The rapid development of Artificial Intelligence (AI) is perhaps the biggest technological change since the open Internet. Much of the focus is currently on mega-cap names—and the question of which of them will gain the lion's share of the AI spoils. How many trillions of graphics processing units (GPUs) is Nvidia going to sell? Will anyone narrow their technological lead? Which of the mega-cap data center providers will win the fight for market share or the battle to provide the necessary High Bandwidth Memory (HPM)? How many household names—and new acronyms—might this technology spawn?
As is often the case with new technologies, small-cap companies tend to proliferate in the background of the megatrend. Nonetheless, they will be meaningful players as they are providing—or will ultimately provide—many of the products and services supporting the buildout of a vast AI infrastructure. And as we often say, we hold companies that will deliver the necessary picks and shovels. In fact, the discussion below represents just a portion of the opportunity we are seeing and does not begin to address the impact that AI will have on driving operating efficiencies in many portfolio names. It should, however, give a flavor of how excited we are about the opportunities for active small-cap investors by the rapid progress of AI.
Much of this opportunity will be somewhat direct. Fiberoptics companies such as Applied Optoelectronics (AAOI, Financial), Coherent (COHR, Financial), and Infinera (INFN, Financial) are poised to provide much of the fiberoptics componentry necessary for these massively high-powered data centers. Modine Manufacturing (MOD, Financial) will provide more mundane, but no less critical infrastructure, such as high-technology cooling equipment. In order to produce the semiconductors needed to support AI, we expect to see another leg up for semiconductor equipment companies. Our portfolio has a number of niche competitors in this space, including FormFactor (FORM, Financial), Onto Innovations (ONTO, Financial), and Ultra Clean Holdings (UCTT, Financial). While these may be niche players, they are at the same time critical suppliers.
One of the increasingly discussed phenomena around AI's development is the intense power demand. When combined with the increased need for electricity for electric vehicles (EVs), power demand looks like a related long-term investment thesis that fits our opportunity to buy key suppliers. This is a broad opportunity set, one that could be a topic in and of itself. However, to give a synopsis—it encompasses engineering & construction companies such as Matrix Service (MTRX, Financial), Primoris Services (PRIM, Financial), and Argan (AGX, Financial), secondary product suppliers such as WESCO International (WCC, Financial) and Newpark Resources (NR, Financial), direct energy suppliers, such as BWX Technologies (BWXT, Financial), and data center providers like Applied Digital (APLD, Financial). Furthermore, this energy will need to be fueled somehow, and despite its currently depressed commodity price, we expect in the intermediate term that this need result in the increased use of natural gas. We see Archrock (AROC, Financial), which specializes in natural gas compression services & equipment, Southwestern Energy (SWN, Financial), an exploration & production business, and Patterson-UTI Energy (PTEN), which offers drilling services, all as likely beneficiaries.
Finally, we see opportunities in securities that we believe have become mispriced due to concerns about the impact AI may have on their business models. WNS Holdings (WNS), Grid Dynamics Holdings (GDYN), TaskUS (TASK), and DHI Group (DHX) are all in the technology services industry where there are fears of disintermediation. We agree that AI is going to be disruptive. Yet if past is prologue, many of these companies can actually benefit, provided they can help longstanding clients embed and efficiently use AI capabilities. It was no surprise to us that several of these companies issued incrementally positive forecasts on their clients' IT spending in their respective 1Q24 earnings releases.
We are hopeful for more positive news for all of the companies discussed in the months and years ahead.
Mr. Stoeffel's, Mr. Hartman's, Mr. Harvey's, and Ms. Venkatraman's thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.
