As this earnings season has shown, big companies continue to invest heavily in AI. But one problem is the sheer electricity demand of these power-hungry AI servers. And with even more powerful AI chips coming to market next year, this problem will only get worse.
To alleviate AI’s enormous energy demands, data center operators are only just beginning to implement direct liquid cooling (DLC) for AI server racks, as opposed to the traditional air-cooled racks currently used in the vast majority of data centers.
Liquid-cooled data centers made up only about 1% of the market this year, but are now poised to soar, potentially leading to a major shake-up in the fast-growing AI server industry. With its long history of leadership in new energy-efficient technologies, it’s no surprise that Supermicrocomputer (NASDAQ: SMCI) positions itself to dominate this disruption in the sector.
From 1% to 15% in the blink of an eye
Liquid cooling has only made up 1% of the data center market to date because it traditionally takes a long time to implement, costs more, and leaks can lead to component failure. In addition, managing liquid cooling systems requires a different type of expertise than managing air-cooled systems.
However, it appears that Supermicro has cracked some sort of code on the mass deployment of liquid-cooled racks. And that could be a big deal.
While analysts have been concerned about Supermicro’s decline in gross margins this past quarter, the decline could actually be good news for long-term investors. According to management, the company has seen stronger-than-expected demand for its liquid-cooled racks since unveiling its new liquid-cooling solutions at Computex in early June. As a result, the company has had to pay for expedited shipping of liquid-cooled components, which has cost more and hurt gross margins this past quarter.
But stronger-than-expected demand isn’t a bad thing. During the recent earnings conference call, Supermicro CEO Charles Liang said the company shipped about 1,000 liquid-cooled racks in June and July, which Liang said represented more than 15% of all new global data center deployments worldwide during those two months. Liang also noted that Supermicro predicts that 25% to 30% of all new data center deployments will use DLC solutions over the next 12 months, “with the majority of deployments coming from Super Micro, we think.”
Supermicro invests to dominate this market
In the pre-AI world of traditional servers, Supermicro’s premium, custom servers tended to have a relatively low market share in the fragmented enterprise server industry, around 5%. However, Liang believes Supermicro is responsible for “at least” 70% to 80% of all DLC servers shipped in recent months.
While it is unlikely that Supermicro will maintain this much market share in the future, the company is clearly investing to maintain a leading market share in DLC.
That could turn the enterprise server industry on its head, as DLC quickly goes from 1% to potentially 30% of the server market in just a year. The explosion in DLC revenue is why Supermicro predicts it will generate $26 billion to $30 billion in revenue over the next 12 months, roughly double the $14.9 billion the company earned in the 12 months ending in June.
Why Supermicro Doesn’t Charge Anymore
When DLC is done properly without leaks, the benefits include 40% lower power consumption, improved computing performance, and faster time-to-online due to the elimination of large air conditioners. All of this also reduces the carbon footprint of a data center.
Analysts are wondering why Supermicro isn’t charging more. The company saw its gross margins fall to 11.3% in the quarter, partly due to accelerated shipping costs, but it’s only aiming for a return to its traditional gross margin range of 14% to 17% by the end of the year.
But if you have a value-added solution like DLC, you have two choices: Either charge a higher price, or try to disrupt the industry with high volumes at a lower price. Supermicro appears to be choosing the latter disruptive path, at least at this early stage of the liquid cooling era.
That could prove to be a smart strategy in the long run, as it paves the way for more market share. AI is a revolutionary technology, but it’s expensive. Therefore, by keeping prices low, Supermicro could unlock more overall spending on AI servers from its customers. And if DLC eventually becomes as expensive as air-cooled servers, it could potentially be deployed in traditional data centers as well.
With Supermicro also implementing a new data center building block (DCBBS) solution later this year, which includes end-to-end data center construction, including maintenance software and services, the company can generate more recurring maintenance/software revenues associated with its deployments than in the past when it was solely a hardware components supplier.
So, getting more high-volume customers right away could be a smart move. Plus, Supermicro’s costs are likely to come down next year as its new Malaysian manufacturing facility comes online in November with significantly lower costs.
While many investors in Supermicro now appear to be pushing for more profits, the company’s heavy investments to take the lead in direct liquid cooling for AI data centers (perhaps a big lead) could prove to be a game-changer.
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Billy Duberstein and/or his clients have positions in Super Micro Computer and hold the following options: short January 2025 $1,840 calls on Super Micro Computer, short January 2025 $110 puts on Super Micro Computer, short January 2025 $125 puts on Super Micro Computer, short January 2025 $130 puts on Super Micro Computer, short January 2025 $280 calls on Super Micro Computer, and short January 2025 $85 puts on Super Micro Computer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Super Micro Computer Just Made a Breakthrough Move. Here’s What You Need to Know. was originally published by The Motley Fool
