A $5B Collaboration And Ellendale Completions Will Drive Data Centers

Key Takeaways

• Strategic partnerships and financing arrangements are expected to significantly boost revenue and improve net margins through capital investments and reduced interest expenses.
  
• Transitioning to a data center REIT structure and exploring strategic options for the Cloud Services Business could streamline operations and enhance earnings potential.
  
• Transition to multi-tenant and on-demand models may increase costs and revenue instability amidst high debt and interest expenses, impacting financial flexibility and margins.

Catalysts

Designs, develops, and operates digital infrastructure solutions and cloud services high-performance computing (HPC) and artificial intelligence industries in North America.

• The strategic partnership with Macquarie Asset Management, with the potential for $5 billion in capital investment, is expected to significantly boost revenue and scale the development of next-generation data centers.
  
• The $375 million financing arrangement with Sumitomo Mitsui Bank Corporation provides necessary capital at attractive rates, potentially lowering the cost of capital and improving net margins through stable financial support and reduced interest expenses.
  
• The completion and revenue generation timeline of the Ellendale campus and its expansion opportunities (first building by end of calendar Q4 2025, second building by Q2 2026, and third by Q1 2027) is anticipated to substantially increase future revenue.
  
• Plans to transition to a data center REIT structure can lead to improved net margins by reducing cost of capital and assigning higher multiples to the stability and long-term growth of the data center business.
  
• The exploration of strategic options for the Cloud Services Business, including a potential sale, aims to reduce competition friction with hyperscalers, streamline operations, and potentially enhance earnings by realigning business focus toward the data center segment.

Applied Digital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Applied Digital's revenue will grow by 38.4% annually over the next 3 years.
• Analysts are not forecasting that Applied Digital will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Applied Digital's profit margin will increase from -110.4% to the average US IT industry of 7.9% in 3 years.
• If Applied Digital's profit margin were to converge on the industry average, you could expect earnings to reach $46.6 million (and earnings per share of $0.17) by about May 2028, up from $-244.2 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 79.3x on those 2028 earnings, up from -4.1x today. This future PE is greater than the current PE for the US IT industry at 31.0x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.58%, as per the Simply Wall St company report.

Applied Digital Future Earnings Per Share Growth

Risks

• Technical issues and challenges transitioning from a single tenant to a multi-tenant model in the Cloud Services Business could impact revenue growth and increase operational costs.
  
• The change from reserve contracts to an on-demand model in the Cloud Services Business has led to a temporary decline in revenue, indicating potential instability in revenue streams from this segment.
  
• Seasonal fluctuations in power costs caused margin compression in their Data Center Hosting Business, impacting net margins negatively.
  
• There are risks associated with concluding leasing agreements for the Ellendale campus, which are diluted by macroeconomic factors, potentially delaying revenue recognition and increasing operational expenses.
  
• High debt levels, with $689.1 million in debt, coupled with increasing interest expenses, could strain net earnings and reduce financial flexibility, especially if cost of capital remains high.

Valuation

• The analysts have a consensus price target of $9.944 for Applied Digital based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $18.0, and the most bearish reporting a price target of just $7.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $586.9 million, earnings will come to $46.6 million, and it would be trading on a PE ratio of 79.3x, assuming you use a discount rate of 10.6%.
• Given the current share price of $4.48, the analyst price target of $9.94 is 54.9% higher.
• 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.