AI Data Center Wave And Liquid Cooling Shift Will Pressure Returns

Catalysts

About Lite-On Technology

Lite-On Technology provides power supply, cooling and related systems for cloud data centers, AI infrastructure, IT devices and opto-electronics applications.

What are the underlying business or industry changes driving this perspective?

• The aggressive build out of megawatt scale AI power and cooling solutions concentrates Lite On’s exposure in a single, capital intensive infrastructure wave. Any slowdown in AI data center deployments or a pivot to alternative architectures could leave new Vietnam, Kaohsiung and Texas capacity underutilized, which may pressure revenue growth and depress return on invested capital and operating margins over time.
• The shift toward higher voltage DC architectures at 400 volt and 800 volt and emerging solid state transformer designs may compress Lite On’s current product life cycles. This could force heavy, sustained R&D and CapEx just to stay technically relevant, and it also risks eroding net margins if next generation platforms are adopted more slowly or at lower pricing than implied by today’s record earnings.
• As AI power shelves, BBUs and cooling systems already account for a very large share of company revenue and future capacity is largely pre booked, Lite On’s growth profile becomes increasingly binary. Changes to GPU and ASIC road maps, platform qualification delays or tighter customer concentration terms could flatten or reverse the current high double digit revenue and earnings expansion.
• Escalating competition from Chinese and multinational power and infrastructure vendors targeting the same AI and low earth orbit satellite markets raises the risk of price wars and design share losses just as Lite On scales up system level offerings. This may threaten gross profit rate sustainability and the company’s ability to keep operating profit near the targeted 10 percent range.
• The migration toward liquid cooling and liquid to air solutions for multi megawatt racks is still in an early, highly customized phase. If hyperscalers standardize around rival ecosystems or in house designs, Lite On’s current low revenue base in cooling may never scale to match its investment levels, which could lead to structurally lower blended margins and more volatile earnings.

Assumptions

This narrative explores a more pessimistic perspective on Lite-On Technology compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Lite-On Technology's revenue will grow by 11.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 8.9% today to 11.7% in 3 years time.
• The bearish analysts expect earnings to reach NT$26.0 billion (and earnings per share of NT$11.05) by about December 2028, up from NT$14.3 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as NT$38.1 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 12.0x on those 2028 earnings, down from 24.4x today. This future PE is lower than the current PE for the GB Tech industry at 21.1x.
• The bearish analysts expect the number of shares outstanding to decline by 1.32% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.91%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The rapid, secular expansion of AI compute, with GPUs and ASICs driving explosive cloud demand and AI already exceeding 20 percent of revenue and trending far higher next year, could sustain double digit top line growth for many years and support continued revenue expansion.
• Management is deliberately shifting the mix toward high value cloud, AIoT and optoelectronics solutions, which has already lifted the gross profit margin to 23.3 percent and the operating margin to 10.4 percent, so a richer product portfolio and rising scale could structurally improve net margins.
• Significant, long term capacity investments across Vietnam, Kaohsiung and Texas, combined with fully booked AI related production for next year, position the company to capture incremental share of the AI power and cooling wave, which could accelerate earnings growth.
• The company maintains a strong balance sheet with a sizeable net cash position and is using zero coupon convertible bonds to fund overseas expansion, which lowers financial risk and supports sustained investment in R and D that can underpin higher, more durable earnings.
• Diversified growth in non AI businesses, including low orbit satellite power, gaming consoles and mini LED optoelectronics, together with rising contributions from emerging liquid cooling systems, could broaden the revenue base and smooth cycles, reducing downside pressure on both revenue and earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Lite-On Technology is NT$117.0, which represents up to two standard deviations below the consensus price target of NT$192.94. This valuation is based on what can be assumed as the expectations of Lite-On Technology's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NT$245.0, and the most bearish reporting a price target of just NT$117.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be NT$221.3 billion, earnings will come to NT$26.0 billion, and it would be trading on a PE ratio of 12.0x, assuming you use a discount rate of 6.9%.
  
• Given the current share price of NT$153.5, the analyst price target of NT$117.0 is 31.2% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.