One key concern has emerged from
Dell
Technologies’ earnings report and conference call: Whether it makes money selling AI servers.
Dell
posted April quarter financial results that topped Street estimates on Thursday, but the results also reflected lower-than-expected margins, in particular in the company’s infrastructure services group, which includes servers, storage, and networking gear.
That segment had revenue of $9.2 billion in the quarter, up 22% from a year ago, and ahead of the Street consensus at $9 billion. That includes 42% growth in servers and networking revenue.
Shipments of AI servers were up more than 100% sequentially to $1.7 billion. Dell said its backlog of orders for AI servers jumped 30% to $3.8 billion from $2.9 billion one quarter earlier.
That is impressive, but nonetheless not quite as strong as the bulls had hoped. Mizuho analyst Jordan Klein writes the backlog figure “missed the high buyside bogey” in the $4.5 billion to $5 billion range, and that in the January quarter AI server backlog had doubled sequentially.
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Klein also notes
Nvidia
“makes all the money selling GPU optimized hardware and systems,” with not much left for anyone else.
On the call, Bernstein analyst Toni Sacconaghi wondered if Dell is selling AI servers at zero margin.
“If I just look year-over-year at the ISG business, storage was perfectly flat,” he said. “AI servers went from zero to $1.7 billion, which sort of suggests that traditional servers were flat. So, really the only thing that changed was you added $1.7 billion in AI servers and operating profit was flat. So, does that suggest that operating margins for AI servers were effectively zero?”
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Dell CFO Yvonne McGill responded on the call that when it comes to AI servers, they are “margin rate dilutive, but margin dollar accretive” for Dell, which implies the company drops a smaller slice of each dollar to the bottom line on AI servers than on other hardware, but the result nonetheless is higher overall net income.
McGill also noted on the call that in general it is seeing increasing competitive pressure for business from enterprise customers.
In a research note Friday, Sacconaghi wrote that the operating margin weakness in the quarter resurfaced “concerns that AI serves are being sold at near-zero margins.” He estimates that AI server operating margins were about 5% in the latest quarter.
Sacconaghi said the “poor incremental profitability from AI servers” likely caps near-term earnings upside for Dell. Still, he remains bullish on Dell’s AI opportunity for the long term and continues to the rate company at Outperform, with a target of $155 for the price.
In an interview with Barron’s,
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C3.ai
CEO Tom Siebel suggested that in the long run, most of the value in AI will go to the application providers.
“Let’s look at the AI stack,” he says. “At the bottom we have silicon, and above that we have infrastructure. Above that we have foundational models, and on top of that we have applications. The bulk of the value in the market today is being attributed to silicon and infrastructure. It was the same thing in the PC market in 1990. But as we saw in PCs…in the long run, silicon gets commoditized, because it always does, and the infrastructure gets commoditized, because it always does. We’ve seen this movie before.”
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Melius Research analyst Ben Reitzes pointed out gross margin in the quarter came in 70 basis points below consensus estimates—and the company reduced its full-year margin guidance.
“While component cost pressures were well known, a negative mix shift within storage, pricing pressure in traditional servers and upside in the lower margin AI server category were the issue—and it lingers this year,” he wrote.
Reitzes nonetheless remains a Dell bull.
“We get it—it ran a little too far too fast,” he writes. “However, it’s a buy here as PC’s are set to turn, AI servers are still soaring, and storage can still pick up.”
The concerns about Dell’s AI server margins are seeping into other AI hardware plays, with
Super Micro
down 7% and
Hewlett Packard Enterprise
off 5%. Dell shares have plunged 21% in the wake of the earnings report.
Write to Eric J. Savitz at eric.savitz@barrons.com
