I think the creed (NASDAQ: CRDO) could be the next AMD (AMD) as it looks to disrupt the incumbent giant and gain market share as a small player. Credo’s competitive advantage comes from its patents SerDes technology enables its products to have better performance and lower cost than existing products. Additionally, as a small company competing with larger rivals, it can leverage its agility and growing need for a more resilient and diverse supply chain to gain market share. The market opportunity for Credo remains huge as it appears to be gaining market share from incumbents. Additionally, Credo’s customer base looks promising as it works with 5 of the top 7 hyperscalers, most of which are big tech companies.
Founded in 2008 by a former Marvell (MRVL) director of engineering, Credo is focused on delivering solutions to address increasing data rates and higher bandwidth requirements in the data infrastructure market. Therefore, the value proposition of Credo technology is to alleviate system bandwidth issues as the demand for more data and bandwidth increases exponentially, while ensuring higher performance than its competitors in terms of reliability, security and power.
Credo’s crown jewel is the patented Serialization/Deserialization (“SerDes”) intellectual property. This IP can be licensed as part of their solution. The company also has its own line of high-speed connectivity products for data centers. Currently, its product portfolio includes optical digital signal processors (“DSPs”), HiWire active cables (“AECs”), and SerDes chiplets.
Growing market opportunity
Credo looks to disrupt incumbents in the market due to the dramatic increase in data generation over the past decade, which presents different challenges for traditional market players. As a result, Credo is able to use its proprietary SerDes as well as its DSP technology to bring innovation and gain market share to the data infrastructure market as Credo’s products are better able to meet customer demands for ever-increasing energy efficiency and performance requirements.
Credo serves the data infrastructure market driven by 5G, high performance computing and hyperscale infrastructure. As end consumers live more digital lives online and move education and work, this places higher demands on bandwidth, power and security, as well as better cost efficiency.
Gartner predicts that the wired connectivity market in the data infrastructure ecosystem will grow from $12 billion in 2020 to $17 billion by 2025, and the 650 Group expects hyperscalers to have the fastest growth rate in the market.
Credo expects the market for high-speed connectivity products to grow from $2 million in 2022 to $5 billion in 2025. Thus, as the need for faster speeds continues to grow, this gives Credo a competitive advantage over its existing competitors as it is poised to disrupt markets that require innovation.
Promising customer base
Another prominent customer is Microsoft (MSFT), which has partnered with Credo on the AEC business, and Amazon (AMZN) is said to have also purchased Credo’s AEC. Credo also previously revealed that they have worked with 5 of the top 7 hyperscalers. For reference, the largest hyperscalers in the US are Microsoft, Amazon, Metaplatform (META), and Google (GOOG). While Credo may be small relative to incumbents in the industry, the fact that these large hyperscale companies (i.e. big tech companies) are talking to Credo and even buying its products provides incredible insight into the company and its products reliability. Other clients it has worked with are companies such as Arista (ANET), for its licensing business, it has conducted more than 30 licensing operations since its inception.
The biggest problem with Credo is the concentration of customers. The company certainly has a concentrated customer base, but should that be a cause for concern? As the chart below shows, 69% of its revenue in fiscal 2022 came from just 4 customers, compared to 54% of revenue from 3 customers in fiscal 2021 and 44% of revenue from just 2 customers in fiscal 2020.
The way I think the revenue is concentrated on a small number of customers is that it’s a function of Credo’s small size and business nature. I think we’ll continue to see the concentration of Credo’s massive customer base due to the continued design wins Credo has from hyperscale and other big tech companies. Because the company is currently small, these big design profits will continue to make up a significant portion of its revenue in the near term. I think over time we’ll see Credo’s customer base start to diversify and become less concentrated. Therefore, investors need to be aware of some risks associated with a high concentration of clients. Having said that, I still think it’s very beneficial for Credo to make these profits from these big tech companies and hyperscalers because these companies provide credibility to Credo’s products.
In my opinion, Credo has a competitive advantage because its products offer better energy efficiency, competitive performance at a lower cost and smaller size. The key technology to be highlighted here is the patented serialization/deserialization (“SerDes”) intellectual property. While competitors do have their own SerDes architectures, the patented IP gives Credo’s products an architectural advantage, resulting in cheaper manufacturing processes, best-in-class power efficiency and smaller chips. I think all of this is important for Credo’s customers, especially for hyperscalers, because they need a lower power budget. So I think this patented technology will help Credo continue to gain market share in fast-growing areas like optical DSP.
Participate in the competition
However, it is important to note the current industry dynamics in which Credo operates. Broadcom (AVGO) is the leader in the wired communication connectivity market with nearly 50% market share. In Ethernet semiconductors, Broadcom and Marvell both hold nearly 90 percent of the market. Therefore, we must pay great attention to the two major competitors of the current industry veteran. While incumbents may fall someday if they lose their competitive advantage, I think Broadcom and Marvell are more than likely given their track records, the economies of scale they can get from their size, and the wider variety of networking products they offer. Both are strong competitors to Credo. These competitors also continue to spend nearly $6 billion in R&D to help them maintain a competitive edge and meet industry needs.
Given this industry dynamic background, I think it further proves my point that Credo brings added value as a new player in an industry dominated by 2 big players.
First, I think the high concentration of market share between these two players points to the need to improve supply chain resiliency to diversify supply away from these two dominant players. Credo will benefit as a new entrant and alternative supplier due to a renewed focus on supply chain resilience.
Second, I think the fact that Credo works with 5 of the top 7 hyperscalers and over 20 blue chip clients underscores the fact that these large companies see the value Credo brings. As mentioned above, this provides further credibility to the company’s patented technology, which can help clients achieve better results at a lower cost.
In the end, size probably doesn’t matter, especially if Marvell and Broadcom are much larger than Credo. I think Credo’s advantage, in addition to having patented technology, is a more flexible and flexible business model that can meet the needs and wants of customers. By moving faster than larger peers, this helps Credo have a first-mover advantage in emerging areas and demonstrates its credibility and reliability to customers.
I assume Credo’s EV/Revenue multiple is 7x, which is in line with its competitors Marvell and Broadcom, both of which are currently trading at 7x NTM EV/Revenue. I think a similar multiple is necessary given Credo’s higher growth profile. Applying this 7x EV/revenue multiple to Credo’s fiscal 2025 sales and discounting at 10% WACC gives me a 1-year price target for Credo of $19.50, representing a 64% upside from current levels.
Customer concentration risk
As mentioned above, 69% of its fiscal 2022 revenue comes from just 4 customers. I think this concentration risk was unavoidable in Credo’s early days as a company because the company was targeting hyperscalers, which were the top 7 hyperscalers in the market. That said, I’m cautious that this could cause some near-term volatility in earnings. That could also affect the type of multiples the market is willing to give Credo, given some uncertainty about the near-term business model.
One of the biggest challenges Credo has faced and will continue to face is that the industry’s established players, Broadcom and Marvel, do control a significant portion of the market right now. So they do have some track record with existing customers, benefiting from economies of scale. As such, Credo needs to demonstrate that its product can integrate well with the existing data center ecosystem and demonstrate interoperability with existing vendor solutions. While I do think Credo will succeed in this David vs. Goliath fight, the risk remains that the competition from these two big players could be more intense than expected.
While Credo’s SerDes IP may have some competitive advantages, if its competitors are able to create better technology or products to compete with Credo’s products, this could erode Credo’s competitive advantage in the marketplace. If so, that would undercut Credo’s investment case, as it doesn’t have the credibility to gain market share in the long run.
supply side problem
The rest of the industry has limited growth due to the limited supply of the required substrates, which could also be the case with Credo if they can’t get a sufficient supply of wafers. Credo could experience supply-side disruptions that could limit the company’s growth.
While it’s still early days for Credo, I think the company’s future is bright. A promising customer base includes hyperscalers and large tech companies, which lends enormous credibility to Credo’s technology and products. Also, while Credo is a small company competing with two big incumbents, by leveraging its technology and being more nimble, it can compete with these incumbents and gain market share. Additionally, Credo’s market opportunity is enormous, and its patented technology brings innovation to an industry that is constantly evolving its need for faster speeds and more data. My 1-year price target for Credo is $19.50, representing a 64% upside from current levels.