Motley Fool Hidden Gems Investing - Digging into the bottlenecks of AI

Starting point is 00:00:00 diving deep into the ai supply chain today on motley fool hidden gems investing welcome to motley fool hidden gems investing i'm your host tyler crowe and today i'm joined by longtime full contributors john quass matt frankl so we wanted to start the discussion today about ai spending basically and some of the kind of nooks and crannies that a lot of that is falling into it. And to do that, we want to start with the big news event of the day. And that was Oracle's earnings. They reported earnings earlier today and the stock is down. Pre-market was down about 11 percent right around the time that we are taping. And, you know, the numbers were pretty good, at least from a quarterly earnings perspective. But I think the biggest reason

Starting point is 00:00:43 we saw this massive decline in the shares was because CapEx spending is going way, way up. They spent much more than they had expected. They were expecting $50 billion for this entire fiscal 2026, but they ended up spending $55 billion. And their plan for 2027 was to add more to that and do about $70 billion in capital spending. Now, there's a lot of reasons for that. The remaining performance obligations, basically, however, hyperscalers are spending has gone way up. And we'll get into that. So, guys, one of the things I think about with Oracle compared to like the other hyperscalers is this is not like their bread and butter business. This is something they've been really getting into. And is this seeing these kind of large, large numbers, is this like a risky approach? Is this like the way Oracle should be attacking this? You're right that the earnings report was very strong, but the earnings are not the full story. If they were, the stock would probably be up today. Both revenue and earnings grew by 20% or more. They beat expectations. Cloud revenue grew by 47%. The RPO number that you mentioned, it is simultaneously the company's biggest risk factor and the biggest bull case, really. I mean, having a $638 billion backlog would be a dream of most companies. But when

Starting point is 00:02:02 it's all tied to one customer, it does seem to be diversifying a little bit. It's now estimated that, quote, over 50% of that backlog comes from OpenAI, as opposed to virtually all of it not that long ago. The number that you just mentioned, it increased $85 billion sequentially. And so that's not OpenAI deals. Prepaid AI contracts, it's worth mentioning now, total $75 billion of that. So that kind of helps the need to raise capital, but there's still a pretty big gap there. So having said all that, the company does have a massive CapEx need, $56 billion in fiscal 2026. That's up from $21 billion a year ago. Negative free cash flow for the first time in a long time and probably for the foreseeable future, if we're being honest. It could certainly pay off if Open

Starting point is 00:02:47 AI and the others can afford to pay for all of their committed spending. But it's still a risk factor in the near term, almost $130 billion in debt, and that's growing fast. And anytime you're adding debt quickly, you're adding risk. To your point, Matt, there's really no other way to do this, to be fair. When the space is moving as fast as it is and you've got to spend a ton of money to build something that's very expensive up front, of course, you're going to take on a lot of debt and you're going to take it on very quickly. So I want to be fair to Oracle on the one hand. And also, I want to acknowledge that it is a long game that the company is playing. This is to the RPO number specifically. OK, six hundred thirty eight billion. Yes. But over half of that is more than

Starting point is 00:03:34 three years out. So it's not expecting this money anytime soon. Now, that's a little bit risky for sure. Do I think that AI data centers are going to still be a big thing in three years? Yes. Do I think that all of that money is necessarily in the bag right now for Oracle? No, not necessarily. That said, I mean, OpenAI, much of what it is doing is the Stargate initiative. And there's a lot of companies involved in that. Also, the White House is supportive. So it's risky, but I wouldn't say that it's, you know, humpty dumpty risky. To your point with the idea of it being risky or not or something like that, one of the things that is, it does seem like these companies are really dependent on, Matt, you said it was over 50% of it is an open AI. I'm assuming a lot of it is anthropic. We've seen anthropics, open AIs, these other AI companies in the world, they have been signing some very large checks related to spending on compute and stuff like that. part of the reason we when we discussed the s1 for spacex i think it was last week or a couple weeks ago we were talking about anthropic doing i think it was 1.2 billion dollars per month in basically renting compute from from spacex and a lot of what we're seeing here with these rpos

Starting point is 00:04:52 are similar deals these are big big numbers and a lot of money that they have to even cough up kind of up front and that kind of gets me to like one of the things we i've also seen open ai just confidentially submitted their S-1. So they're also planning on going public relatively soon. Anthropic already did it. We're expecting that S-1. When we see these numbers coming out from Oracle, I'm starting to wonder, do you think that the reason these companies are going public right now is because the bills are starting to come due for some of these very large bills? Yeah. And I mean, don't be fooled just because they recently both did funding rounds. Anthropic very recently raised $65 billion.

Starting point is 00:05:31 It's really rare for a company to have a big, you know, serious F or G or whatever it was for this and then do an IPO almost immediately afterwards. And it's because they know they'll burn through this capital very quickly and are going to need more. I mean, fortunately for them, investors seem very happy to open their wallets right now and give them whatever they need.

Starting point is 00:05:49 We're seeing this with demand for the SpaceX IPO. It's just a question of whether that's sustainable. In a year from now, if they wanted to do, you know, a big offering. Would they still be able to do that? No. So they're rushing while it's a hot IPO market. So the rush to IPO, especially if the market gives them trillion dollar valuations, which is expected, is driven by their massive capital needs. After all, it's really a lot easier to sell an IPO to investors than it is a follow on offering as Oracle has found out. Here's the thing with IPOs. You definitely want to go public when the timing

Starting point is 00:06:26 is attractive and most attractive. And you look at the valuations in the stock market right now, I'd say that they're pretty generous. I'd say it's a pretty attractive time to go public. And I think that is why, more than anything, we're seeing three, perhaps the three biggest IPOs of all time are going to happen right in a cluster when you talk about Anthropic, OpenAI, and also SpaceX. I think that that speaks more to what is going on. The market has a very, very favorable, it's a very favorable time to go public. It is smart to take the most money that you can when it is available, right? When we had 0% interest rates, it was smart to borrow money because there's really no, there's no interest payment involved. So yeah, why wouldn't you borrow? So

Starting point is 00:07:15 taking money when it is very attractive is smart. I think that is more the motivation for going public right now rather than where are we going to get the money to pay? I think that financially they're in better shape than it's not a desperation move. It's a this is a really good time to do it move. To that, we're talking about the IPOs. I think within the past 48 hours, I have seen news articles or headlines basically going from the SpaceX IPO is two times oversubscribed, which means there's twice as much demand as the shares that should be going available. And then I think it was 24 hours later, it was four times oversubscribed. Who knows how true those are?

Starting point is 00:07:55 It might be just a little bit of leak to kind of drum up interest in the IPO. It's hard to necessarily confirm that. But, you know, I've got to imagine this is, we're recording this on Thursday. SpaceX goes public tomorrow. I'm sure we're going to see a couple more with basically this rapid demand for these IPOs. And I would not be too, too shocked if we saw something similar with the open AI and the anthropic IPOs in the coming months. But I think a lot of it might depend on what we see with this upcoming one. Now, we've done a lot of discussion on kind of the big companies, AI, CapEx spending, who's going to be spending it.

Starting point is 00:08:31 So coming up after the break, we want to dig down into some of the nooks and the crannies of who's making the money in these areas. is what are some of the bottlenecks and maybe some of the smaller companies that people might not be paying attention to? As is the case with just about any investment trends, there are some of the obvious winners. We were talking about SpaceX. We were talking about Oracle, some of the big hyperscalers that we did in the previous segment. But with every sort of industry like this, there's always like the hidden winners. You dive deep down into the various parts of the supply chain and you can find bottlenecks and constraints and companies that tend to like dominate small niche parts of their industry that may not, most people may not be thinking about, but can be

Starting point is 00:09:18 incredible wealth creators for a lot of investors. So guys, we've been talking about AI infrastructure build out. I've, I've lost count of how many times over the past six, eight months here doing this podcast. And what I want you guys to do is, you know, instead of thinking about like the big companies here, think about like the bottlenecks. What are some of the constraints that you have been seeing as the AI infrastructure gets built out? And what are some of the opportunities? Because I know that when people are listening to this podcast, it is obviously investing, it's stock picking. Where are you seeing some bottlenecks, unique industry perspectives, and perhaps some companies? John, when you pitched this to me, you said chip production

Starting point is 00:10:01 and kind of like the real deep cut parts of the industry. Yeah, I'm looking definitely at the fact that chip production is increasingly a national security issue, and there's a big push to bring all that production domestically, not to mention that there are more chips needed just in a general sense.

Starting point is 00:10:19 And so we're seeing all of these companies projecting, hey, we're gonna build this, we're gonna increase this production, that production. Talk about Tesla's Terafab. We can mock it a little bit, But they're saying because they're saying they want it to be the biggest facility on earth, essentially. But is it going to be probably a big facility? Yeah, I'd say so. Is it going to pump out a lot of chips? Yeah, definitely. And so what is interesting to me about that is perhaps the margins for the chip makers could go down. But I think that it creates an opportunity. It is creating an opportunity for a company such as PDF Solutions, and that's ticker PDFS. This is not PDF from Adobe, the portable document file. This is process diagnostic framework. work. And so this company, essentially what it does is it is looking for defects on the chips.

Starting point is 00:11:15 And then as it detects them coming up with a way that we can now fix the process so that we don't produce a ton of chips that have the same defect. The value proposition here for the chip makers is as these chips become more complex, more expensive to make, now it makes more and more sense to have a company like PDF Solutions coming in and finding the flaws and so that the processes can be fixed as they go. And so this is creating incredible business opportunity for PDF Solutions. Revenue has more than doubled over the last five years. One of the things I like about it here is that this isn't a recent all of a sudden skyrocket. This is more of a steady line up and to the right for this company. The margin profile is improving as it scales. And so you look at it, yeah, 40 times

Starting point is 00:12:05 forward earnings, that looks expensive. But at the same time, I believe its opportunity is only getting bigger. And I believe that its margin inflection is just now starting. So maybe not as expensive as it seems at first glance. I want to ask a question about this because I think there's actually this interesting little fiefdom in like the semiconductor industry where, you know, I think of like the suppliers, you know, ASML Holdings, people have heard of this. This is the one that makes those lithographic machines. They basically have a monopoly on it. And there's other like random processes within the chip making process, like that there's either one company that makes 80 percent of them or there's two companies and they're always fighting like 40, 60 percent. I think of like KLA Corp and Lamb Research when for PDF solutions, are they a dominant market player in their respective field or is this kind of one of the more fragmented parts of that industry?

Starting point is 00:13:00 I would say that there are more dominant players in PDF solutions. And there's a lot of sometimes overlap between companies, one company might have a broader portfolio, one might have. So I mean, not always are they directly competing on all aspects with its competitors, sometimes just in one area. And so there are many companies out there doing I don't know if many is the right word, but there are multiple out there. And so I'm not necessarily saying PDF Solutions is a screaming buy. Definitely one in this area. I would say this area is one that is definitely a fertile hunting ground for potential opportunities because you look at the chip makers, maybe the margins do pull back at that level, but it makes sense that more and more this kind of a company is going to be in hot demand. And so that's where I'm looking for opportunities. Matt, you really kind of whetted my appetite because the pitch that you had said it was

Starting point is 00:13:52 energy. and then I kind of saw a little bit of your notes. I was like, well, this is a very interesting take on energy. So what do you got? Yeah, so, I mean, John's absolutely right that the chip making is a big constraint when it comes to building out AI infrastructure. I mean, that's why Micron

Starting point is 00:14:06 hit a trillion dollar market cap recently, which was not on my bingo card for 2026. But all the chips in the world, it doesn't matter if you can't power them. So I'm closely watching the energy bottleneck. Data center projects are being delayed left and right and power constraints are the main reason for that. It's not likely to become any less of a problem in 2027 and beyond.

Starting point is 00:14:27 Companies getting ahead of it and actively working to solve the power problem could be in a great position. But having said that, a lot of energy sector companies, as you know, are very richly valued or are speculative in nature. I'm thinking the small nuclear startups, for example. One company that is kind of a hidden player in this is Prologis. It's not a hidden company. Prologis is, ticker symbol PLD, the largest real estate owner in, I think,

Starting point is 00:14:51 the world. They've been quietly getting into the data center space with a particular focus on power capacity. So they explicitly state in their proxy filing that power availability remains a key constraint and securing capacity gives them a meaningful advantage over their peers. So they have long established relationships with the utility companies. In some of their markets, they are the number one customer to big established utilities, and that's a tough relationship to replicate. They're increasingly looking at on-site power generation rather than waiting for utility upgrades, gas turbines, fuel cells, solar, nuclear options, battery storage. They've already deployed over one gigawatt of installed battery and storage, solar and battery

Starting point is 00:15:35 storage capacity across their data center portfolio. And I mean, the sites with secured power capacity right now for data center development are trading at pre, they're selling for five to 10 times just conventional industrial land. And it's because of this, the power constraint problem. And they have 3000 development, development ready acres in their portfolio right now. And it's, it's a real big competitive advantage that's being underappreciated. This might be a little bit more of a challenging one, but one of the things, one of the things we're also seeing too, is not just access to power, but also access to water. That's kind of a little bit more of a tough nut to crack here. It does, Prologis kind of have

Starting point is 00:16:14 similar relationships with like water utilities that they do with the powers that this shouldn't be a problem? They do. And most of that land I mentioned, it's located near water sources. So, you know, their land's concentrated in coastal areas. You know, the Northern Virginia data center market is, you know, they actually have a pretty substantial presence there. But no, water capacity is kind of a different nut to crack. And I wonder if after, you know, there are more solutions in place for the energy problem, which is honestly the bigger of the two right now. I'm wondering if water isn't going to be one that we're talking about on this show in six months. We've said it on the shows before that it seems to be like the supply chain or

Starting point is 00:16:52 bottleneck whack-a-mole of, oh, geez, this is the problem now. And before you know it, next time it's going to be insurance or some like weird switchboard piece of equipment that nobody else can find. When the numbers that we see for this industry is getting put up there, Oracle's like, oh, we're going to do 20 more. Google or Alphabet says we're going to do 25 more just because stuff cost more, not because we're building more. You see things like this, these infrastructure bottlenecks, these kind of, you know, constraint companies, these ones that basically hold the keys to the kingdom here are going to be increasingly important, probably going to be able to exert an immense amount of pricing power. So maybe this will be a nice little

Starting point is 00:17:28 recurring segment that we do as we think about this going forward. Coming up next, we're going to hit the nail back. Hey everyone, just a quick reminder. If you want to get your questions in and have us answer them on air, email us at podcasts at fool.com. That's podcasts with an S at fool.com. All three rules as always, keep it foolish, keep it short enough I can read on air and don't try to avoid anything that involves personalized advice. We have to try to keep things relatively generic. So this first one comes in from Neil, which based on the question, I think he's based in Europe. So here was the question. I was fascinated by your episode about European stocks and was baffled as

Starting point is 00:18:08 to the huge difference in valuations on the NASDAQ and New York Stock Exchange, basically all the American exchanges compared to other similar components in the UK and Europe. There was a very long list of companies he was giving examples to, but I want to kind of condense down to the couple of the big ones here. It's like, for example, Danish wind farm engineer Vestas wind simper. It's one of the largest in the world. I think it's basically a duopoly with M and GE Vernova and Danish semiconductor manufacturer supplier, which is ASML Holding, which mentioned it earlier. Oh, excuse me, Dutch, not Danish. Again, this is a problem that we have for European companies. Stocks barely know where the countries are. His argument is basically they would be worth

Starting point is 00:18:46 a lot more if they were, you know, given standing in the American market. ASML, maybe. It does have ADR does trade for 50 times earnings. Well, I might pump the brakes on that one. But the rest of the question is, is this a case of American companies getting more news coverage in the States, stock trading platforms being not offering company or foreign based stocks? Like why such the large discrepancy? And this is something that's been going on for a long time. Basically, the last time that international stocks outperformed American stocks was during like the dot-com crash all the way to about 2007, kind of that slight like recession that we had in the 2003-2004 period was the last time we saw actual international

Starting point is 00:19:28 outperformance. So what is the big discrepancy do you guys see today? First of all, it's not just Europe. Foreign stocks in general trade for a significant discount to U.S. companies as a whole. Just as an example, most listeners know that I'm the dividend stock guy in a lot of ways. the big part of my strategy. The average international large cap dividend stock right now trades for 14 times earnings and 1.7 times book value. For the average U.S. stock in that same category, it trades for 22 times earnings and 3.1 times book. It's a pretty big gap. I don't know if it's just a case of them not being listed on U.S. markets or just that the AI tailwinds are generally U.S. based and have the U.S. market trading at premium valuations.

Starting point is 00:20:11 We could probably go into four or five other reasons, but I think one of the more underappreciated aspects of it is that there is no single European stock exchange. They all tend to be fragmented across a bunch of different ones. Basically, every country has their own, which makes the pools of capital a little bit smaller because people tend to invest in their own markets. Things like that can go to pricing discrepancies. I know certainly I probably would be more active on a you're looking at European stocks if there was a just a single European stock exchange, because I know there's companies, you know, Swedish companies, Polish companies. I start going across the list and I have to go to different exchanges. And when I go to buy them, it's harder been depending on the country and whether or not there's like some sort of agreement with the account that I happen to have, which is Fidelity. So it's yeah, it's it's a bunch of things just kind of compounded over time. Now, to kind of satisfy Neil's question a little bit, I want you guys to like think about or maybe a company that you really like that you have been following for a while that isn't traded on the U.S. exchanges. John, is there anything like are you a European or is there some other like parts of the market that you really find intriguing that aren't necessarily on the U.S. exchange? Well, I mean, Tyler, this is admittedly not my cup of tea.

Starting point is 00:21:26 If you look at my portfolio, it's 100 percent U.S. listed stocks. So this isn't something that I normally play in. I will say that as the 80s kid in me who grew up with Ninja Turtles, Japan has always been interesting to me. And so there are some Japanese companies that actually have crossed my radar. This isn't necessarily anything that I've followed for a long time, but they've crossed my radar recently that I find very intriguing. And the first one that I would put here is the company NITO BOSEKI or NITOBO. this is a company that makes pretty much all of the world's tea glass and this is a substrate in making ai chips there are some other companies that are starting to get into the game here

Starting point is 00:22:09 because it is such in high demand and there is so little of it compared to how much demand there is so we'll see what that does to the economics but so far it's really interesting the topo and how it's locked up customers for multiple years and how it is the one company making this material So the other thing that has crossed my radar more recently is a company called Ajinomoto. It makes this film. It's a buildup film, ABF, Ajinomoto buildup film. Essentially, this is some insulating material that goes on GPUs and CPUs. Personally, I'm of the opinion that CPU demand is going to be very strong over the next several

Starting point is 00:22:49 years due to agentic AI. I think that while I am starting to position my portfolio accordingly, so I think that does create a situation where Ajinomoto's material is going to be in higher demand. Now, there are companies looking to diversify away from that, use other materials. And so that is a key risk here. But these are two companies that have crossed my radar. I'm going to refrain from giving. They do have OTC, over-the-counter ticker symbols. They're very thinly traded. So I'm going to refrain from giving those here. But listen on the Japanese exchange. It's a nice job, too, tying in together the bottlenecks and supply chain constraints that we have with AI build out, because those two clearly fall into that realm.

Starting point is 00:23:32 I'll give mine really quick and then Matt will finish with you. I want to mention Exor NV. This is a portfolio company. It's basically the wealth of the Agnelli family. They're a very powerful, rich family in Italy. they own a portfolio it's basically like they own Stellantis, Ferrari, CNH Industrial they're a significant investor in Philips the health care company several wholly owned subsidiaries like it owns an economist newspaper for an example and it's a slightly strange company because of the way it reports earnings because it's a holding company of a lot of publicly traded companies I don't know I feel like we've mentioned a couple of large companies that own publicly traded stocks before

Starting point is 00:24:14 The fascinating thing to me is this company trades for about 0.4 times book value. So trading for a significant value for its underlying portfolio. Trades on the Amsterdam Exchange, but in the U.S. it does trade over the counter as EXXRF. And there's enough trading that I don't feel like we're going to move the market here. So I thought I would mention that one. Matt, what do you got? Yeah, so I'm going to halfway dodge your question. There are a few on my radar, but instead of buying any of them directly,

Starting point is 00:24:42 I prefer the ETF approach in my portfolio, and I'm sure a lot of listeners will feel the same way when it comes to international stocks. I own the Vanguard International High Dividend ETF, ticker symbols BYMI. It owns shares of over 1,500 dividend payers, mostly large caps, all based outside the U.S. Some are listed on major U.S. exchanges, like Toyota is one of their top holdings. But you'll also find some of my favorites, like all those Japanese conglomerates that Berkshire Hathaway can't get enough of are among the top holdings of this one. It has a fantastic yield. It's got a cheap valuation. I mentioned some of the multiples that international dividend stocks are trading for. And it could be a really excellent hedge against an expensive U.S.

Starting point is 00:25:22 stock market right now. Of all the times that international stocks have outperformed U.S. stocks, it tends to be at times when it's either one really high inflation or coming down from a major asset bubble. I'm not making any predictions. I'm just throwing those two kind of factoids out there for everyone to consider. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure,

Starting point is 00:25:59 check out our show notes. Thanks for producer Dan Boyd and the rest of The Motley Fool team, From John, Matt, and myself, thanks for listening, and we'll chat again soon.

Motley Fool Hidden Gems Investing - Digging into the bottlenecks of AI

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