400-Megawatt Ellendale Campus Will Increase HPC Capacity For AI

Key Takeaways

• Strategic partnerships and extended financing improve Applied Digital's capital resources for expansion in high-performance computing and data center projects.
  
• Growth in Cloud Services and strong demand for data center hosting, driven by AI and cryptocurrency markets, boost potential revenues.
  
• Reliance on cryptocurrency clients and significant infrastructure commitments pose financial risks, with potential earnings strain from execution delays and increased interest expenses.

Catalysts

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

• Applied Digital's strategic partnership with Macquarie Asset Management provides a $5 billion perpetual preferred equity financing facility, which significantly enhances the company's ability to finance current and future high-performance computing projects. This funding is expected to support future revenue growth and reduce the cost of capital for construction of data centers.
  
• The demand for Applied Digital's data center hosting services is expected to remain strong, driven by Bitcoin prices reaching $100,000, increasing the demand from cryptocurrency clients. This robust demand should positively impact future revenues.
  
• As part of their ongoing expansion, Applied Digital is constructing a 400-megawatt high-performance computing campus in Ellendale, North Dakota. The energization of the main substation transformer marks a key milestone, indicating progress toward operational capacity, which will increase potential future revenues.
  
• The recent renegotiation of GPU lease terms extends the amortization period from 2 years to 5 years, lowering depreciation and amortization expenses. This change is likely to improve net margins due to reduced ongoing D&A expenses.
  
• Applied Digital's growth in the Cloud Services Business, spurred by the deployment of additional GPU clusters and strategic partnerships, is expected to drive future revenue by meeting the growing needs of AI applications and the high-performance computing market.

Applied Digital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Applied Digital's revenue will grow by 47.6% 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 -128.0% to the average US IT industry of 8.0% in 3 years.
• If Applied Digital's profit margin were to converge on the industry average, you could expect earnings to reach $54.3 million (and earnings per share of $0.2) by about March 2028, up from $-270.9 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 81.3x on those 2028 earnings, up from -5.8x today. This future PE is greater than the current PE for the US IT industry at 44.7x.
• 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 9.11%, as per the Simply Wall St company report.

Applied Digital Future Earnings Per Share Growth

Risks

• The reliance on cryptocurrency clients and the potential volatility in the cryptocurrency market may lead to fluctuations in the Data Center Hosting Business revenue, particularly if cryptocurrency prices decline.
  
• The fixed cost of leasing terms and the high depreciation and amortization expenses could pressure net margins if revenue growth does not meet expectations.
  
• Significant financial commitments tied to large infrastructure projects like the 400-megawatt campus in Ellendale introduce execution risks, which could impact net earnings if not managed carefully.
  
• Dependence on the timely execution of hyperscaler contracts presents a risk; any delays could negatively affect projected revenue streams from the Ellendale campus.
  
• Increased interest expenses due to financing activities, such as convertible notes and secured debt, may strain earnings if not offset by revenue growth.

Valuation

• The analysts have a consensus price target of $12.444 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 $20.0, and the most bearish reporting a price target of just $9.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $680.2 million, earnings will come to $54.3 million, and it would be trading on a PE ratio of 81.3x, assuming you use a discount rate of 9.1%.
  
• Given the current share price of $7.07, the analyst price target of $12.44 is 43.2% 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.