Summary Applied Digital Corporation has expanded its facilities for hosting and AI cloud services, with plans to add 300 megawatts to its capacity in the next 24 months. APLD's financial performance showed an increase in revenue, driven by hosting crypto-mining operations, but the company faces negative reports about its business model and a class action lawsuit. Despite the challenges, APLD's stock has increased, likely due to the growth of Bitcoin, and its current market cap appears undervalued, making it a compelling investment in the sector. Applied Digital Corporation ( APLD ), in Q1 2024, has expanded its facilities for hosting and AI cloud services. APLD changed its name from Applied Blockchain, Inc. to reflect the transformation from cryptocurrency mining rigs into a data center and AI cloud service provider. The company's financial performance showed an increase in revenue, and it plans to add 300 megawatts to its capacity within the next 24 months. A shadow in its growth is the negative reports about its business model and governance and the class action lawsuit started by some shareholders who consider themselves misled and harmed by the company. Despite these hurdles, APLD's stock has increased, likely pushed by Bitcoin’s ( BTC-USD ) price growth. In my valuation analysis, I conclude that APLD’s current market cap appears undervalued, making it a compelling investment in the sector. A Crypto Play: Business Overview Applied Digital Corporation designs, builds, and operates digital infrastructure for High-Performance Computing [HPC] applications, Cloud Services, and data center hosting in North America. The company was founded in 2021, with an IPO in April 2022, and its headquarters are in Dallas, Texas, United States. In November 2022, the company changed its name from Applied Blockchain, Inc. to Applied Digital Corporation because even when APLD continued to be a supplier of cryptocurrency mining servers, the company also provided other high-performance computing [HPC]. The ticker symbol remained unchanged. Nevertheless, as of the latest quarterly information, APLD remains mostly a crypto-related business, with most revenues from hosting crypto-mining operations. APLD has two main business segments: data center and artificial intelligence cloud services, under serving area interface [SAI] Computing. APLD aims to satisfy a growing demand for low-cost digital infrastructure. APLD has three hosting facilities in the data center segment: a Jamestown data center, an Ellendale facility in North Dakota, and a Garden City data center for 500 megawatts. Also, APLD still operates as hosting for blockchain. The company has expanded in the AI cloud services by activating GPU clusters, machine learning, and natural language processing for its clients. Source: Jamestown facility, Contributed / Applied Digital Corp. APLD's Revenue Growth Amid Legal Scrutiny In the APLD’s earnings call for the fiscal first quarter of 2024, CEO Wes Cummins stated that APLD is expanding its blockchain servers with a total hosting capacity of 280 megawatts across the North Dakota facilities. For Q1 2024, the revenue was $36.3 million, a rise compared to the same period last year, with a revenue of $6.9 million. The net loss was $9.6 million. The company has expansion plans with the development of HPC data centers with 300 megawatts in the next 24 months. APLD is securing credit for these facilities. The executives are confident to comply with these timelines due to the growing service demand and funding. APLD also reported ordering 34,000 GPUs for the cloud services segment and deploying 1,024 GPUs in the three months ending August 31. The company obtained the first revenue for its first HPC contract, and the client made a prepayment as part of the agreement signed in May 2023. The contract was signed with its wholly-owned subsidiary, Sai Computing, and the deal is worth $180 million over 24 months. APLD also signed two more customer agreements that include significant advance payments. With those contracts, the total annual contract value for contract services is expected to be approximately $378 million for AI cloud services in the annual contract value. These are notable and encouraging developments for a company with a market of $728.32 million as they herald sustained revenue growth boosted by cryptocurrencies' price action. However, a risk hangs over the company. In October 2023, a securities fraud action lawsuit against APLD was filed by investors with substantial losses in the period from April 13, 2022, to July 26, 2023. The complaint filed alleges that APLD failed in the following points. First, APLD overstated the business's profitability and ability to transition into a low-cost AI cloud service provider. Additionally, the Board of Directors had links with the IPO’s underwriters, contravening NASDAQ listing rules, which likely harmed the company significantly. If proven, these allegations could lead to financial and reputational damages for Applied Digital and potential restitution for affected shareholders. On July 6, 2023, Wolfpack Research , The Bear Cave, raised questions about the business model of APLD as a low-cost AI Cloud Service provider, claiming that it is not an AI company. After that, on July 28, The Friendly Bear also published a short report on APLD highlighting governance issues. Nevertheless, on December 8, APLD presented a 12% share increase, probably related to blockchain mining in a market where BTC is growing. Source: Investor presentation, May 2023. APLD is mostly a bet on cryptocurrencies because its main segment is Hosting. Naturally, hosting provides infrastructure for crypto mining customers. The business model is quite interesting, as it’s not exactly cloud computing. Instead, customers give APLD their hardware, and APLD then places it on its facilities, operating the hardware entrusted and performing maintenance operations. In exchange, APLD charges a fee. As such, it’s inextricably linked to cryptocurrency prices, the largest of which is Bitcoin. Too Cheap To Pass Up: Valuation Analysis In fact, from a valuation perspective, we can reduce our analysis down to the hosting segment. As you can see in the figure below, the Hosting segment contributed 94.1% of the company’s total quarterly revenues and was the only profitable segment of the whole company. This makes APLD essentially a purely crypto mining play, despite the Cloud Services segment seemingly promising AI spin. In fact, for the latest quarter, APLD’s AI segment lost almost 83.0% of the profits that the Hosting segment generated. This throws cold water on the AI narrative that APLD has. In my opinion, the company remains a crypto-related venture almost in its entirety. Source: APLD’s latest 10-Q. However, this is not necessarily a negative thing, and the recent rise in Bitcoin’s price has been an undeniable tailwind for the company. Since it’s a crypto mining-related company, demand for cryptocurrencies increases the price of these financial assets, making mining more profitable. The more profitable crypto mining is, the more mining operations will occur. This directly impacts the company’s revenues, as APLD was the quintessential shovel-selling company during Bitcoin’s gold rush. This is a rather profitable approach to the nascent cryptocurrency sector, and analysts currently expect APLD to generate roughly $754.89 million in annual revenues by 2025. Source: Seeking Alpha. If such revenue growth materializes, APLD will have increased its revenues from $8.55 million in 2022 to $754.89 million by 2025. This would be an incredibly high revenue CAGR of 345.3%. APLD currently has $104.0 million in debt and a small cash reserve of $5.9 million. Moreover, I estimate the company burned through $28.1 million in cash during the latest quarter. I obtained this figure by adding the cash flow from operations and net CAPEX. This is concerning as the company will soon run out of cash to sustain its operations. Naturally, if such impressive revenue growth materializes, the additional revenues should be able to fund APLD’s cash needs. However, there appears to be little breathing room for APLD at this juncture, which is why the next quarter will be vital. If APLD shows growing cash reserves alongside a substantial revenue jump, I presume APLD could soon become a cash-generating machine. However, until then, APLD’s low liquidity has been a question mark for the company, adding uncertainty to the stock as a potential investment. Nevertheless, if we assume APLD will indeed grow its revenues as expected, its current price tag appears too conservative, bringing a potential investment opportunity. The valuation equation would be rather simple. APLD’s latest 10-Q claims its Hosting segment has a 26.2% profit margin. Since APLD’s revenues are 94.1% Hosting revenues, most of the company’s future growth will come from this segment. It’s hard to picture the company's revenue mix in the future. Still, even if we assume that just 50% of the projected $754.89 million 2025 revenues come from Hosting, that’d imply $98.89 million in annual Hosting profits. Since APLD’s current market cap is $728.32, it’d price the company at a 7.4 P/E ratio and a 1.0 P/S ratio. These valuation multiples are arguably cheap on their own but particularly inexpensive when considering APLD would easily be a high-growth company, further corroborating APLD’s “buy” thesis. Investment Thesis Risks However, as with most investments, risks are involved, and APLD is no exception. APLD’s risks are mainly related to crypto and AI. These are rapidly evolving trends, and crypto is notably volatile. When there are periods of rapidly appreciating cryptocurrencies, APLD should benefit, as I previously discussed. However, the reverse is also true. Moreover, APLD’s business model is highly capital intensive, dealing with maintenance costs and regular CAPEX investments to grow and sustain its business. If a decline period occurs and APLD is caught off guard with low cash reserves, it’d quickly burn through its cash and face low liquidity risks to fund its operations. I don’t think APLD is an imminent bankruptcy risk, but it’s hard to imagine such a scenario occurring without a severe price drop in APLD’s stock, which is why it’s worth considering this risk. APLD has rebounded alongside Bitcoin’s price. (TradingView.) Additionally, it’s uncertain if the Cloud segment will remain as unprofitable as it is today. In my “buy” scenario, I didn’t account for the rest of the revenues being also profitable, or at least not meaningfully unprofitable as they are today. Concretely, suppose the remaining 50% of revenues were as unprofitable as APLD’s Cloud segment was this latest quarter. In that case, it’d wipe out 83.0% of the Hosting segment’s profits and materially worsen APLD’s valuation equation. So, the buy thesis is inherently embedded with the assumption of improving Cloud margins, which is realistic but not guaranteed, making it a vital risk to consider before investing in APLD. Conclusion Overall, APLD is a promising company that’s essentially a bet in crypto mining at this stage. It may become more of an AI investment in the future, but that remains uncertain for now. Nevertheless, APLD is undoubtedly poised to become a growth company benefiting from the rise of cryptocurrencies. Its valuation equation appears undervalued at this stage as long as its projected growth materializes, which is a reasonable assumption. Given that the current price tag is remarkably cheap in the face of the forecasted revenue growth, I think there’s a wide margin of safety embedded in APLD at these levels. In my view, this makes APLD a reasonably good “buy” at these levels.
