Sold out?
We spent last week in Tokyo meeting with Japanese technology and materials companies that sit in the middle of the AI supply chain. We have identified this as a theme in our International Fund. We focus on investing in the suppliers of the AI companies, rather than taking a position on who the eventual winner will be. We think the winner in the AI race is much harder to choose (the capex risk is eye watering!!). However, we believe that as a group, the suppliers will benefit along the way. We met with companies that write and inspect photomasks for EUV machines, make tools that dice, grind, bond and test the chips, and manufacture photodiodes & ultra-high-density optical fibre that tie datacenters together. We found it very helpful to meet with management as we believe the company-by-company work surfaces insight before it shows up in the numbers.
Our conclusion, simply put, is that most of the companies report that “everything is sold out”. Backlogs are high and orders are starting to come with long-term commitments to secure supply. Fibre cables manufactures that sell directly to the US hyperscalers are literally turning orders away. Photodiode capacity for datacenter conectivity is fully absorbed roughly a year out, to essentially one large US customer. One of the largest equipment makers in the world has revised its total addressable market up 20% already this year and expects similar growth next year – while at the same time calling competitors’ talk of 30–50% growth “unrealistic” as the entire supply chain is stretched.
What struck us most, however, is that managements do not indicate that this is a new paradigm. We asked every firm “if this time is different” given the magnitude of the compute build out, and the clear answer was no. Many firms are deliberately conservative with capacity expansion plans, despite pressure to increase. There are no real “take or pay” contacts that have any teeth in this industry, similar to the pipeline contacts we see in Canada. One company noted that two of its only three customers canceled orders last year with almost no warning. While cancellation clauses exist, with so few customers, they cannot be enforced. The operators closest to the boom are the ones planning for its end.
“This means that” while at this point we do not see an implied slow down on a fundamental basis, we remain wary of how fast the situation can change. Not one company said that they saw any change in forward sales guidance or orders and most said their backlogs are at all-time highs. This is very different form two years ago when everyone was still quite pessimistic. While it is exciting for the sector, it is clear that at some point, the dance will stop.
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*All returns are time weighted and net of investment management fees. Returns from the Pathfinder Partners’ Fund and Pathfinder Conviction Fund are presented based on the master’s series of each fund. The Pathfinder North American Equity Portfolio and The Pathfinder North American Income Portfolio are live accounts. These are actual accounts owned by the Pathfinder Chairman (Equity) and client (High Income) which contain no legacy positions, cash flows or other Pathfinder investment mandates or products. Monthly inception dates for each fund and portfolio are as follows: Pathfinder North American Equity Portfolio (January 2011), Pathfinder North American High-Income Portfolio (October 2012) Pathfinder Partners’ Fund (April 2011), Pathfinder Conviction Fund (April 2013), and Pathfinder International Fund (November 2014).
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