It has been quite an interesting week. All the election-related noise is over, and we can now focus on actual policies, not the rhetoric. Nothing can be more comforting for investors than a certain level of certainty. As the Trump administration takes over in January, we will know more and start looking at sectors that may be impacted.

It got spicey on the AI front. I got fed a lot of information on NVDA and then got honey-traped and made a fool of. I know better and the zeal to get my hands on proof got the better of me. Be that as it may, here are the confirmed facts:

1. NVDA’s H100 GPUs and H100 racks are available at a massive discount on eBay.

2. If you are a large customer, 24/7 support is available.

3. These racks are wiped clean and untraceable.

4. These are mainly shipping from China and Taiwan. Mainly Taiwan.

5. There are warehouses in Hong Kong full of H100s lying idle.

6. The sudden pile-up of inventory is due to the White House putting its foot down and stationing 20+ customs officials in China to work alongside Chinese customs.

7. This is huge for the whole AI ecosystem, specifically NVDA, as the Chinese market is now all but cut off.

Given these facts, how does an investor judge whether there is a meaningful slowdown? The clues may be gleaned from NVDA’s partners. If wafer sales start falling and finished goods inventory starts piling up, then soon enough it will show up in NVDA, and the server/rack manufacturers.

That brings us to Vertiv (VRT). VRT is a major beneficiary of the AI-related data center boom. Its products and services form an integral part of data centers. While it is famous for its liquid cooling technology, it also offers other products/services in areas like:

1. Thermal systems

2. Power management

3. IT solutions

VRT is a partner of NVDA and is a key part of enabling the deployment of the GB200 NVL72 platform. Essentially, VRT is riding NVDA’s coattails and much of its outperformance is due to the “supposed” high demand for NVDA’s GPUs.

Management

VRT’s management, especially its CEO, comes across as honest, truthful, and trustworthy. All of it comes across clearly in the earnings conference call to the point that they sometimes give away too much information. For instance, in the Q2 conference call, the CEO gave away the fact that new data center builds globally are getting delayed by 12 to 18 months. That was an interesting tidbit as this was not being reported by mainstream media. Tech media has now started reporting this after almost four months. Has this impacted VRT’s business? Most certainly not. It is anybody’s guess as to how VRT may be impacted in the future. For now, its Q4 orders in hand are better than Q3.

However, there is always a catch, isn’t there? VRT is embroiled in litigation due to management making false statements in 2021 and 2022 about inflation and supply chain issues. The following are the pending litigations (refer to Q3 2024 10Q PDF pages 19-20):

1. A class action lawsuit was filed on May 3, 2022, and an amended filing was made on September 16, 2022, in the Southern District of New York. The lawsuit remains pending.

2. On Jun 9, 2023, a derivative lawsuit was filed in the Delaware Court of Chancery alleging a breach of fiduciary duty. On August 10, 2023, the action has been stayed pending the outcome of the class action filed in SDNY.

3. Now the big one. In November 2023, based on the filings above, VRT received a subpoena from the SEC along with requests for documents by the US Attorney’s office for SDNY. This is huge and people seem to be ignoring the magnitude of this.

The pending litigations and the involvement of the SEC do put into question the ethics of the management irrespective of how they come across during earnings calls.

Financial Statements Analysis

Let’s look at the yearly income statement.

Observations:

1. Revenue growth accelerated in 2023, however, costs grew at a slower rate. This highlights VRT’s ability to leverage fixed costs and as revenues grow further this leverage would benefit Operating Margin immensely.

2. The share dilution is a concern. Is there a risk of further dilution? Yes. Consider the following:

Moving on to the income statement highlights for some of the recent quarters and analyzing whether the fixed cost leverage has benefited VRT.

Observations:

1. The revenue growth when looked at QoQ sequentially paints a vastly different picture than when looked at YoY. It has been lumping and fluctuated from positive to negative and the recent quarter shows a slowdown in the growth rate. Something to be wary about.

2. Gross Margins have shown a deterioration.

3. Fixed cost leverage and healthy management of SG&A have helped elevate the Operating Margins.

4. Of concern is the flattening out of net income mostly caused by higher taxes. Going forward, all the tax benefits are gone, hence, net income growth could be under pressure if revenue doesn’t grow substantially.

Balance Sheet

If there was a marked slowdown in the data center builds and an overall slowdown in the AI ecosystem, VRT would be the bankruptcy candidate. I don’t say that lightly.

Everything looks fine and your reaction may be: what is this guy talking about bankruptcy and all? I wouldn’t argue against that thought. However, VRT’s business is capital-intensive and it has a lot of fixed costs. In the event of a revenue slowdown, these fixed costs will come to bite them. While the fixed cost leverage is helping them now, it has the potential to hurt them in the future.

Now the interesting part. How have receivables, payables, and inventory evolved?

Observations:

1. VRT has played around slightly with its payables and that has had a positive impact on its earnings. There is nothing untoward here, however, it is good to know that there is some jugglery going on with payables.

2. DSO has improved over the last two quarters. The stuff is moving.

3. Inventory build-up more than revenue growth is cause for concern, however, the management has forecast a better Q4 than Q3 and the build-up in inventory could be related to that.

Now, inventory can be the good kind or the bad kind. If there is an explosion in finished goods, trouble lies ahead, however, it is not a universal truth and there are nuances to it. That said, what does the inventory breakdown for VRT look like?

All good here. Keep track of this if one is looking for predictive data to preempt a slowdown in the AI space. Once VRT’s finished goods start piling up, a slowdown in the whole AI space is inevitable.

Cash Flow Statement

VRT’s cash flow statement is pristine. No issues at all. With $378.2 million in cash from operations and $341.8 in free cash flow, VRT is expected to cross $1 billion in FCF for 2024. Very healthy signs. Bodes well for VRT.

Valuations

No fancy DCF from me. Let’s keep it simple. PEG of 1.57 and with expected growth in its liquid cooling and thermal management business, VRT is a long-term hold. Growth concerns could be beyond 2025, but that is further out for now. Rather than being uber bullish about VRT, I am cautiously positive due to the litigation overhang and real concerns about the true demand for NVDA GPUs. Also, over the last week, I have come to distrust anybody associated with NVDA or is buddy-buddy with them, i.e. partners.