Vertiv Holdings

Vertiv reported second-quarter sales growth of 24% year over year driven by 29% growth in both the Americas and APAC regions. Management raised full-year revenue and earnings per share guidance, but shares traded down significantly the morning of July 29.

Why it matters: Vertiv's red-hot growth has to be extrapolated far into the future to justify its valuation. After a few consecutive quarters of 30%-plus top-line growth, this quarter's results bring expectations back to reality. Notably, Vertiv chose not to headline orders, book/bill, or backlog dollars this quarter. We are unsure whether management wants to de-emphasize decelerating orders or if Vertiv believes these metrics are simply extreme and unmaintainable. We view nearly 18% organic sales growth as a satisfactory result but note that our model incorporates long-term operating income growth in the midteens after five years of high-teens top-line growth. If Vertiv's growth declines back into the low teens, its valuation will take a massive hit.

The bottom line: We maintain our $236 fair value estimate and Very High Uncertainty Rating for narrow-moat Vertiv. After July 29's selloff, shares trade fairly valued in 3-star territory. We reiterate that we do not know how long this magnitude of data center construction can continue. Vertiv's 80%-plus exposure to the end market and a majority of those sales being derived from greenfield construction make Vertiv especially sensitive to any hiccups. However, we believe the migration of enterprise data from on-premises to the cloud is a multidecade trend that will provide Vertiv a stable source of sales going forward. We estimate that the firm derives a majority of sales from cloud-focused data center construction, with the remainder from artificial intelligence-focused data centers and industrial structures.

Vertiv made a few acquisitions recently in ThermoKey (closed June 12) and Strategic Thermal Labs, or STL (closed July 20). We think Vertiv has formed a coherent, sequential build of the entire liquid-cooling thermal chain: chip-level cold plates with STL, fluid management with PurgeRite, rack integration with Great Lakes, and facility-level heat rejection hardware with ThermoKey.

Each acquisition has been a bolt-on with target revenue in the tens to low hundreds of millions, and the cumulative effect seems to make Vertiv one of the only vendors that can sell a fully integrated power and thermal ecosystem rather than siloed products. In our view, this raises switching costs for large multiyear hyperscale deployments as a mid-program redesign to swap a supplier for one process in the thermal chain becomes less attractive when Vertiv owns the interfaces end-to-end. We also believe Vertiv's full-spectrum solution deepens its technical IP and system-integration know-how.

That said, we believe Vertiv has deepened its exposure to the continuation of hyperscaler/AI-factory capital expenditure; all of its mergers and acquisitions are specific to AI-focused data centers. We remain concerned about any capital expenditure-cycle deceleration.

We assign narrow-moat Vertiv a $236 fair value estimate, equating to around 35 times our estimate of 2026 adjusted earnings.

Vertiv is exposed to a number of supercharged growth drivers, such as the continued buildout of data centers and the rising thermal and power requirements within them. As a base for growth, we expect companies to continue moving their vast and growing swaths of data from on-premises storage to the cloud. Moreover, industry surveys reveal that the average rack density continues to rise as gear such as graphics processing units, or GPUs, are bundled together. Denser racks and faster chips draw more energy and produce more heat, resulting in outsize demand for Vertiv's power and thermal management products, which represent the majority of its revenue.

We expect Vertiv to outpace the growth of its markets, as it directly interfaces with customers, placing field engineers on customer sites and developing products in lockstep with customer needs. As such, we expect its data center business to grow in the high-teens.

Vertiv’s secondary businesses, representing around one-fifth of revenue, sell similar products installed within communication networks and industrial structures. Here, too, we expect above-GDP growth driven by the electrification and industrialization of developed and developing nations.

Combining each of Vertiv’s businesses, we model top-line growth in the high teens over our explicit forecast. Operating leverage and internal efficiency gains can propel significant margin expansion, enabling the low-20s compounding of earnings per share.

We assign Vertiv a narrow economic moat rating based on intangible assets and to a lesser extent switching costs. The firm’s financial history, even in recent years, is somewhat convoluted as it has been bought and sold by numerous public and private entities. However, Vertiv’s operations trace back to the first half of the 1900s, and we have confidence that the company can generate returns on invested capital that exceed its cost of capital over the next 10 years.

Around 80% of Vertiv’s business stems from the sale of data center hardware and services. It primarily sells thermal and power management products—chock-full of useful acronyms, such as the coolant distribution unit, or CDU, computer room air conditioning, or CRAC, unit, power distribution unit, or PDU, and uninterruptible power supply, or UPS. It also sells data center containment systems like racks, cabinets, closets, and aisles. To aid its customers, Vertiv has a sizable team of expert field engineers that offer services like product training, testing, and inspecting, as well as facility design, maintenance, and remote monitoring.

Thermal and power management systems are essential for the safe and continuous operation of servers that host critical data for enterprises. The malfunctioning of a data center can be extremely destructive, and data center owners are risk averse when selecting suppliers. We estimate that Vertiv’s content represents less than 10% of a data center’s cost and remains in operation for many years. As a result, we suspect customers do not select thermal and power management products based solely on price, instead prioritizing factors such as performance, durability, and customer support. We think Vertiv’s intangible assets in the form of brand equity, long-standing customer relationships, and time-tested quality are therefore highly valued within the industry. Its average customer relationship is longer than 20 years, highlighting Vertiv’s product success over time.

Vertiv’s flagship brand, Liebert, was founded in 1946. It invented the first CRAC in 1965, enabling the precise control of temperature and humidity specific to computer rooms. Vertiv estimates the brand holds number one market share in data center thermal management products over peers Stulz, Johnson Controls, Trane, Daikin, and Legrand. Data center owners value quick and consistent support as downtime can be costly and repairs complex. Industry participants note that Liebert’s reliability, longevity, and technical support are second to none, and that some of the equipment Liebert installed in the late 1970s is still in operation today.

Liebert also sells time-tested PDUs and UPSs that have been developed with customer input over the decades. Vertiv asserts that it holds dominant market share within these two product categories, doubling the share of peers Eaton and Schneider Electric. Overall, Vertiv owns one of the broadest portfolios of data center equipment and has operations around the globe, making it an attractive partner for national and multinational data center developers. Each of its major product lines interact with one another, and brand uniformity makes data center designs and product issues easier for customers to handle.

We think costly downtime and operational redesign deter customers from switching Vertiv’s equipment with that of another supplier. The useful life of power and thermal management equipment can respectively exceed 10 and 15 years, and once a piece of Vertiv’s equipment is installed, the firm deploys a field engineer to periodically service it. At the end of its useful life, Vertiv’s equipment is anticipated to be replaced like-for-like as electrical and thermal systems are carefully specified and cannot be swapped out with equipment from a different supplier without proper testing. We estimate Vertiv derives around one quarter of revenue from these aftermarket services and spares. Moreover, Vertiv’s products are becoming more technically complex over time, raising the probability the firm will win lucrative maintenance service contracts over third parties.

Although we think data centers will remain a relevant, utility-like service for decades to come, we are hesitant to award Vertiv a wide economic moat rating given the spending volatility and fast cadence of technological innovation within the data management space.

The remaining one fifth of Vertiv’s sales stem from thermal and power management products installed within communication networks and industrial structures. Here, we see the same moat sources at play given the critical nature of Vertiv’s products within its customers’ operations.

Data center spending should be strong regardless of the development of AI as the runway remains vast for companies moving their data to the cloud for the first time.

Vertiv is a great way for investors to gain exposure to the exponential production of data and its growing number of use cases.

The firm’s core product lines have remained relevant for upwards of six decades, indicative of their slow-moving pace of technological innovation.

Spending on data centers has become more volatile and less predictable. Estimating Vertiv’s growth is therefore a highly erroneous exercise.

Capital is pouring into the data center market because it is a high-growth industry, which has likely attracted unwanted competition where Vertiv plays.

Vertiv’s financial history is somewhat limited given that it has changed ownership a number of times between public and private entities.