This AI Data Center Startup Stock Is Hot, But Is It Really A Buy? | The motley fool

Hype surrounding AI is heating up, sparked by generative artificial intelligence (AI) app ChatGPT in late 2022 and cemented by booming sales Nvidia is enjoying for its leading semiconductor systems.

The jury is still out on whether this hype is a bubble waiting to crash and burn or simply a media frenzy overlaying real economic and trade growth that will normalize at some point. Given that AI systems have been around for decades and are already pervasive, I believe this is more of a temporary hype than a bubble.

However, that doesn’t mean stock market pockets haven’t reached ridiculous heights. Starting the AI ​​data center Applied digital (APLD 1.81%) it is an emblematic case.

Applied Digital was one of the rare 2022 initial public offering (IPO) stocks (more on that in a bit). Shares have tumbled during the bear market, but are up more than 350% so far in 2023. The invocation of the phrase “AI” seems to be working its magic here. But is this stock really a buy?

Building “next-generation data centers” for the future of AI

I hadn’t heard of Applied Digital until earlier this year. Its popularity among some investors has heated up in recent months, along with its share price.

Run a screenshot on “AI” and “best performing stocks” and chances are the name will come up. Or maybe you learned about it thanks to several short reports on Applied Digital that have come out recently.

Either way, Applied Digital claims it “designs, develops, and operates next-generation data centers,” specifically for use in AI. That alone helps explain some of the optimism some feel about this company.

In recent months, Applied Digital has announced two customers for its new “AI cloud services,” operated through its newly formed subsidiary called Sai Computing (announced in May 2023). The first new cloud customer will spend “up to $180 million over a 24-month period.” However, no timeline is provided for that 24-month period. The second client will reportedly spend “up to $460 million over 36 months.”

Applied Digital also announced a couple of partnerships with data center hardware manufacturers Hewlett-Packard EnterpriseAND Supermicrocomputers. Both of these “partnerships” sound a bit more like Applied Digital purchasing equipment from the two vendors, but suffice it to say, details about what’s going on were scarce.

Applied Digital explains in its financial filings that its business model is “colocation,” which is when a data center owner (Applied, in this case) leases space to other companies to install their own servers, usually on a long-term contract. fixed. This is similar to the services that data center developers and operator giants like EquinixAND Trust of digital realitysupply.

A pivot from one hype cycle to another?

This all sounds nice and good, and Applied is seeing an increase in revenue ($14.1 million during the three months ending February 2023, up from just $1 million a year ago). But I have concerns.

APLD Revenue Chart (Quarterly).

YCharts data.

When Applied Digital finally had its IPO in April 2022, it went public under the name “Applied Blockchain”. That’s right: its fleet of three small data centers was initially conceived for the cryptocurrency market that was booming in late 2020 and early 2022 before last year’s bear market hit cryptocurrency prices. By November 2022 (just as a small AI app called ChatGPT was going viral), the company name was changed to Applied Digital to reflect a pivot towards high performance computing (HPC) applications other than cryptocurrency mining.

Additionally, Applied Digital’s management team seems to be somewhat related to the business advisory, wealth management and investment banking firm B Riley Financial. Applied Digital CEO Wes Cummins was the founder and CEO of an investment advisory firm called 272 Financial, which was just acquired by B Riley in 2021. Cummins owns 22% of Applied Digital’s shares.

Nokomis Capital, which Cummins previously worked for, heading up technology investments, owns 3.7% of the shares. Bryant Riley (co-CEO of B. Riley) owns 2.5%, and various branches of B. Riley Financial also own shares.

Pause before you buy

During its latest earnings call, Applied Digital said that once two of its new data centers come online, the company will have enough capacity to host high-performance computing and AI workloads to bring them to an Adjusted EBITDA of $100 million annually (earnings before interest, taxes, depreciation and amortization).

In fact, despite this small stock’s epic rise, it’s only trading with a market cap of around $800 million. It would appear that the shares are trading cheap given the company’s short-term potential. I can see why a lot of investors are getting excited.

However, the ability to house enough data center activity to generate $100 million annually in adjusted EBITDA doesn’t mean the company will, in fact, be generating that much money anytime soon.

In addition to some of the other question marks outlined above (rapid shift from the cryptocurrency market, potential management conflicts of interest), I’m skeptical. I believe most investors would be better off watching this company from the sidelines for now, rather than trying to chase the hot “AI stocks” of the moment.

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