need to look at Lumen’s trend on a much larger timeframe.

LUMN has been trading since the 1979s (due to CenturyLink). From its IPO into the 2000 top, it traced a perfect 5 wave pattern that took decades to complete. What always follows a 5 wave pattern is a 3 wave retrace of the same degree. The problem with the retrace that followed was that it lasted 23 years and retraced 98% of the uptrend. This is a very deep and long, which warrants caution until Lumen can further prove itself.

We need to see the pattern off the 2023 low turn into another 5 wave pattern to signal a new uptrend is starting. So far, it’s only 3 waves higher. For now, we need to see any weakness hold over $2.70 and then make a new high to meet this criterion. If we can see a new 5 wave pattern develop off the 2023 low, it will imply a new and investable uptrend has started.

Conclusion

It is not often that you see a century-old company at the forefront of new secular trends, but Lumen’s large and hard-to-replicate network of fiber assets is proving important as data center customers look to ever-increasing amounts of data with fast transmission to train AI models.

After concerns of potential bankruptcy in recent years, Lumen has successfully capitalized on recent AI-related contracts to stabilize its liquidity position as the company looks to return to growth in coming years. While the idea remains speculative given the high leverage, competition, and the lack of details surrounding the new contracts, Lumen could see a continuation of its rally if management is able to execute.

The I/O Fund has no plans to enter Lumen at this time.

This analysis is a preview of what you can expect in our upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier November/December. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier November/December. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!

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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Lumen Technologies – AI Turnaround Fuels Its Future

Posted on October 8, 2024June 30, 2026 by io-fund

Company Overview

The CenturyLink brand has been around since 1930, and was renamed Lumen Technologies in 2020 to reflect the shift away from the shrinking copper-based CenturyLink broadband business.

Largest Intercity Fiber Network

Lumen’s primary advantage comes from its scale with over 450,000 route miles of fiber optic cable globally that make it the largest ultra-low-loss intercity fiber network in North America.

Business Segment (79% of FY’23 revenue)

As stated, Lumen is going through double-digit declines in revenue and it will be some time before the company returns to growth.

The Harvest segment has experienced the largest decline as a percentage of revenues over the last year, although all segments have seen revenue decline in absolute terms.

Mass Markets Segment (21% of FY’23 revenue)

Finally, the Voice and Other is comprised of phone services and government programs. This segment also saw an (-11.7%) YoY decline in Q2.

Financials

Revenue

Q2 revenue fell by (-10.7%) YoY to $3.27 billion, beating expectations by 0.58%. This compares to Q1 revenue decline of (-12%) for revenue of $3.29 billion. Next quarter is expected to decline further at (-11.5%) YoY to $3.22 billion
2023 revenue fell by (-16.7%) YoY to $14.56 billion. This compares to 2022 revenue decline of (-11.2%) for revenue of $17.48 billion. In 2024, the revenue decline is expected to narrow to (-10.9%) YoY to $12.97 billion and (-4.3%) YoY in 2025 to $12.41 billion
The majority of the $5 billion in Private Connectivity Fabric solution sales is expected to be recognized over the next 3 to 4 years

Margins

Q2’24 gross profit declined (-39%) YoY to $1.62 billion. Q2 gross margin was 49.4%, decreasing from 52.5% in the same quarter last year and 49.8% in the previous quarter
Q2 operating income increased to $135 million from loss of (-$8.42) billion in the year ago quarter which was affected by goodwill impairment charges. Q2 operating margin was 4.10%, up from (-230%) in the same quarter last year when there was a loss of $8 million, but up from 1.40% in the previous quarter

Adjusted EBITDA declined (-17.7%) YoY to $1.01 billion, representing a 30.9% margin, down from 33.6% last year but up from 29.7% last quarter.

Net income was (-$49) million or (-1.5%) of revenue compared to (-$8.736) billion or (-238.6%) of revenue in the same period last year due to a non-cash goodwill impairment charge of $8.793 billion
Adjusted net income was (-$124) million or (-3.8%) of revenue compared to $98 million or 2.7% of revenue in the same period last year

EPS

Lumen is expected to remain unprofitable on a GAAP and adjusted EPS basis due to its interest expense burden.

Q2 GAAP EPS improved to ($0.05) from ($8.88) last year and beat estimates of ($0.11). Adjusted EPS fell from $0.10 last year to ($0.13) and missed estimates of ($0.04)
Analysts expect adjusted EPS to grow 4.6% YoY to ($0.09) in Q3 and to ($0.06) in Q4
Analysts expect 2024 adjusted EPS to decline from $0.20 in 2023 to ($0.32)

Cash Flow and Balance Sheet

One of the primary risks to Lumen has been its high debt load, with debt of $18.6 billion, for a debt-to-equity ratio of 39.9x.

With the company guiding for free cash flow guide of $1.0 billion to $1.2 billion for FY’24, liquidity is not much of a near-term concern.

The management guide for FY’24 FCF is in the range of $1.0 to $1.2 billion, significantly improved from their previous guide of $100 to $300 million issued in Q1.

Operating cash flow was $511 million or 15.6% of revenue compared to (-$100) million or (-2.7%) of revenue in the same period last year
Adjusted free cash outflow was (-$156) million or (-4.8%) of revenue compared to (-$896) million or (-24.5%) of revenue last year
Capex was $753 million compared to $796 million in the same period last year. The management guide for FY’24 capex is in the range of $3.1 to $3.3 billion, up from their previous guide of $2.7 to $2.9 billion issued in Q1

Valuation

Risks

Technical Analysis

Conclusion

The I/O Fund has no plans to enter Lumen at this time.

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Micron Q4: Data Center Drives Beat, Profitability Soars

Posted on September 26, 2024June 30, 2026 by io-fund

Micron beat estimates on the top and bottom line in Q4, driven by strength in data center DRAM/HBM and a record for NAND. In addition, the company’s Q1 guide far exceeded consensus estimates. Margins expanded sequentially primarily due to HBM and operating cash flow also saw significant sequential growth (whereas free cash flow was much lower due to higher capex).

The report looks to have eased concerns as there were quite a few analyst downgrades following the conferences held in August. We were net buyers in September of Micron, and so we are pleased to see the air cleared on this stock. Analysts had downgraded (and even double downgraded) the stock on comments that bit shipments would be flat to slightly up. The report revealed that despite flat DRAM bit shipments, prices increased in the mid-teens for DRAM, leading to the beat. For NAND, bit shipments increased in the high single-digit percentage and prices increased in the high single-digit percentage range.

Management said they “forecast record revenue in fiscal Q1 and a substantial revenue record with significantly improved profitability in fiscal 2025.” Driven by strong HBM demand, management added that its “mix of data center revenue reached a record level in fiscal 2024, and we expect will grow significantly from here in fiscal 2025.”

Revenue

Micron reported revenue growth of 93% YoY to $7.75 billion in Q4, closing out FY24 with nearly 62% YoY growth to $25.1 billion in revenue. FY24’s recovery was broad-based, with DRAM and NAND both reporting substantial YoY increases.

DRAM revenue increased 14% QoQ to $5.3 billion in Q4, representing 69% of total revenue. For FY24, DRAM revenue totaled $17.6 billion, increasing 60% YoY.
NAND revenue rose 15% QoQ to a record $2.4 billion in Q4, representing 31% of total revenue. For FY24, NAND revenue was $7.2 billion, increasing 72% YoY.

For Q1, management guided for revenue growth of nearly 84% YoY to $8.7 billion at midpoint, easily surpassing the $8.2 billion consensus estimate. Q1’s guide still points to a 900 bp QoQ deceleration with Q4 remaining Micron’s peak growth quarter.

Current estimates for FY25 revenue sit at $37.6 billion for 50% YoY growth, though it’s likely that this gets revised higher in the coming days based on the size of Q1’s guidance beat.

Margins

Micron topped all of its guided figures for margins in the fourth quarter, with gross, operating and net margin all significantly expanding sequentially. For Q1, this expansion is set to continue, with management guiding for operating margin to expand to the mid to high 20% range.

GAAP gross margin in Q4 was 35.3%, ahead of management’s guide for 33.5% and expanding from 26.9% the prior quarter. Adjusted gross margin was 36.5%, expanding from 28.1% last quarter and (9.1%) in the year ago quarter. Management said that in Q4, “HBM remained accretive to both DRAM and overall company gross margins.”
For Q1, management guided GAAP gross margin of 38.5%, implying another sequential expansion of ~320 bp. Adjusted gross margin was guided at 39.5%, Management emphasized that Q1’s gross margin “is projected to improve sequentially primarily on better pricing and portfolio mix.”
GAAP operating margin in Q4 was 19.6%, up 9 percentage points sequentially, and ahead of management’s guide for 17.8%. Adjusted operating margin was 22.5%, up from 13.8% last quarter and ahead of the guide for 20.5%.
For Q1, management’s guided operating expenses implied a GAAP operating margin of 24.6%, another 5 percentage point sequential increase.

Micron closed out FY24 with significant improvement in both gross and operating margin:

FY24 GAAP gross margin was 22.4%, up more than 31 points from (9.1%) in FY23.
FY24 GAAP operating margin was 5.2%, up more than 42 points from (37%) in FY23.

Net margins also significantly improved due to the increased leverage.

For Q4, net margin was 11.4%, up from 4.9% last quarter as net income rose more than 167% sequentially to $887 million. Adjusted net margin was 17.3%, up from 10.3% last quarter.

EPS

GAAP EPS was $0.79 in Q4, up more than 163% QoQ from $0.30 in Q3 and a substantial improvement from a loss of ($1.31) in the year ago quarter. Adjusted EPS was $1.18, up 90% QoQ from $0.62 in Q3 and again a significant improvement from ($1.01) in the year ago quarter. Management said this was “driven by better pricing and profitability.”

What these numbers reflect is that Micron has officially bottomed on EPS and is firmly returning to positive growth.

Micron guided for sequential growth to continue, expecting Q1’s GAAP EPS to be $1.54, up nearly 95% QoQ. Adjusted EPS was guided at $1.74, well ahead of estimates for $1.59, and it’s likely to push Q2 and Q3 estimates higher as well.

Cash Flows and Balance Sheet

Micron grew operating cash flow by nearly $1 billion QoQ; however, increased capex kept adjusted FCF growth to a minimum.

Q4’s operating cash flow was $3.41 billion, or 44% of revenue, up from $249 million or 6.2% of revenue in the year ago quarter. For FY24, operating cash flow totaled $8.51 billion, increasing more than 445% YoY from $1.56 billion in FY23.

Adjusted FCF in Q4 was just $323 million, or 4.2% of revenue, compared to $425 million in Q3, as Micron spent ~$3.1 billion on capex in the quarter. For FY24, adjusted FCF was minimal, at $386 million, or 1.5% of revenue, though this was a stark contrast to FY23’s adjusted FCF of ($5.44 billion), or (37.1%) of revenue.

It was stated capex would be meaningfully higher in fiscal 2025 at mid-30s percentage range to support “growth in both greenfield fab construction and HBM” investments, as Micron works to build out its fabs in New York and Idaho in FY25 and FY26. Capex totaled $8.1 billion in FY24, but management expects FY25 capex to be “meaningfully higher and at around the mid-30s percentage range of revenue,” suggesting capex easily surpasses $10 billion next year.

The company stated wafer capacity is below peak levels, partly due to an increasing mix of HBM that is reducing DRAM supply for traditional products. The capex spending is needed to continue to supply HBM. There is also a low-capex environment for NAND at the moment, and it was stated this would ultimately lead to healthy NAND supply-demand dynamics.

Inventory was $8.9 billion, or 158 days, and Micron expects to draw down this inventory to support revenue growth in FY25.

Cash, equivalents and investments totaled $9.16 billion, while debt totaled $13.4 billion.

Business Units

Compute and Networking (CNBU) revenue was $3.02 billion, up 14% QoQ and 152% YoY. This was significant growth acceleration, up from 85% YoY in Q3 and 59% YoY in Q2.

Management said that “data center server DRAM achieved a quarterly revenue record in fiscal Q4, driven by strong demand for high-capacity solutions as well as our continued ramp of HBM.” The company expects HBM TAM to grow from $4 billion in CY23 to over $25 billion in CY25. As a percent of overall DRAM, HBM will grow from 1.5% in 2023 to 6% in 2025. Micron reiterated it will be able to capture a similar market share of HBM as it has in DRAM, which was 21.5% of market share in early 2024.

Mobile (MBU) revenue increased 18% QoQ to $1.88 billion, though YoY growth of 55% decelerated from 94% YoY in Q3. Management said the growth was driven by seasonal product launches.

Micron provided a hint as to when investors can expect to see AI PC growth, which looks to be H2 2025: “PC unit volumes remain on track to grow in the low single-digit range for calendar 2024. We expect unit growth to continue in 2025 and accelerate into the second half of calendar 2025 as the PC replacement cycle gathers momentum with the rollout of next-gen AI PCs, end of support for Windows 10 and the launch of Windows 12.”

The timing was repeated again: “So that too plays a factor. And of course, I would just like to remind you that we have pointed out that overall smartphone and PC, unit growth will be occurring in 2025 and of course, increasing penetration of AI phones and second half, that acceleration, that growth will be obviously stronger than the first half.”

On average, PCs require 12GB of DRAM today with AI PCs needing a minimum of 16GB and up to 32 to 64GB of DRAM. We covered this previously here. Micron’s LP series for PCs offer are low-power DRAM modules that provide 60% lower power and up to 70% better performance with 60% space savings.

Mobile devices require 8GB of DRAM whereas AI-powered mobile devices will come with 12GB to 16GB of DRAM.

Storage (SBU) revenue rose 24% QoQ and 127% YoY to $1.68 billion, with the YoY growth rate accelerating from 116% in Q3. Management said the growth was “led by data center SSD, which reached a quarterly revenue record,” while NAND storage reached a record for the full year.

Embedded (EBU) was the only segment to record a sequential decline in Q4, with growth falling (9%) QoQ but rising 36% YoY to $1.17 billion. Management added that the “automotive segment achieved a new fiscal year revenue record for the fourth consecutive year.”

Earnings Call and Addt’l Commentary

The company stated they are upgrading their expectation for calendar 2024 industry DRAM bit demand growth to be in the high-teens percentage range. It was further stated: “In calendar 2025, we expect both DRAM and NAND industry bit demand growth to be around the mid-teens percentage range.”

The company also stated: “We see increasing DRAM and NAND content both in traditional as well as AI servers” and that “our mix of data center revenue reached a record level in fiscal 2024 and we expect will grow significantly from here in fiscal 2025.”

There is a slight slowdown in management’s guide for DRAM for next year, as it’s being stated as growth in the high teens is expected for 2024 while growth in the low teens is expected for 2025. As we noted in our pre-earnings writeup, the slowdown is coming from AI PCs and smartphones.

“At 2024, we have increased the outlook to high teens based on the strength in the data center. And 2025, as we look at it, just keep, in fact — mind two factors: one is we are now comparing it to the higher base of 2024, which has gone to high teens. So that, of course, impacts the percentage of the '25. And second piece is that, as we have noted, that smartphone and PC, which at the end market level are continuing to do fine.

But given for the 3 factors that we have mentioned in our earnings call script that the customers built some inventory. The sell-in is somewhat less than their sellout in terms of memory, and we have said that by spring of 2025, we expect in PCs customer inventory levels to get to healthier levels versus now, and these will continue to improve.”

Another factor is that HBM3e is leading to wafer capacity constraints. It has a 3:1 trade ratio, which which means it takes 3X more wafers to produce HBM3e.

High Bandwidth Memory (HBM)

We’ve covered the importance of HBM for some time now, which you can reference here.

This quarter, Micron started shipments of HBM3e which are 12 high, 36-gigabyte units. These units provide up to 20% lower power consumption and 50% higher DRAM capacity than its competitors’ 8 high, 24 gigabyte solutions. As Micron stated during the call when asked about competitors, the company’s strategy is to provide the best HBM on “planet earth.” Micron will continue to increase its mix of HBM3e 12 in early CY2025.

As GPUs move toward a 1-year road map, so will Micron. HBM4 will be shipping in 2026.

Last quarter, the stock sold off following commentary that Micron’s HBM is contracted 6-8 quarters out. The company reiterated this again, yet it’s clear the exact contract pricing details are not being disclosed. This was evident in the beat in today’s report.

This was an important statement regarding next year’s setup:

“And we are looking at strong momentum, not just with HBM. We have talked about multiple billions of dollars of revenue that we target to generate in our fiscal year 2025 from high-capacity DRAM modules as well as LP memory in data center, so these are all the elements that point to strong demand trends and demand trends driven by AI in data center as well as in smartphone and PCs where more and more content is required in an environment where the leading-edge supply is today tight.

So I think the opportunity is tremendous, and we see healthy demand supply balance and a constructive environment for our financial performance in fiscal 2025. And that's why we say with confidence that we'll deliver a substantial revenue record in fiscal year 2025, the significant improvement in our profitability as well.”

DDR5 SDRAM memory products reduce power consumption while doubling bandwidth. The lower power DRAM is assisted with LP5 solutions that increase speed while lower power requirements. The LPDDR designs were originally designed for mobile yet have been optimized for AI server infrastructure.

Data Center Storage up 300% in One Year

Micron’s strategy for vertical integration of SSDs has resulted in Micron seeing a “quarterly revenue record” of over $1 billion in revenue and data center SSDs in fiscal Q4. The company stated “our fiscal 2024 data center SSD revenues more than tripled from a year ago.”

Conference Commentary

As we covered in our pre-earnings report, conferences in August led to many analysts downgrading Micron. The first question on the call was about the confusion this caused.

Timothy Arcuri UBS Investment Bank

Mark, I guess my first question is, some of the assumptions in guidance. I think you've been saying kind of on the conference circuit that bits would be pretty flat in fiscal Q1 for both DRAM and NAND. Is that what you're still assuming so that most of the increase in the revenue is basically pricing? Is that correct?

Mark Murphy Executive VP & CFO

Tim, what we see now and we had provided a slight update in August, but we now see that DRAM bits, we expect to be up somewhat higher than what we had said before. We had said before they were going to be flat and then we revised that to flat to slightly up, and in this latest guide, we now view DRAM to be up somewhat higher from that. NAND bits, we expect to be sequentially flattish.”

Conclusion:

Micron had a fantastic earnings report and is sitting at an attractive valuation, which cannot be said for many AI stocks right now. The company has been doubted by Wall Street for most of the year, and yet this report easily places Micron as a top choice among AI peers as we head into 2025.

It makes sense Wall Street would doubt Micron in CY2024 as the company had several millions in HBM3 revenue this year, with is low compared to some of the heavyweights. Yet, the AI-related portion of its revenue is not only going to ramp next year, but it’s also accretive to margins. It’s this last piece that is key as AI markets such as custom silicon or AI servers have the opposite effect and weigh on margins. Keep this in mind as we move along.

We are glad to have Micron in our portfolio and are looking forward to building a bigger position in time.

Recommended Reading:

4 Things Investors Must Know About AI

Posted on September 24, 2024June 30, 2026 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.

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

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.

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.

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.

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AI PCs Have Arrived: Shipments Rising, Competition Heating Up

Posted on September 19, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Updated Sep 13, 2024, 06:42am EDTForbesForbes on Updated Sep 13, 2024, 06:42am EDT

Chipmakers Qualcomm, Intel and AMD are working to bring AI-capable PCs to the “mainstream”, delivering powerful neural processing units to PCs for on-computer AI operations. AI PCs are not only a consumer market, rather will also be driven forward by enterprises and developers seeking to upgrade their employee PCs. This being one of the biggest upgrade cycles in PC history, competition has heightened as Q3 comes to a close.

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.” Lenovo executives believe that “AI enables a personalized user experience that, once adopted, will lead to significant productivity gains and foster greater innovation and creativity.” AMD’s executives have explained that they “see AI as the biggest inflection point in PC since the Internet with the ability to deliver unprecedented productivity and usability gains.” Qualcomm’s CEO has said that he believes the AI PC “is as significant as Windows 95. It is changing the experience, delivering groundbreaking AI capabilities, fundamentally changing how we interact with our PCs.”

AI PCs are expected to usher in a new wave of AI underpinned by increased productivity. AI’s trajectory will increase when more people can access AI-powered applications, which in turn, will help AI developers build larger ecosystems. Existing PCs are not yet powerful or efficient enough to run AI at the edge, yet the PCs currently being released with NPUs (neural processing units) will exceed 40 trillion operations per seconds (TOPS) and this will usher forth the performance upgrades needed to make on-device AI a reality for millions of consumers and enterprises.

AI PCs Drive Growth in Q2

AI PCs gained momentum with AI PC shipments doubling sequentially despite low-single digit growth in the broader PC market in Q2. Further growth is expected in the second half of the year as Intel and AMD prepare competing chips to Qualcomm’s Snapdragon X lineup.

Current AI PC projections:

For Q2, PC market growth was estimated in the low-3% range:
Canalys is placing growth at 3.4% YoY
Counterpoint Research seeing 3.1% YoY growth
IDC reporting is reporting 3% YoY growth with its preliminary numbers.
Total shipment figures varied slightly for each group ranging from 62.5 million to 64.9 million, representing QoQ growth of 9.1% for the broader PC market.

AI PCs were a predominant driver of growth sequentially, rising from approximately 7% share in Q1 to 14% share of shipments in Q2. On a unit basis, AI PCs shipments jumped 120% QoQ, from 4.0 million in Q1 to 8.8 million in Q2. For the first half of the year, that puts shipments at around 12.8 million units.

Full year forecast from Canalys projects shipments of 44 million AI PCs in 2024, implying that Q3 and Q4 will combine for 32 million units, or averaging nearly 50% QoQ growth in both quarters. IDC expects AI PC shipments to run closer to 50 million, with Gartner estimating 54.5 million earlier this year, though that would require ~300% growth from 1H to 2H.

Regardless of the exact number, the setup looks strong for H2 growth, although keep in mind, many competitors are competing for market share.

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.

2024 is the Spark for 2025’s Boom

While 2024 is off to a strong start so far for AI PC shipments with Q2 showing triple digit sequential growth, the true growth story for AI PCs will be in 2025. This year is the initial spark for AI PCs to boom in 2025, when they are expected to quickly take significant market share.

AMD CEO Lisa Su cautioned that some investors may have mistakenly expected 2024 to be the big growth year, but that she believes that will instead be 2025. Su said at Goldman Sachs Communacopia and Technology Conference that she believes “we are at the start of a multiyear AI PC cycle. So again, you guys are always trying to go a little bit too fast. So, we never said AI PCs was a big 2024 phenomena. AI PC is a start in 2024. But more importantly, it's the most significant innovation that's come to the PC market in definitely the last 10-plus years.”

Should the broader PC market register growth in the mid-to-high single digit range to ~260 million shipments this year, AI PCs would take 17% share at 44 million units.

For 2025, shipments are forecast to rise more than 134% YoY to 103 million units, at the midpoint. Assuming high single digit growth in total shipments in 2025 to 280 million PCs, AI PCs would take close to 40% share at the midpoint of 106 million shipments forecasted.

Source: Gartner/IDC/Canalys

Longer-term, growth is expected to remain robust. Intel’s executives expect AI PCs to account for more than 50% of the PC market in 2026, and as much as 80% market share by 2028. Canalys sees AI PC shipments top 200 million by 2028, taking up to 70% market share.

Commercial to Drive AI PC Growth

AI PC’s rapid adoption curve will be driven primarily by the commercial market, with AI PCs expected to be a catalyzing force ahead of the upcoming Windows refresh at the end next year.

There is indication the early majority will adopt AI PCs in 2025, and the late majority in 2026, with industry projections matching this narrative. This leaves time for consumers to participate, which so far has been a challenge for AI.

I covered this in the past, stating: “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.” For a deeper dive on AI PCs and industry commentary on the growth potential, refer to AI PC Stocks: Emerging 2024 And 2025 Story (io-fund.com).

AMD’s Su believes that while the industry is only in the “beginning” of the AI PC cycle, “next year, as we think about commercial PCs and commercial refresh cycle, we actually see AI PC as a driver of that commercial refresh cycle.” This is a view shared by IDC, which “believes the commercial market has the biggest short-term upside for AI in the PC industry,” with the consumer side “yet to be told in full.” This is a view shared by Lenovo’s executives, who believe the end of support for Windows 10 in 2025 “will necessitate a migration to Windows 11 for enterprises and commercial users, further driving demand for new PCs.”

Commercial market share of AI PCs is projected to reach almost 60% by 2027, per Canalys. This implies end-market shipments of nearly 100 million, with the remaining 40% share in consumer. Additionally, Gartner forecasts that 100% of commercial (enterprise) PC purchases will be AI PCs by the end of 2026, driven by the productivity gains realized by on-device AI, and as enterprise applications begin to take advantage of AI features. Lenovo also expects that “enterprises may increasingly require AI-enabled PCs to remain competitive.”

Competition is Intensifying

Competition in AI PCs is quickly intensifying, with Qualcomm moving downstream to the $700 and below market with a new Snapdragon chip. The x-86 based competitors, Intel and AMD, see growth opportunities ahead, with Intel forecasting a surge in CPU shipments as it comes off the launch of its Core Ultra 200V (Lunar Lake) chips.

Nvidia and AMD reportedly are lining up powerful Arm-based CPUs to take on Qualcomm after its Arm exclusivity deal expires at the end of 2024. Apple is also rumored to be planning an M4-powered Mac refresh either by the end of this year or early 2025.

The chipmakers 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 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 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, meeting the bill for AI PCs. 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.

Intel’s Shipments Ahead of Expectations, AMD Execs See Share Gains

Though we are on the precipice of going through a major shift to where Arm architecture will compete more directly with x86 architecture for PCs, Arm lost share in both desktops and notebooks in Q2, according to data from Mercury Research.

In notebooks, Arm lost 144 bp market share QoQ to 11.4% share in Q2. AMD’s notebook share rose 121 bp QoQ to 18.0%, while Intel gained 23 bp QoQ to 70.6% share.

In desktops, Arm lost 31 bp QoQ to 5.9% share, AMD also lost 83 bp QoQ to 21.6% share, while Intel’s share rose 113 bp QoQ to 72.5%.

This was reflected in Intel’s Q2 report, where management noted that its Core Ultra (AI PC chip) shipments exceeded expectations in that quarters and “more than doubled sequentially.” Core Ultra shipments have surpassed 15 million since December 2023, with Intel believing that it remains firmly on track to surpass 40 million AI PCs by the end of 2024 and more than 100 million cumulatively by the end of 2025.

Qualcomm has also said that its initial launch of Copilot+ PCs, powered by its Snapdragon lineup, is exceeding internal expectations, but management has not shed light on AI PC shipments or revenue. Analysts questioned management over the impact of AI PCs on fiscal Q4’s guide, with management stating that “it's too early to kind of have either a bullish assumption or a specific assumption on PC,” and it is more “about kind of the longer-term growth opportunity, and being very specific on sell-through in the short term is not really something that we have insight into.” Management plans to provide more information on the revenue ramp during its upcoming Investor Day conference.

Qualcomm also mentioned that “20 Copilot+ PCs from Microsoft, Dell, HP, Lenovo, Acer, ASUS and Samsung are now available across 20 countries and 47 retailers.” This is a fraction of what Intel is launching, with Intel saying that “Microsoft has qualified Lunar Lake to power more than 80 new Copilot+ PCs across more than 20 OEMs.”

Similar to its competitors, AMD has been quite bullish regarding the impact of AI PCs on the upcoming refresh cycle, as it eyes a growth opportunity in commercial PCs.

AMD’s Ryzen AI 300 series (featuring the industry’s fastest NPU with 50 TOPS) launched at the end of July to “to strong reviews,” with “more than 100 Ryzen AI 300 series premium, gaming, and commercial platforms on track to launch from Acer, ASUS, HP, Lenovo, and others over the coming quarters.” Management noted that “customer excitement for our new Ryzen processors is very strong, and we are well positioned for ongoing revenue share gains based on the strength of our leadership portfolio and design win momentum.”

This builds on CFO Jean Hu’s prior comments that AMD was “gaining share” in PCs, as CEO Lisa Su sees “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.” AMD’s executives hold the view that the company is “underrepresented” in PCs, “but particularly in the commercial PC side.” Management believes they can do “above-typical seasonality” in the second-half of 2024, based on the timing and strength of its product launches.

Intel’s Margin Troubles and AMD’s Growth

While Qualcomm is bringing a formidable Arm-based competitor to the industry, management has provided little clues to the revenue or margin impacts from AI PCs. Intel is looking to make large strides by prioritizing shipments at the expense of margins (and shareholders), while AMD is posting the strongest YoY growth rates, though comps were still weak in Q2.

Qualcomm’s IoT revenue, which houses its PC segment, has posted YoY revenue declines since fiscal Q2 2023, or six consecutive quarters. IoT revenue in Q3 declined (8%) YoY to $1.36 billion, as the pace of declines slowed, from (32%) YoY in Q1 and (11%) YoY in Q2. Management has not stated the impact of PCs on IoT revenue growth, or its contribution.

Intel reported 9% YoY revenue growth in Client Computing in Q2 to $7.41 billion, decelerating from Q1’s 31% YoY growth. On a dollar basis, growth has declined for two consecutive quarters, falling from $8.84 billion in Q4 to $7.53 billion in Q1 and now $7.41 billion.

Source: Company IR

Notebook revenue declined sequentially for Intel, despite shipping AI PC chips ahead of expectations. Desktop revenue gained sequentially, but not enough to offset the softness in notebook: desktop revenue rose just 2.7% QoQ to $2.53 billion, while notebook slipped (4.3%) QoQ to $4.48 billion.

While Intel is reporting sequential weakness, AMD is seeing growth recover and growth rates remain strong. AMD’s Client segment has registered YoY growth of 42%, 62%, 85%, and 49% respectively, though against weak comps. Revenue in Q2 was just under $1.5 billion, up 9.1% QoQ and reaching the highest level in eight quarters. However, Client revenue is still one-third below its peak levels since in 2022, suffering from the sharp inventory correction that hit the industry.

Source: Company IR

As this growth story unfolds, operating margins will be critical to track for both Intel and AMD. Intel’s margins and profitability took a hit from its decision to prioritize AI PC shipments, and management seems keen on keeping that a priority moving forward, suggesting margins may have not stabilized. For AMD, the Client segment has historically been a significant driver of operating income. For example, in Q2 2022, when revenues were above $2.1 billion, Client’s operating margin was 31%, compared to 6% now – essentially, there’s much more ground to cover on the profitability side versus the growth side.

Conclusion

AI PCs bring x86 and Arm to the battlegrounds, with Qualcomm’s Snapdragon lineup making an attempt at the first major inroad on x86 Windows-based CPUs. Intel and AMD see strong growth ahead for their x86 competitors, though Apple is expected to bring a major upgrade with M4 chips later this year. This is ahead of possible new Arm-based CPUs from Nvidia and AMD next year.

Shipments of AI PCs have only just begun accelerating, with Q2 showing triple-digit sequential growth but penetration rates remain low. AI PC adoption is projected to skyrocket towards 70% share of total PC shipments by 2027, with growth arising predominantly in commercial markets first.

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Optical Interconnects Overview: Strong Growth Expected Ahead

Posted on September 11, 2024June 30, 2026 by io-fund

Generative AI’s spending boom has not only driven increased demand for data centers as hyperscalers work to expand capacity, but also is driving a surge in optic connections. This is due to the heavy data requirements needed to support genAI services and connections needed to link GPUs together in the clusters. Optical transceivers are becoming increasingly important in addressing bandwidth, a primary bottleneck in large-scale data centers, which refers to the speed of data transfer in the data center.

Corning is a centuries-old bellwether for materials such as advanced optics. The management team recently explained in its Q2 earnings call that “traditional data centers contain a network of interconnected switches and CPUs. GenAI requires a second network within data centers to connect every GPU to every other GPU in the cluster, creating a neural network. Now because GPUs have more processing capacity than CPUs, they need higher bandwidth links connecting them. The result is about 10 times the number of fiber [optic] connections in this new network versus a traditional data center.”

We’ve previously discussed memory bandwidth as a primary bottleneck at the GPU level, but scaling from singular GPUs to hyperscale data centers featuring hundreds of thousands of GPUs sees bandwidth arise as a primary bottleneck due to the immense data transfer requirements of AI training and inference.

GenAI to Drive Optical Growth

AI requires interconnected processors, to where thousands or tens of thousands of processors are connected. In turn, connectivity is needed for accelerated compute, which includes an increased number of switches, NICs, ports and also port speed.

For example, Chat-GPT was trained on a 25,000-accelerator cluster with roughly 75,000 optical interconnects. Increasingly powerful AI models, with escalating data and compute demands, are making bandwidth, data speeds and latency critical factors for future data centers to address.

Copper had long been standard for data center interconnects, but it cannot support network speeds of 800 gigabits (800G) to 1.6 terabits (1.6T) over long distances due to substantial signal loss. This isn’t to say copper is dead – Nvidia’s GB200 NVL72 utilized copper over optics (with more than 2 miles of copper cabling in the rack) to reduce power consumption by 20 kw (the system still draws 120kw of power). According to a representative from Marvell’s Cloud Optics division, “optical is the only technology that can give you the bandwidth and reach needed to connect hundreds and thousands and tens of thousands of servers across the whole data center.”

Optical transceivers are crucial in enabling high-speed data transfer, by transmitting and receiving data from optical (light) signals to electrical signals. In data centers, optical interconnects and transceivers are becoming the de facto standard to handle AI workloads, since they can function at significantly higher speeds than copper (currently at 800G+ speeds and moving quickly to 1.6T), with longer range, higher data capacity, and lower latency with minimal signal loss. One drawback, however, is that due to the electronic complexity of optical products, costs are higher as well as power consumption versus copper.

800G transceivers are a driver of growth industry-wide at the moment, with Marvell, Lumentum, Coherent, Mitsubishi Electric, Broadcom, Nvidia and others all shipping 800G transceivers and seeing high growth and demand. Coherent forecast in 2023 that the datacom transceiver market would more than double to $11.4 billion by 2028, with 800G transceivers taking more than 50% market share, up from the mid-teens in 2023, with the majority of that growth arising through 2026.

Source: Coherent

Mitsubishi Electric sees much more market share growth ahead for high-speed transceivers, forecasting the optical transceiver market to nearly triple from just over $4 billion in 2023 to $12 billion by 2029, with 800G and 1.6T transceivers accounting for more than 80% of the market.

Source: Mitsubishi Electric

Other industry forecasts suggest the broader optical transceiver market (including other end markets in industrial and telecom) will nearly double from $13.3 billion in 2024 to $24.7 billion by 2027.

Industry Executives See Strong Growth in Optics

Management teams from companies in the optical transceiver industry remain quite bullish about growth prospects in the future, catalyzed by AI data center demand.

Mitsubishi Electric, which reportedly commands nearly 50% market share in optical transmission devices for data centers, per Bloomberg, is rapidly expanding capacity to meet demand. Mitsubishi is “ramping up production capacity for optical devices to a level 50% above last year’s,” though CEO Masayoshi Takemi said that “won’t be enough to meet the strong level of inquiries we’re getting, [and] we may need double what we’ll have in September.”

Coherent CEO Jim Anderson similarly sees strong growth ahead for transceivers: “one of the most exciting growth opportunities is our optical transceiver technology, which underpins and drives the high-speed connectivity required by new AI data centers.” He added that the company “saw strong sequential growth in our 800G datacom transceiver revenue in Q4 and [is] also seeing increasing orders in backlog for the current and future quarters. We also delivered initial samples of our 1.6T datacom transceivers, which we expect to begin ramping in calendar 2025.”

Barclays analyst Tom O’Malley asked Anderson about the trajectory of the “big growth engine” for Coherent, the ramp of 800G and soon 1.6T transceivers, with Anderson saying that “It's stronger than what I had thought. And we've seen, just over the last, I would say, gosh, four to six weeks as I've spent a lot of time with our top customers across the – across all of our different product lines, but especially in our datacom business, I've gotten a much better sense for the opportunity that's in front of us, and I would say it's a very strong opportunity. And we continue to see demand strengthening, forecast strengthening, billings, backlog.”

Optics has also been a primary growth driver so far this year for Marvell, with electro-optics revenue exceeding expectations in Q2 and expected to grow in each quarter of this fiscal year. To note, Marvell is targeting to exceed its $1.5 billion AI revenue target this year, with optics contributing $1 billion or more of that sum.

Marvell CEO Matt Murphy explained in Q2’s earnings call that “demand has been extremely strong in the AI business, as we mentioned, both in custom and in our optics business. And that's the 800G products as well as traditional cloud, as well as DCI [data center interconnects]. So that's all going extremely well. And for next year, that should absolutely ripple through. We see continued strength next year above what we had communicated relative to the target for next year both in custom and in optics and the broader portfolio. … Demand has been strong. Bookings momentum has been extremely strong.”

Marvell’s management also noted in Q1 that its 800G PAM4 modules are currently the “primary interconnect enabler for state-of-the–art AI deployments,” while qualifications have begun for its 1.6T modules, which it expects will enable the next generation of AI chips. Marvell added in Q2 that “strong bookings continue for our market leading 800G PAM products and 400ZR data center interconnect, or DCI products,” while its 1.6T DSPs (digital signal processors) would begin shipments in Q3.

Marvell has the advantage of scale over its competitors. Per a Marvell spokesperson in June, “every single large language model today runs on compute clusters that are enabled by Marvell’s connectivity silicon.”

Lumentum is expecting the optical opportunity to quickly drive quarterly revenues to $500 million by the end of 2025, up 60% from last quarter’s $308 million, with management saying that transceivers will be the “number one growth area,” with EML chips and optical switching other growth drivers as the company works to rapidly boost transceiver capacity in Thailand. You can access our previous Lumentum deep dive here.

In terms of optics (and/or networking revenue), Marvell likely leads the three, with Coherent close behind. Marvell’s data center optics segment alone contributed more than $1 billion in revenue in fiscal 2024, and in Q2 FY25, optics and networking and switches likely accounted for revenue in the mid-$600 million range, given management’s comments that suggested between $200 million to $250 million stemmed from ASICs and storage. For FY25, Marvell’s optics, networking/switches and enterprise networking revenue could reach approximately $3 billion annualized (~54% of FY25 revenue estimate of $5.54 billion), with more than $1 billion in AI revenue (mgmt’s $1.5 billion AI revenue target has 2/3 coming from optics).

Coherent reported approximately $2.3 billion in networking revenue in the twelve months ending in June, or ~49% of overall revenue; Coherent has not provided an AI revenue target, but noted that datacom revenue rose 16% QoQ and 58% YoY due to AI demand. Lumentum reported $1.08 billion in cloud & networking revenue in FY24 (~80% of revenue), down 18% YoY, with management eyeing AI to drive revenue to a $2 billion-plus run rate by the end of calendar 2025.

Interestingly, it was announced on September 5 that Marvell, Lumentum and Coherent have demonstrated the industry’s first 800G ZR/ZR+ pluggable modules for 500 kilometer data center interconnects (an industry first distance for 800G modules). Utilizing Marvell’s Orion 800G DSPs, modules from the three are now interoperable, allowing regional data centers to take advantage of a multi-vendor solution and minimize vendor lock-in risk by having the ability to link together transceivers from different companies in a cost-effective and power-efficient manner.

Blackwell in Focus

Nvidia’s Blackwell is a force of its own, and with initial shipments expected to begin in Q4 this year (which ends in January), but will ship in volume come Q1 (ending in April), analysts are working to identify which companies will be primary suppliers on the optics side as Blackwell brings an enormous revenue opportunity for Nvidia and its suppliers.

Broadcom was the latest to field questions from analysts about optics tie-ins to Broadcom, though Marvell, Lumentum and Coherent all have been questioned as well – the common denominator is that the management teams are not commenting on individual customer engagements.

Interestingly, a Broadcom announcement from March 2024 noted that “Google and Nvidia will be the first adopters of 200G per lane optics for interconnecting GPUs and TPUs in AI Clusters” as 1.6T shipments begin by the end of the year (aligning with Blackwell). Broadcom also continued its partnerships with Innolight and Eoptolink in optics; this cross-checks with a report from SemiAnalysis on GB200 component suppliers, saying that “while Marvell was 100% share on Nvidia last generation with H100. This generation, Broadcom comes in a big way. We see both Innolight and Eoptolink looking to be adding Broadcom in volume for the DSP.”

Notably, in the most recent earnings report, the CEO stated he was not “directly” in the market of supplying Blackwell, so we will see if Broadcom is downstream or not come next year. Per the CEO of Broadcom: “We’re happy to be part of that ecosystem as I said. But directly, we’re not in that [Blackwell] market as you know.”

Marvell:Marvell:

Question (Atif Malik, Citi): “Curious when are you thinking about the volume adoption of 1.6T and what is holding that if it's not the DSPs. Are the lasers not ready? Or is it just waiting for the Blackwell?”

Answer (CEO Matt Murphy): “I think the way to think about it is just timing relative to the system builds our customers call, schedule their ramp, et cetera. … I remember all these issues in the past, right. There's a green laser problem. There's this problem or that. There's always some issue in this optical space, but this time it's really, everyone's going a million miles an hour trying to get their products ramped. Our module partners are ramping up with our solution. Our end customers that are driving this are going as fast as they can.

So it's just more of a timing issue that we need to intercept the platforms as they're ramping and we're doing that. So think of that as sort of shipments in the back half, but really contributing much more meaningfully next year on the 1.6T transition. But it's definitely underway, and we see a clear path to help enable right, this part of this next generation of accelerators to be able to ship in volume with the latest optical standards. And we're at the forefront and in the lead in that regard. So yes, it will be later this year and then more volume next year and it will — I think be a big product cycle for us.”

Quick Note on CXL: About two years ago, our firm covered Marvell’s CXL memory catalyst. Compute Express Link (CXL) improves how data centers add memory by offering a new switch that offers “cache coherent” memory pooling. Essentially, this means offering a new architecture that boosts memory bandwidth and helps to enable memory pooling through partially-disaggregated racks.

The new fabric required for disaggregated memory from the CPU is based on PAM electro-optics that Marvell specializes in. In July, new CXL memory-expansion controllers were announced called Structera with partners AMD, Intel, Micron and Arm participating in the press release. Custom CXL silicon is expected to sample in the fourth quarter and will represent an expansion to Marvell’s TAM assuming all goes well.

Lumentum:Lumentum:

Question (George Notters, Jefferies): “I'm just curious if you guys have an Nvidia qualification on this 800 gig single mode transceiver?”

Answer (CEO Alan Lowe): “Yes, we're not going to comment on who the customer is, George. I would say that — as I said before, most customers are working with us on products they don't already have. And so, for instance, we are designing 1.6T transceivers, and the performance is quite good. We plan on sampling customers this quarter on 1.6T. So, there's a few leaders that would be consuming that. And so, you can imply what you want from that, but we're not going to speak specifically about any individual customer.”

Coherent:Coherent:

Question (Vivek Arya, Bank of America): “Are you seeing any impact at all, positive or negative, because of changes in Nvidia’s product schedule or does that have no impact?”

Answer (CEO Jim Anderson): “On the first part, on the part that was about the order book, yes, we continue to see the order book strengthen. I think you asked about a particular customer. I can't comment on that particular customer, or really any particular customer. But I can say that in aggregate, we're continuing to see, again, the order book strengthen and demand growing, which is good.”

Margins May Determine the Winners

Given that optics is a fairly fragmented market with four major firms vying for market share in 800G and soon 1.6T transceivers, margins may ultimately determine the winners. This view is shared by Coherent, with management stating that on pricing and gross margins, “in general, what we would usually see in the transceiver market is the newer speed grades like 800G and then soon to be 1.6T generally carry higher gross margins than the older speed grades, right? The older speed grades are usually become commoditized over time.”

Based on Coherent and Mitsubishi Electric’s forecasts, shipment growth in 800G is expected through 2026 before shifting to 1.6T, leaving four to six quarters for these companies to drive shipments and revenues before commoditization potentially occurs with product margins shrinking.

Of the trio, Marvell has the best gross margin profile, at 46.2% last quarter, compared to 32.9% for Coherent and 16.6% for Lumentum. Marvell is expecting gross margin to expand to 47.2% next quarter, while Coherent guided flat QoQ and Lumentum guiding for some sequential improvement in future quarters.

Moving down the line, Coherent is the only one of the three with a positive operating margin, reporting a ~300 bp sequential expansion to a 4.8% margin last quarter. Marvell reported a (7.9%) operating margin, while Lumentum reported a (43.3%) operating margin.

With Marvell’s success likely equally tied to the ramp of ASICs in the coming quarters, and Lumentum deep in the red, Coherent is better positioned with a stronger bottom line profile to be able to withstand pricing competition, should the manufacturers prioritize capacity expansion. In this case, Coherent has leverage to boost market share gains by undercutting on price. Coherent also is showing slightly better sequential growth than Marvell, reporting ~10% QoQ growth in networking revenue to $680 million, while Marvell reported 8% QoQ growth in data center to $881 million (though Marvell is seeing growth arise from ASICs as well); Lumentum, on the other hand, reported an (11%) YoY decline as it struggles with weaker end market demand from telecom.

One primary theme evident in Big Tech’s recent earnings reports was the need for continual investments in AI infrastructure and physical data centers, with management teams positive on the long-term potential of generative AI products and services. Lead Tech Analyst Beth Kindig spoke with Yahoo Finance following Nvidia’s Q2 earnings report last month, saying that Big Tech is “in a race toward preventing extinction,” in that whichever company succeeds in AI first “could completely dominate to a level” to where competitors’ businesses will decline substantially. This is a view shared by Alphabet CEO Sundar Pichai: “the risk of under-investing is dramatically greater than the risk of over-investing.”

We’re seeing clear growth in Big Tech’s capex with no slowdown in sight – Bank of America is estimating that the Big 4 (Microsoft, Meta, Alphabet, and Amazon) will spend a combined total of $700 billion through the end of 2026. While a majority of AI capex is expected to flow to Nvidia and other AI accelerator beneficiaries including AMD and Broadcom, physical data center construction is surging, and outfitting new data centers requires AI server racks, cooling infrastructure, power systems, connectivity and other components. One component subsegment where we’re currently seeing growth arise, with positive forward-looking commentary from executives, is optical transceivers, with Marvell, Lumentum, and Coherent among the leading manufacturers we’re currently tracking.

Big Tech’s AI Spending, Physical Data Center Construction Surging

As we explained in our free newsletter in early August, “Big Tech Battles on AI: Here’s the Winner,” Big Tech’s capex spending is surging. Microsoft, Meta, Alphabet and Amazon committed more than $104 billion in the first half of 2024, up 47% YoY, with the four well on the way to spending more than $210 billion in capex for the year.

Spending is not expected to slow any time soon – UBS expects capex from the four to rise 25% YoY in 2025, well ahead of the current consensus estimates for 10% to 15% YoY growth, as AI demand still outpaces capacity as management teams push AI investments to the forefront.

The weight of four Big Tech CEOs speaking in unison on this topic (risking overinvesting and building AI capacity before it’s needed) 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.

For a deeper understanding of Big Tech’s AI capex spending and outlook, and crucial comments on AI capacity and ROI, read our August newsletter here.here.

Stemming from this prioritization of expanding AI capacity comes a rapid uptick in physical data center construction, along with other signs that data center demand is rapidly increasing.

In North America, data center capacity under construction has soared more than 70% YoY to 3.87 GW through the end of June – for comparison, construction in all of 2023 totaled less than 3.1 GW. Preleased capacity surpassed 3 GW, with Big Tech and GPU renting startups such as CoreWeave accounting for more than 80% of this upcoming capacity.

In addition to this surge in construction activity, data from CBRE points to asking rental rates also rising, driven by tight existing supply and strong demand. Asking rental rates have increased 6.5% to $174 per kw/month this year, following an 18.6% rise in 2023 and a 14.5% increase in 2022. To put it a different way, asking rental rates have jumped 45% since 2021 (as construction began to accelerate), from ~$120 per kw/month to $174 per kw/month.

Building and optimizing these new data centers to meet the increasing performance and efficiency demands of Nvidia’s and AMD’s next-generation GPUs is placing more emphasis on fiber optics and optical transceivers for high-speed and high-capacity data transmission.

The I/O Fund strongly believes investors should look for demand signals for AI, which is why we steered away from best-of-breed software companies where AI revenue was entirely speculative and became a trap for investors, such as MongoDB or Snowflake. Big Tech does not use these software platforms, and therefore, the demand equation had not been solved. Instead, we focused tracking capex as it relates to AI semis and data center buildouts over the past 3 years, and that remains our strategy until we see capex contracts – with optics fitting well within this strategy.

Conclusion

As the industry gears up for Blackwell’s imminent ramp into 2025, we’ll be closely monitoring sequential growth in data center and networking segments, along with management commentary about the growth trajectories in optics as it unfolds. Optical transceivers and interconnects are becoming a key component in AI data centers due to transfer speed and other benefits, with the industry set to more than double over the next few years as data center construction surges along with hyperscaler AI capex.

Our Advanced members have received technical analysis updates and a possible buy plan for one of these optics stocks, as well as a handful of other AI stocks in explosive growth trends such as AI PCs.

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

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Optical Interconnects Overview: Strong Growth Expected Ahead

Posted on September 11, 2024June 30, 2026 by io-fund

GenAI to Drive Optical Growth

Source: Coherent

Source: Mitsubishi Electric

Other industry forecasts suggest the broader optical transceiver market (including other end markets in industrial and telecom) will nearly double from $13.3 billion in 2024 to $24.7 billion by 2027.

Industry Executives See Strong Growth in Optics

Management teams from companies in the optical transceiver industry remain quite bullish about growth prospects in the future, catalyzed by AI data center demand.

Blackwell in Focus

Marvell:Marvell:

Lumentum:Lumentum:

Question (George Notters, Jefferies): “I'm just curious if you guys have an Nvidia qualification on this 800 gig single mode transceiver?”

Coherent:Coherent:

Question (Vivek Arya, Bank of America): “Are you seeing any impact at all, positive or negative, because of changes in Nvidia’s product schedule or does that have no impact?”

Margins May Determine the Winners

Big Tech’s AI Spending, Physical Data Center Construction Surging

For a deeper understanding of Big Tech’s AI capex spending and outlook, and crucial comments on AI capacity and ROI, read our August newsletter here.here.

Stemming from this prioritization of expanding AI capacity comes a rapid uptick in physical data center construction, along with other signs that data center demand is rapidly increasing.

Conclusion

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

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Broadcom Fiscal Q3: AI Revenue Outlook Raised, but Valuation is Stretched

Posted on September 6, 2024June 30, 2026 by io-fund

Broadcom boosted AI revenue outlook for the year from $11 billion to $12 billion. Based on the forecasted $51.5 billion in revenue in fiscal 2024, AI is expected to contribute more than 23% of Broadcom’s revenue this year.

During the CEO’s opening remarks, more information about Q3’s AI revenue and Q4’s AI revenue was provided: “AI demand remains strong and we expect, in Q4, AI revenue to grow sequentially 10% to over $3.5 billion. This will translate to AI revenue of $12 billion for fiscal '24, up from our prior guidance of over $11 billion.” The issue is that AI revenue was flat QoQ compared to being up 35% QoQ last quarter.

Overall, Q3 did beat yet Q4’s guide was a bit light, with Broadcom forecasting revenue of $14 billion next quarter versus consensus for $14.04 billion. Semiconductor solutions revenue growth also missed growth forecasts with YoY growth of 5%, while estimates from Oppenheimer expected 7% growth.

The stock is priced to perfection, and we do not think this earnings report is not enough to sustain the valuation. We discuss this and more below.

Revenue

Broadcom beat Q3’s revenue estimates marginally and was one percent ahead of consensus estimates, compared to a nearly 4% beat last quarter. Q4 was also guided slightly below analyst estimates.

Q3 revenue was $13.07 billion for YoY growth of 47.3%, accelerating 430 bp from 43% YoY growth in Q2. Excluding VMWare’s contribution, YoY growth was 4%.
For Q4, management guided for $14 billion in revenue, for YoY growth of 50.6%, marking another 330 bp acceleration, but short of the 51% growth estimate from analysts.

For FY24, management did not provide an updated revenue guide, with the previous guidance provided of $51 billion. However, given Q4’s guide, revenue for FY24 is projected to be $51.5 billion.

As probably the most-closely watched (and most anticipated) figure, AI revenue for FQ3 was $3.1 billion, flat QoQ. Through Q3, AI revenue totaled $8.5 billion. For fiscal 2024, Broadcom increased its AI revenue outlook to $12 billion, a 20% increase from $10 billion in Q1 and another $1 billion increase from last quarter’s view for $11 billion. The increased outlook is driven by strong growth for Ethernet and ASICs, and implies Q4 AI revenue of $3.5 billion, up nearly 13% QoQ.

The issue that remains is, will this AI revenue be enough to justify the valuation (in the near term)?

Key Segments

Semiconductor solutions revenue was $7.27 billion, increasing 5% YoY and 1% QoQ. This was a 100 bp deceleration from 6% YoY growth last quarter, while also falling short of estimates, with some analysts expecting growth of ~7% YoY and 2% QoQ.

Networking grew 43% YoY to $4 billion. Ethernet switching, driven by Tomahawk 5 and Jericho3-AI grew over 4x year-on-year. We’ve covered these products here. Within networking, lasers and dies used in optical interconnects grew 3X, PCI Express switches grew 2X and Broadcom is shipping 5nm 400GB NICs and 800GB DSPs.
The CEO stated non-AI networking bottomed in Q2 and was up 17% QoQ yet down (-41%) YoY
The CEO stated custom AI accelerators grew 3.5X year-over-year. Notably, we did not get a QoQ number which is where the weak metric was at $3.1B AI revenue flat QoQ.

Infrastructure solutions revenue was $5.80 billion, accelerating to 200% YoY growth from 175% YoY in the prior quarter. The segment was up 9.7% QoQ and this segment also grew QoQ last quarter, which helps to illustrate the acceleration from VMWare.

VMWare contributed $3.8 billion with the acquisition helping to drive the strong YoY growth.
VMWare’s annualized booking value (ABV) was up 32% QoQ to $2.5 billion, and is shaping up to be a major piece to Broadcom’s story. You can read more about this here. Two quarters ago, the ABV for VMWare was $1.2 billion, proving there has been a sudden acceleration underway. The VMWare segment is expected to be quite profitable, achieving adjusted EBITDA of $8.5 billion by next fiscal year. During the Q&A portion, it was discussed the overall software margin will remain between 80% and 90%.

Aligned with the commentary that the non-AI segments have bottomed (with the exception of Broadband), the remaining revenue segments reported QoQ growth despite being down double digits YoY.

Server storage connectivity revenue was $861 million, up 5% QoQ yet down (-25%) YoY. Server storage is expected to grow QoQ yet will be down YoY
Wireless revenue of $1.7 billion grew 1% YoY and is expected to grow 20% QoQ next quarter.
Broadband revenue declined 49% YoY and is expected to bottom in the beginning of 2025.

On the call, an analyst asked if these segments will return to prior levels, to which the CEO stated they would and he cited bookings as an indication the bottom is likely behind them.

Hock Tan:

“As you all know, we've gone through your typical down cycle of semiconductors. And I'm referring particularly to non-AI, and we have talked about that before many times. We've gone through a down cycle as the ecosystem, as many of our customers, but the broad ecosystems, work on an adjustment in inventory levels in all stages in the supply chain. And we're not immune from it, obviously as we try to insulate ourselves from it as much as possible. We've gone through it. And the signs on the indications we have seen very clearly is we have, in fact, passed through the bottom. The best indicator is the bookings we are receiving. In non-AI, our bookings in Q3 of non-AI semiconductor demand is up 20%. And so that tells us we are well on the way to recovery.”

Margins

As outlined in our pre-earnings analysis, the VMWare merger integration has weighed on margins so far in fiscal 2024, though Q3 showed more positive signs on margin recoveries. Adjusted margins strengthened sequentially across the board, with larger growth visible down the line.

Gross margin was 63.9% in Q3, down from 69.5% in the year ago quarter but up from 62.3% in Q2. Adjusted gross margin was 77.4%, up from 75.1% last year and 76.2% last quarter.
Operating margin was 29.0% in Q3, up from 23.7% last quarter and a remarkable increase from 17.3% in Q1; however, Q3’s margin remained much lower on a YoY basis, down from 43.4% last year. Adjusted operating margin was 60.8%, up from 57.2% last quarter but decreasing from 62.4% last year.
Net margin was (14.4%) for Q3, due to a one-time non-cash tax provision of $4.5 billion in the quarter. Adjusted net margin was 46.8%, up from 43.2% last quarter but down from 51.8% last year.

Regarding the tax liability, there was a question in the Q&A session if it was related to selling assets, to which the CFO responded that it was not due to a sale of assets, rather: “It's just we relocated the IP and that caused the $4 billion charge. The offset to that is a deferred tax liability. So think of that as noncash, very little cash impact to that.”

EPS

GAAP EPS was ($0.40), not comparable to estimates for $0.55 due to the $4.5 billion tax provision in the quarter. Adjusted EPS was $1.24, beating estimates by $0.04, and representing YoY growth of 18% and QoQ growth of nearly 13%.

Adjusted EPS growth is currently estimated to accelerate to nearly 24% YoY in Q4, and to the low-30% range for the first half of fiscal 2025. Given the sequential rebound in margins (partially due to better controlled costs at VMWare) and adjusted EPS beat in Q3, these growth projects may get revised higher in the coming days.

Q3’s adjusted EBITDA was 62.9%, with growth of 42% YoY to $8.22 billion. This was a solid improvement from 59.5% in Q2. Management guided for a 64% adjusted EBITDA margin in Q4, with the sequential improvement being driven by the integration of VMWare as Broadcom charts a path to pre-acquisition EBITDA margins.

Cash Flows and Balance Sheet

Cash flows and cash flow margins improved sequentially, while total debt took a step lower this quarter.

Operating cash flow was $4.96 billion, increasing more than 5% YoY and 8% QoQ. Operating cash flow margin as 38.0%, improving from 36.7% last quarter, though this is lower than pre-acquisition margins of 53.2% in the year ago quarter.
Free cash flow was $4.79 billion, rising more than 4% YoY and nearly 8% QoQ. Free cash flow margin was 36.7%, increasing from 35.6% last quarter but also lower than the 51.8% margin in the year ago quarter.
Cash, equivalents and investments totaled $9.95 billion.
Total debt was $69.96 billion at the end of Q3, down from $74.02 billion in Q2, with Broadcom repaying more than $9.2 billion of debt in the quarter, offset by nearly $5 billion in proceeds from long-term borrowings.

Valuation:

Broadcom is priced for perfection at 32 forward PE Ratio and 14 forward PS Ratio. We’ve covered semis since 2018 and a quality semiconductor stock rarely trades at these levels, it’s normally in the 6-8 forward PS range.

The 3-year median is only available on current PE Ratio, but I have a 3-year PE ratio of 28.5 compared to the current PE ratio of 65.8. The 5-year median is at 39.5.

Earnings Call:

Analysts asked in various ways what growth rate they could expect on AI revenue moving forward, but to no avail on any specific numbers. Here was the first question on the call:

Question
Vivek Arya (Analysts)

Just a clarification, Hock, and then the question. So I think AI revenue roughly $3.1-ish billion in Q3, flattish sequentially. What was the mix in terms of compute versus networking? And the $3.5 billion for Q4, what do you see of that mix? And then as we get into fiscal '25, I realize you're not guiding overall AI, but just how is your general kind of confidence and visibility? Do you think that Broadcom can kind of grow in line or better than the overall AI silicon industry in fiscal '25?

Answer
Kirsten Spears (Executives)

Yes. Well, as we indicated in the last earnings call, for this past quarter, I think we're talking about 2/3 in compute and 1/3 in networking. And we kind of expect Q4 to run the similar trend. And to answer your second part, no, we don't guide yet for fiscal '25, but we do expect fiscal '25 to continue to be strong, to show strong growth on our AI revenue.

-End Quote

There was a more tempered tone in terms of timing. For example, when asked where custom silicon is in the adoption curve, it was stated it will take some time.

Question
Edward Snyder (Analysts)

Right. That basically suggests that you're on the early part of your curve where I'm not trying to call the GPUs whatever, but you could be getting to something closer to the peak of the GPU market just because everything, right, beside the cost expense and as you're spending all this money and you're paying all this money for power, the ASICs become more and more attractive. So the curves are going to look different, right?

Answer
Hock Tan (Executives)

It's an accelerating curve. It may take longer than we all want it to happen but definitely accelerating because the size of the demand from those hyperscalers will totally rival that in the enterprise.

-End Quote

Conclusion:

Given AI growth has plateaued this quarter from its rapid growth, there will likely be a re-rating of Broadcom’s valuation sometime in the next 1-2 quarters. Our goal is to trim this position and buy back at lower levels. This strategy requires remaining steadfast to the bigger picture as this company is setting up to be a clear winner over the next decade. We want to do our best at actively managing the position while not losing sight of the bigger picture. With that said, valuation is a common pitfall for tech investors, who grow complacent with their positions. Our firm works to avoid valuation traps, and thus we plan to follow our disciplined process, which is to actively manage stocks that are richly valued.

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

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