Why is this data center SPAC up 770%?
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Vertiv stock has seen immense popularity lately as the second-best performing SPAC to hit the market. That surprised us because most SPACs we’ve covered have lost over half their value, with many going bankrupt or delisting. What makes Vertiv different? According to the company, they’re a leader in thermal management solutions for data centers, a market that is expected to grow at a compound annual growth rate of 40% over the next 3 years. Today, we’ll see if Vertiv’s rapid rise in price is justified, or if it’s all hype.
Data-center stock Vertiv, an ex-SPAC, is up 670% over the past two years. Now when a stock moves upwards that quickly it’s not a good thing. That’s because intrinsic value doesn’t change so quickly. Now there are some exceptions to that rule like NVIDIA where the fundamentals justify the appreciation and that’s what we want to look at today. Is Vertiv an exception to the rule? Is the stock fairly valued or overvalued? We’re going to answer those questions today and look at why investors are so excited about Vertiv stock.
About SPACs
So Vertiv happens to be a SPAC and nearly all SPACs debuted at $10 a share so that makes it very easy to calculate performance. Now you need to watch out for reverse splits. For example, Desktop Metal has actually lost their shareholders 95% over the years versus the 50% loss that it seems to be today, based on the price. Same thing with Spire. So whilst it may look like $14 a share represents a 40% gain, they’ve actually lost 82% since their SPAC because of a reverse stock split.
So most SPACs have lost investors a great deal of money. We’ve covered over a 100 SPACs and at least half of those have lost half their value or more. So these are typically firms that had no business going public and frankly, when we come across a SPAC, it’s a sign that we need to dig very deeply for red flags.
VRT Stock Performance
Now when we look at returns for Vertiv, 5-year return of 670% versus NASDAQ at 108%, that’s certainly a lot of outperformance.
But if we isolate that down to the past several years, we can see that 670% gain over two years versus a NASDAQ gain at 40% is quite remarkable.
So what we can then do is look at the fundamentals and you see here that whilst revenues have been growing, they certainly haven’t been growing fast enough to justify this rapid share price appreciation. So we can break those out. You see here at a quarterly basis, there’s some cyclicality around what it appears to be the fourth quarter of the year and the quarter afterwards, seems to be less.
You can see that here with their last quarter results. Now when it comes to annual revenues on the right there you can see, well, you’re selling lots of stuff then it shouldn’t be unreasonable to expect 20% growth. Here you can see starting in 2021, they started realizing double-digit growth and then this year, oddly enough, they’re only expecting 12% growth. That seems rather odd.
Vertiv: Metrics to Watch
So as we discussed in our recent piece on AI hype, excessive valuations are just fine as long as the fundamentals are there and for Vertiv, fundamentals- one key fundamental would be Revenue growth. Now other things we want to look at.
What are their gross margins? Like so, for 2023, they saw gross margins of 35%. There’s nothing that great about that. Pretty much expected for a hardware company. What you’d like to see is that they supplement Hardware Sales with Software sales which will help boost those margins. Now when it comes to survivability, we’re interested to know: are they generating positive operating cash flows and indeed they are. So $900 Million last year, the same expected for this year. In regards to debt, they have about $3 billion in debt which seems manageable given their positive operating cash flows.
So one thing we want to look at, as I said, is this Hardware only. That’s problematic. If you’re only selling hardware and then the music stops. Solar companies are a great example of what happens when sales subside and you’re left with a whole bunch of manufacturing that’s dragging on your business. Services for Vertiv were 23% of total revenues in 2023, though that’s rather problematic and we’re going to take a look at that.
Now what does revenue segmentation look like? And what we found is that it’s very difficult to figure out the thermal management exposure you’re getting from this company which happens to be a lot of the appeal. And that stems from this piece that we did on data center stocks.
Vertiv’s Leadership Position
And we looked at some estimates here from Spear Invest on outside the rack, total addressable market for data centers.
You see thermal management, they’re expected to grow significantly from last year until 2027, a 20 billion opportunity. Well, Vertiv happens to be a leader in thermal management and you see the chart on the left there showing their competitors.
If we go back to Vertiv’s original SPAC deck, first of all, this is a very large company. They have more than 20,000 employees now, 19 manufacturing sites across the globe. So they’re enjoying quite a bit of geographic diversification, as you can see there in the center.
On the left, their portfolio breakdown. Back then it was 20% thermal management and 70% of sales to Data Centers, all right. If you’re interested in what this company does, I think this slide, again from back in 2019, shows exactly what they offer for data centers. you can see that thermal management, they’re accounting for 20% of revenues.Â
What’s appealing here is their Market position, so enjoying a number one or number two position in whatever you’re doing is great because it allows you to out-compete. Now their most recent investor deck throws up this slide here talking about how they’re uniquely positioned to lead the rapidly developing Thermal Evolution.
Indeed, if they’re number one in data center thermal management then that makes sense. However, it’s very difficult to figure out just how much revenue is coming from this particular niche.
Unpacking the Short Report
And one thing we noted is that there are several short reports on this company which should be taken with a grain of salt. But they’re likely to contain any red flags that need flushing out.
This really does a lot of heavy lifting for bulls who should be most critical of the stocks they’re holding that they’re most bullish about. So a recent short commentator said a number of things I think were interesting.
They said the non-AI segments aren’t growing very much for Vertiv and that the portion of non-AI accounts for two-thirds of their sales. Now I’m not sure how they were able to extrapolate that based on the segmentation that the company provides. But it was an interesting statement. They say, as a result, VRT’s growth is capped. Well, growth stalling, expected to slow this year, isn’t very good if you’re selling into a TAM that’s growing at, what, 40% a year for the next four years.
Now they said Vertiv is very expensive, though that could be argued differently if you look at what we use – a simple valuation ratio. We’re going to take a look at that. And they say that while the long-term picture of liquid cooling is constructive for data centers, that- everybody seems to agree on that, they say there’s uncertainty in how that’s going to play out and that expectations for Vertiv are very high.
Again we’re very interested in Recurring Revenue. So what we can do is dig into this company’s financials and this chart tells us a lot.
First of all, it shows the geographic diversification. By the way, they actually have margins broken out for the different geographies which I thought was useful. But look at how they categorize revenues along the top there. So Critical Infrastructure and Solutions, Services and Spares, and Integrated Rack Solutions.
So the first and third of those segments both contain thermal management so we’re not able to tell what percentage of revenues come from that. But what’s of more interest here is this table that shows timing of Revenue Recognition.
Now look here. So they say products and services transferred at a point in time. So that assumes Hardware but not necessarily the case. Transferred over time, the second entry there, implies recurring revenues, right? And that numberers slightly over Services and Spares which would imply that Services would be transferred over time. But look at this below statement, it’s rather confusing: “the company recognizes revenue for software applications at a point in time.” That’s counterintuitive. Software is typically transferred over time, software as a service solutions, and they say, “whilst monitoring services are recognized over time.”
All right, well, what they need to do is clearly define their ARR and spell that out and that would help improve or justify their valuations. Annualized Recurring Revenues are what we look for that would help sustain this business when the demand for Data Center Hardware inevitably subsides.
Valuing VRT Stock
Now speaking of valuations, here we’ve simply taken the market cap of this company and divided it by annualized revenues, over various points in time, and what you can see here is that just based on what’s found in our catalog, this company wouldn’t be considered overvalued.
So the average simple valuation ratio in our catalog is around six and you can see for Veriv, that’s just floating under five. So whilst the valuation seems to have increased dramatically over the past year, it still isn’t something that would be excessively overvalued. Now one shouldn’t expect the valuation to be enjoying a premium when growth is expected to be stalling this year.
But I found that interesting because I would have thought that with such a rapid appreciation in share price that the valuation would be a lot higher. But again, there is no free lunch and those who want to argue that Mr Market just hasn’t realized the tremendous value at stake here, that’s really not how the financial world works.
Conclusion
Just some concluding thoughts here. Invest in companies, not stocks. And Vertiv needs to show cooling as a segment so investors can see what growth is happening.
Their current Revenue segmentation buckets aren’t very useful. We’re not convinced they are viable recurring revenue streams here, at least the company isn’t spelling that out. And with growth slowing even after a cooling acquisition they made late last year, that doesn’t seem very promising. The stock price run-up, while not excessively valued, reeks of hype.
Now if you’re looking for other stocks to invest in, to play the growth of data centers, so we did this recent piece looking at 37 different stocks, one of them being Vertiv. Give that a watch. Please make sure to check out our premium subscription offering there’s a link in the comment section for that. Thanks so much for taking the time to watch this today.
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