Article Thesis
New IPO Astera Labs, Inc. (ALAB) has soared on its first trading day. AI hype seems to play a major role, and while ALAB could continue to rise in the near term, I don’t see the company as an especially attractive pick from a fundamental point of view which is why I am staying on the sidelines.
What Happened?
On its first trading day, Astera Labs, Inc. has seen its shares jump by more than 70% on the first trading day. While volatility is to be expected when a company goes public, it is far from usual for shares to soar this much on the trading debut (or on any other day). Shares closed at $62 per share, up from an IPO price of $36 per share. The company has sold around 20 million shares in the IPO, raising around $700 million.
Astera Labs Overview
Astera Labs is not a well-known household name, but the company has still gotten significant attention due to it being exposed to the current AI mega-theme.
Astera Labs is a semiconductor connectivity company that describes its mission in the following words (from the S-1 filing which I also used for the financial data in this article):
Our mission is to innovate, design, and deliver semiconductor-based connectivity solutions that are purpose-built to unleash the full potential of cloud and AI infrastructure.
The company sells to hyper-scale data center companies such as Alphabet (GOOG)(GOOGL), Microsoft (MSFT), Meta Platforms (META), etc. primarily. According to its investor relations website, Astera Labs sells to all major hyper-scale and AI platform providers across three product families.
Astera Labs sells both connectivity hardware products as well as its own software suite called COSMOS, which is embedded in its hardware products and which is integrated into the systems of its customers. Here’s how Astera Labs describes its three groups of offerings (source: S-1 filing linked above):
Aries PCIe®/CXL™ Smart DSP Retimers. Our Aries products, which include our COSMOS software suite, are essential to enable higher PCIe/CXL data bandwidth and lower latency interconnectivity between various heterogeneous compute processors, storage, and network controllers. Aries digitally recovers degraded high-speed signals and retransmits a clean copy of the data, thereby extending the reach of existing cost-effective interconnects, while enabling higher data bandwidth.
Taurus Ethernet Smart Cable Modules™. Our Taurus products are hardware modules based on our Taurus ICs that increase network connectivity bandwidth between servers and switches over copper media. Taurus modules incorporate our COSMOS software suite and extend Ethernet signaling reach at higher data rates, providing cost-effective, rack-level network connectivity for cloud and AI infrastructure, removing rack-level Ethernet connectivity bottlenecks.
Leo CXL Memory Connectivity Controllers. Our Leo products allow our customers to overcome processor memory bandwidth bottlenecks and capacity limitations, while leveraging our COSMOS software suite’s built-in memory management and deep diagnostic capabilities. Leo ICs and boards enable expanding, sharing, and pooling of industry standard DRAM memory over high-speed serial links to support memory-intensive workloads running on AI accelerators and CPUs.
In general, the data center interconnectivity market with a focus on huge customers such as the well-known hyperscalers is an attractive market to be in, as the current AI hype and huge investments by these large tech companies with deep pockets such as Alphabet and Microsoft make for significant market growth potential. Astera Labs is far from the only company targeting the market it is active in, however, as it competes with major companies such as Broadcom (AVGO) and Marvell Technologies (MRVL) with more reach and more financial power, relative to Astera Labs.
Astera Labs is quite small still, employing fewer than 300 people (265+ according to the S-1 filing). Astera Labs is active in five countries, while competitors have more reach and more resources, both from a personal perspective as well as from a financial perspective.
That being said, when a market is growing fast enough, even “smaller fish” will be able to get some of that growing market, as the larger players will not be able to get all of the market for themselves.
We see this in Astera Labs’ recent results, as the company has generated revenue growth of 45% in 2023, relative to 2022. That’s pretty strong in relative terms, although revenues have now just broken above $100 million per year, meaning competitors such as Broadcom — with annual sales of close to $40 billion — are way larger than the rather young Astera Labs.
Astera Labs plans to grow its revenue in the future, too, which seems like a likely scenario. Astera Labs has several ways to generate growth. First, it can add more customers over time, as more and more companies are investing in cloud infrastructure and AI data centers, which grows the number of potential customers over time. Astera Labs can also grow its business with existing customers if everything goes right, as companies such as Meta Platforms will likely grow their cloud and AI data center investments in the coming years. Last but not least, Astera Labs can offer more and more additional services, upgrades, and so on, which is why the company believes that it will be able to grow the revenue it generates on a per-server-rack basis.
Is ALAB Stock A Good Investment?
Some markets have obvious growth tailwinds, where market growth is highly likely or even (almost) guaranteed. The AI data center market is such a market, I believe. That does, however, not mean that every company that is active in this space will be a good investment. There are several examples where investing in a company solely due to said company having growth tailwinds didn’t work out well:
– Switching hardware was a growth market during the tech bubble and beyond, but buying Cisco (CSCO) at the bubble highs didn’t work out well. Cisco is still trading below its dot.com high, despite being a much larger and more profitable company now, compared to 24 years ago.
– Medical and recreational cannabis are growth markets, but buying into the likes of Aurora Cannabis (ACB) at the highs when the market was euphoric was a disastrous decision — ACB is down more than 99% from its all-time high, despite being active in a growth market.
– EVs are a growth market, but buying into new IPOs such as Lucid Group (LCID) or Rivian Automotive (RIVN) when they went public turned out to be a bad bet. These companies produce more vehicles and higher revenues now, compared to the time they went public, but their shares nevertheless crashed, as the IPO price was just too high and the valuation was not justified, despite EVs being a major growth market.
Being active in a growth market alone does thus not automatically result in share price appreciation, as other factors have to be considered as well. Will the companies that are active in this market be highly profitable, or will margins be weak for some or even all players? Will a company compete successfully versus peers, or will others outperform it? Does the current valuation make sense?
While I doubt that Astera Labs will experience the same fate as Aurora Cannabis and some other bubble stocks, I do not believe that Astera Labs is particularly attractive at current prices.
First, the company isn’t profitable yet — there are competitors that will experience growth tailwinds as well that are very profitable, however, such as Broadcom. Astera Labs has lost $23 million last year, or around 20% of its revenues.
Second, Astera Labs’ valuation is quite high: The company is now valued at roughly $10 billion today. Based on revenues of $116 million in 2023, that makes for a trailing sales multiple of more than 80, which is extremely high. Even a company such as Nvidia (NVDA), which has grown at a much faster pace last year, relative to Astera Labs, and which has way better margins and arguably a much larger moat, is valued at a comparatively low 36x last year’s revenues right now. On a relative basis, I believe that Nvidia would be the better pick among these two.
Third, there is considerable dilution. Even before the IPO, Astera Labs has seen its share count climb by close to 10% in 2023, with the share count rising from 34 million to 37 million. Since Astera Labs is unprofitable for now and since the company has to compete with major deep-pocketed tech companies for engineers and other employees, it is likely that dilution will remain meaningful going forward, as Astera Labs will be offering shares to employees and management as part of their respective pay packages. At the same time, without positive free cash flows, Astera Labs does not have the means to buy back shares to offset dilution — in contrast to the major tech companies such as Apple (AAPL), Microsoft, and so on, where dilution is no problem.
Takeaway
Astera Labs is active in an attractive growth market, but it is far from the biggest player in this space. It remains to be seen how well this rather small company can compete. Astera Labs has potential, but its shares are very expensive, which is why I am staying on the sidelines for now. For those seeking AI exposure, I believe that a proven company like Nvidia with excellent fundamentals and better growth, relative to Astera Labs, is a more attractive choice — especially since Nvidia trades at less than half of Astera Labs’ valuation.
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