Opinion: AI Boom Needs Vertiv Almost as Much as It Needs Nvidia

(Bloomberg Opinion) -- The artificial intelligence craze has driven Nvidia Corporation to a $2.3 trillion market value from about $360 billion at the beginning of last year, which means the chipmaker is trading at a price that’s 75 times higher than earnings. It is also taking some industrial companies along for the ride with a lot of room to run.

Astute investors figured out that the huge demand for everything AI will require the handling of an unimaginable amount of data that will be stored and processed at data centers. This is where the opportunities for industrials come into play. Every company that supplies something — anything — for data centers is riding the coattails of Nvidia and is being scooped up by investors.

An eclectic number of industrial companies have their fingers in the data center pie — from Caterpillar Inc., which provides generators in case the power goes out, to Trane Technologies, which makes the chillers that cool computer servers. Eaton Corporation makes all kinds of power-supply gear, and American Towers is building the complex data facilities after acquiring CoreSite in late 2021.

Caterpillar is up 24% this year through March, more than double the S&P 500 Index. Eaton jumped 30%, and Trane climbed 23%. That’s solid growth but only a bump compared with the mountain that Nvidia has scaled. That’s because the data center play is only a small portion of these companies. Caterpillar, whose main business is making backhoes and bulldozers, had $67 billion of sales, and diesel generators for data centers is likely a tiny number. American Tower, which is being dragged down by slower investment in 5G wireless deployment, fell more than 8% this year even though CoreSite reported a second year of record data center sales in 2023.

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The takeaway is that the purer the play on data centers, the more Nvidia-like the stock gain. That’s the case for Vertiv Holdings Company, arguably the hottest stock among the industrials that were smart enough (or lucky enough) to be tied to the data center boom. Vertiv, which supplies equipment to data centers, has soared 70% this year, and that’s on top of a 252% gain last year.

The company is trading at 66 times earnings. That’s in the nose-bleed section for an industrial stock and towers over current industrial darlings such as Trane and Eaton, which have price-earnings ratios of 34 and 36 times earnings. This begs the question of whether Vertiv and the data center construction spree have legs. The answers all point to yes.

Related:Modular Data Centers: When They Work, and When They Don't

The first thing to keep in mind is that the explosion of data and the ways to mine it for value are only starting. Dave Cote, the chairman of Vertiv, says the digital age started about three to four decades ago and, if it follows a pattern similar to the industrial age, will likely last at least a century. The gold rush for Graphic Processing Unit chips, or GPUs, has only begun as companies investigate how AI can bolster productivity.

“Everybody’s trying to figure out what exactly does an AI data center look like and how do you use new technologies to cool these AI chips,’’ Cote, who turned around a once-flailing Honeywell International Inc. during his 15-year stint as chief executive officer, said in an interview.

Global data center power needs are expected to double between this year and 2030, according to Wolfe Research. Vertiv set annual sales growth targets of 8% to 11% over five years, which Wolfe says “lean low” and will likely be in the mid-teens. Vertiv’s adjusted operating margins are at 15% now, and the company expects those to rise to 20% or more in the next two to four years.

There are potential pitfalls. A lack of electricity generation from utilities could slow the pace of expansion. The environmentalist and the not-in-my-backyard crowds could push back against the power-gorging facilities.

Still, there are signs the demand will accelerate and favor industrial companies already in the market. The increasing density of the computing power requires new ways, such as liquid cooling, to deal with the heat generated by these GPUs. That creates a significant technological barrier for new entrants. Quantum computing, which is on the cusp of becoming commercially viable, will require even more extreme and exotic cooling. The superconducting quantum computers, the type being built by International Business Machines Corp., operate just above absolute zero (or about 460 degrees below zero Fahrenheit).

Unlike other industries, there’s not a significant threat from a subsidized Chinese competitor to swoop in and gobble up the market for the equipment that keeps the power flowing evenly at data centers. Huawei, the largest Chinese competitor for these data center technologies, is mostly banned from the US and Europe. Vertiv competes with Huawei in African countries and other smaller markets, Cote said.  

There are risks around the execution of the companies themselves. High demand can often put stress on a company. That happened to Vertiv during the pandemic when supply-chain snags delayed customer deliveries and the company fell behind on raising prices to offset inflation. Cote stepped in directly to help correct the problems and admitted during a February 2022 earnings conference call that he was “disappointed and embarrassed” by Vertiv’s  performance. The company now has a new CEO, Giordano Albertazzi, who has put the company back on firm footing, and Cote is now busy  designing an acquisition strategy. For Goldman Sachs, which teamed up with Cote to create a special purpose acquisition company in 2018, Vertiv has already been a hit. The stock started trading at about $10 when the SPAC bought Vertiv from Platinum Equity LLC for $5.3 billion including debt. Vertiv’s stock now trades above $80 and has a market value of more than $30 billion.

The data center trend has long legs, and the digital age is holding up to the 2006 observation by British mathematician Clive Humby that data is the new oil. Data centers are the new refineries for this valuable raw material, and industrial companies can take advantage of that.