Credo Stock: Benefits From The Rising Demand For Faster Data Connectivity (CRDO) (2024)

Credo Stock: Benefits From The Rising Demand For Faster Data Connectivity (CRDO) (1)

Summary

I am positive about Credo Technology Group Holding (NASDAQ:CRDO). My summarized thesis is that CRDO will continue to benefit from the increasing demand for faster data transmission as the world becomes more digitalized and adopts more AI applications. Its ability to innovate and roll out industry-leading products well positions it to stay competitive and win share from legacy technologies.

Company overview

CRDO designs and sells high-performance, low-power products and intellectual property. The crown jewel of the CRDO product portfolio is the patented SerDes IP (Serialize/Deserialize IP) that determines how to effectively transform and transmit data at a high speed across a wired connection (also known as the Ethernet) and, conversely, how to translate and convert the signal back into its original form so the data can be used. CRDO primarily monetizes its SerDes IP through licensing agreements and the sale of the company’s own line of high-speed connectivity products currently targeted at data centers.

Long-term tailwind

CRDO comprehensive Ethernet connectivity products (line card solutions, optical DSPs, active electrical cables [AEC], etc.) enable high-speed data transmission and are found in all layers of modern data centers, and as such, CRDO provides investors with direct exposure to the growing demand for data. Per IDC estimates, the world is set to see strong growth in this aspect, touching as much as 175 zettabytes by 2025 (while this data might be dated, the point is the growth is strong). The driving force behind this massive growth is the digitalization of business models. Which has resulted in a massive surge in data generated and consumed from cloud, streaming, and more recently, AI and ML applications. Given this paradigm, I see the demand for even greater Ethernet transmission speeds increasing.

Given that continued improvement in SerDes transmission architectures plays a major part in facilitating this increase, it is a massive long-term tailwind for CRDO as it has consistently rolled out leading technology to the industry, which has enabled it to gain industry traction, and I see this ability to innovate as a strong advantage. For instance, CRDO was the first to demonstrate 28G SerDes on 16FinFET Plus Technology in 2015; 7nm, 11G PAM4 XSR SerDes technology in 2019; introduce industry-leading 40GBPS PAM3 SerDes Tech in 2022; and recently, launched the 112G PAM4 SerDes IP for TSMC N3 process technology.

AI is a growth accelerator

I see the growing adoption of AI as a big growth accelerator for CRDO (AI business is roughly 75% of total revenue in 4Q24) as it drives up the need for faster data transmission and more power consumption.

Both of these have a big positive impact on demand for optical DSPs, and I expect CRDO to benefit greatly from this because of its LRO designs with its leading 800G solution, which are structurally better than traditional 800G solutions in terms of power reduction. Underlying this superiority is the structural advantage of a LRO (Linear Receive Optics) architecture vs. the conventional LPO (Linear Pluggable Optics) architecture, and as per management (in the 4Q24 earnings call), LRO is the only way to achieve a sub-10 watt 800G module that meets existing industry optical standards and allows for multi-vendor interoperability. As the world shifts towards higher optical modules, the importance of optimizing power consumption will only get more important as they consume more power, which will be a major growth tailwind for CRDO.

In fact, one hyperscale provider said, the so-called linear pluggable optics, LPO sets the industry back to the Stone Age because there's no telemetry, no diagnostic, no interop, and so on and so forth, okay. Marvell Technology Inc Accelerated Infrastructure for the AI Era webcast

On this end, so far, there has been very good progress, as CRDO has already delivered samples of this sub-10 watt 800G module to its first hyperscaler potential customer, and it has also begun multiple new optical DSP design engagements with leading optical manufacturers, both with its new LRO DSP and traditional full DSP solutions. Given all these visible tailwinds and execution so far, I am expecting the optical DSP segment to become a major growth driver over time.

AEC demand traction and execution remains positive

CRDO has executed very well in its AEC product segment. Over the past year, they have ramped up production for its second hyperscaler customer, qualified for a third hyperscaler customer, and expanded AEC engagements with customers.

One notable aspect is that CRDO is seeing strong demand for customization, and is already developing >20 custom SKUs. Given that such customization requires multiple back-and-forth meetings, close follow-up from each party, and trust that CRDO can deliver the required technology, I think the CRDO relationship with hyperscalers is getting stickier (which is good for future up-and-cross-sell opportunities). Looking ahead, CRDO should also benefit from more parallel computing, which drives up the density in the number of AEC connections per GPU. CRDO is already on track, with developing a product to fit this (which will increase the number of AEC connections to more than 8 per GPU).

Valuation

Credo Stock: Benefits From The Rising Demand For Faster Data Connectivity (CRDO) (2)

My target price of ~$37 is based on FY26 revenue of $465 million and a 12x forward revenue multiple. I think the growth tailwinds are clear and visible for CRDO in the coming years, and the 4Q24 performance of 89% growth should be a convincing data point that the slowdown seen in the early parts of FY24 was a temporary one (not structural). Assuming the same level of sequential growth acceleration in FY24 for FY25, I modeled CRDO to see 61% growth in FY25, followed by 50% growth in FY26 (following the same step-down seen in FY22 to FY23). 60% growth is not an implausible figure (consensus also expects ~60% growth), as 4Q24 grew 89% and management guidance for 1Q25 represents ~70% y/y growth, which historically has been the weakest quarter of the year (excluding FY23). The ramp-up of product for CRDO’s third hyperscaler customer further supports the plausibility of this growth assumption. The lack of profitability compared to peers such as Cadence Design (CDNS) (35% EBTIDA margin) and Synopsys (SNPS) (30% EBITDA margin) is preventing CRDO from trading above peers’ levels (CDNS at 18x and SNPS at 14x), despite a higher growth outlook. Hence, I believe CRDO will remain trading at this level until the gap closes

Investment Risk

While I expect CRDO to expand its customer base (it recently added its third hyperscaler customer), I worry that the company's short-term performance could be severely affected by the demand levels from its concentrated base of customers. For reference, in 4Q24, CRDO had 4 customers with >10% revenue contribution. Also, in FY24, the top 3 customers accounted for 61% of total revenue.

Conclusion

I am giving CRDO a buy rating as I see strong tailwinds ahead for CRDO. Specifically, I expect increasing demand for faster data transmission, driven by the growing digitalization of businesses and adoption of AI applications. CRDO's ability to consistently develop leading SerDes technology positions it well to capitalize on this growth. Notably, CRDO's focus on LRO architecture should allow it to benefit from the industry's increased focus on optimizing power consumption. That said, customer concentration is a risk, and investors should size their position properly as quarterly performance may be volatile.

Eleceed Capital

I'm a passionate investor with a strong foundation in fundamental analysis and a keen eye for identifying undervalued companies with long-term growth potential. My investment approach is a blend of value investing principles and a focus on long-term growth. I believe in buying quality companies at a discount to their intrinsic value and holding them for the long haul, allowing them to compound their earnings and shareholder returns.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Credo Stock: Benefits From The Rising Demand For Faster Data Connectivity (CRDO) (2024)
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