Credo Technology Group Holding Ltd

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Creedo is a provider of high-speed connectivity solutions that enhance data bandwidth, power, security, and reliability, primarily for the data infrastructure market.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Creedo Technology Group Holding Ltd (CRDO) is a fabless semiconductor company that provides connectivity solutions to the high-performance networking space. They specialize in high-speed connectivity solutions that improve power efficiency and reliability in the data infrastructure market. Their products enable data transmission speeds from 100 Gbps to 1.6 Tbps per lane. The company’s products are based on their proprietary SerDes (Serializer/Deserializer) technology, Active Electrical Cables (AECs), and Active Optical Cables (AOCs), and they target the data infrastructure market, particularly in areas such as AI, machine learning, and 5G.

Revenue Distribution

Product Sales: This represents the sale of their high-speed connectivity products to a variety of customers, such as original equipment manufacturers (OEMs) and data center providers. Product sales constitute a significant portion of the company’s revenues.
IP Licensing Revenue: This involves licensing the company’s intellectual property (IP) to other companies for use in their own products. This revenue stream contributes to the company’s financial performance and is associated with the use of their proprietary SERDES, IP, and technologies.
Product Engineering Services Revenue: Creedo offers product engineering services, including design and system integration. Revenue is recognized at the point in time that engineering services are delivered and deemed by management to be complete.

Industry Landscape

The data infrastructure market, including hyperscale data centers, is experiencing high growth, driven by the increasing demands for data processing and transfer. This growth is accelerated by the expansion of AI and machine learning, which require higher bandwidth and low-latency connectivity. Trends within the sector include:

High bandwidth and low latency: the demand for high performance with low latency is growing, with connectivity speeds of 400G/800G and now 1.6T being heavily adopted, requiring companies to keep on innovating.
Growing cloud adoption: Cloud infrastructure is growing at a fast pace and it’s being fueled by the need to access large datasets, more data processing and more complex computing at cloud centers.
AI infrastructure: Artificial intelligence is expected to be a primary driver for data infrastructure buildout in the future and create a demand for new, better connectivity solutions.
Geopolitical landscape: Many international companies are looking to diversify their supply chain due to geopolitical risks and instability.

Competitive Landscape

Credo operates in a highly competitive market, facing both large and small competitors. Key competitors include Marvell Technology Group, Broadcom, and several smaller players. Competitive advantage here comes down to cost, technological capability and product performance. They have also mentioned increased competition, as large players try to build similar solutions in-house. Key factors that contribute to competitive advantage are intellectual property, rapid innovation, close collaboration with customers, and a strong manufacturing network.

What Makes Creedo Different?

Proprietary Technology: Creedo’s strength lies in its proprietary SERDES technology, which enables them to design differentiated products for various applications.
Focus on High-Performance Connectivity: Creedo focuses on providing leading-edge high-speed connectivity solutions that are crucial for the AI and data center markets. This focused approach allows them to invest in technologies that cater to rapidly expanding areas of need in data transmission.
Customer-Centric Approach: Creedo has direct relationships with tier-1 customers who are early adopters of new technologies and value their ability to solve difficult technical problems.
Manufacturing Strategy: They use a fabless manufacturing model, partnering with semiconductor manufacturers, enabling them to stay flexible and quickly scale production.

Financial Analysis

The company’s latest results come from Q1 2024, which ended on April 27, 2024. Here’s a detailed look at their financials:

Revenue: Total revenue for the three months ended November 2, 2024 was $72.2 million, a decrease of $64.2 million, or 47%, compared to $136.4 million for the three months ended October 28, 2023. The YoY revenue for product sales dropped by ~50%.
- Product revenues are the primary source of revenues and contributed $53.8 million, and IP licensing revenues made up $18.5 million for the quarter.
Gross Profit: Overall gross profit decreased by $34.2 million in the quarter compared to the same quarter last year.
- Gross margin decreased to 57.8% in the three months ended November 2, 2024, from 66.1% in the three months ended October 28, 2023, and has been relatively unstable recently.
Operating Expenses: Total operating expenses for the three months ended November 2, 2024 was $81.2 million, a decrease of 6.6% compared to $86.9 million for the three months ended October 28, 2023.
- Research and development (R&D) expenses remained high, at $39.4 million for the quarter, an increase of 15.7% as compared to same period in prior year, illustrating the company’s focus on innovation.
- Selling, general and administrative expenses also grew to 41.8 million for the quarter, a jump of 18.6%.
Net Income (loss): Net loss for the quarter was $13.8 million, compared to a net income of $13.3 million in the same period of the prior year.
Cash Flow: In the six months of the year, cash flow from operations was $14.2 million as opposed to $229.1 in the same time period a year ago, signaling a cash flow issue.
Balance Sheet:
- Credo has ~$370 million of cash and short-term investments.
- Net assets totaled $645 million, with total liabilities standing at $156.7 million.
- Inventories increased to $94.4 million compared to $74.7 million in the preceding quarter, suggesting a possible overstock of raw materials.
- They have about 300 millions worth of property, plant, equipment.

Risks to Moat and Resilience

Technological Disruption: The technology landscape is fast-evolving, and new innovations could render their existing solutions obsolete. They emphasize constantly developing new products, indicating they are actively trying to combat this.
Intense Competition: Their high margins, strong client list and innovative products are vulnerable to competition from both large incumbents and smaller competitors, who are keen to cut margins and price out other competitors.
Customer Concentration: A significant portion of Creedo’s revenue comes from a limited number of key customers. The loss of one or more of these customers could severely harm their revenue. 2 customers made up 31% of revenues in first 6 months of fiscal 2024 and this is an ongoing risk for the company.
Supply Chain Disruptions: They are subjected to supply chain risks which could affect their ability to deliver their products and solutions on time and in the required quantities. They also rely on TSMC in Taiwan for all of their manufacturing. Any disruption here would halt their production capabilities.
Acquisition related risks: Acquired goodwill and intangible assets makes the books more complicated and make it harder to analyze and determine the intrinsic value. Integration risks after acquisitions may cause disruption and lower profitability as well.
Geopolitical Risks: Tensions between China and Taiwan could disrupt supply chain if Taiwan’s production is negatively affected.

Understandability: 3 / 5

Creedo’s business model is moderately complex. While their core business of high-speed connectivity is easy to understand, their dependence on intellectual property, multiple components, and a diverse market segments can be a lot to grasp. It’s slightly above average due to its complex supply chain, and many components associated with it. For the individual investor, some of their IP may be difficult to evaluate and verify how good it is.

Balance Sheet Health: 4 / 5

Creedo’s balance sheet is fairly healthy, with a high amount of cash and investment securities, indicating strong liquidity. Their total liabilities to assets ratio of about 23.7% indicates good solvency, with no major debt and a reasonable risk level. One concern is the increasing inventory values, implying possible supply chain issues. Still, the balance sheet is in a good shape.

Recent Concerns and Management Response

Share price volatility: The stock has seen massive volatility and price decline recently, due to decreased revenues and earnings which has been primarily caused by slow down in the market. Management has said on their most recent earnings call that they are reducing production rates and implementing a cost reduction plan.
Lowered guidance: For Q2 2024, they have given lowered guidance due to supply chain challenges and lower than expected revenues. This is very concerning and should be noted.
Competetive threats: Management has also noted increased competition from larger companies who are starting to develop their own in-house solutions.

Conclusion

Creedo has a business with promising long-term growth prospects, but they are in a very competitive space where technological shifts can disrupt the business or a competitor can emerge who offers a more desirable product and steal their market share. In order to justify its current valuation, Credo will need to continue to grow, innovate and reduce cost structure. Therefore the moat rating is a 3 as long-term sustainable growth is still not fully clear yet. The management seems capable in navigating the volatile market, but will have to keep a close watch on the competition.