The Drop in Credo Technology Group (CRDO) . . . is justified

The Valuation Knife Cuts Both Ways

Life and everything else important has had me away from posting. And at that, even this one will be a quick one.

CRDO, one of the AI supplier darlings reported what appeared to be a strong report this week but the next market day got crushed, down ~16%. Year over year revenues up over 120%, it flipped to being GaaP positive and they guided above estimates, what gives?

Expectations and guidance, as usual. Michael Mauboussin has laid out in his Expectations Investing tome, perhaps the most singular and complete thesis to equity prices, especially in the technology industry. Below are some examples of this in play.

Four main points:

1. Expectations were lofty: all revisions for revenue and EPS have been/are up. There was little room for disappointment. Revenue now is expected to be + 120% and EPS +566% for FY’25. As you will see below, that was not good enough and more was priced in.

2. Earnings numbers were solid: + operating leverage, GaaP positive and continuing to grow. However, barely GaaP positive so the premium RELIES on continued execution as such.

3. KPIs have seen continued interval deceleration, YoY revenue is flattening out and went from 40s to teens/twenties. And due to investments, FCF/share is flat to negative. The intrinsic value of a company when teetering on the brink of being FCF/GaaP positive, especially when priced out 3, 5 or 10 years changes A TON when this flips. Hence I identified it as being on a "valuation thin edge" (slide 3)

4. Guidance for revenue and operating expenses suggest a possible reversal of operating leverage, which could mean they are GaaP negative, FCF negative and further KPI deceleration in place, this quarter or next (see below). Caveat here is that if their volume does allow for operating leverage, this should not happen. They did not break out in the guidance how much of the expenses will be for growth per se but the indication is that the ROIIC is capped or negative here.

Hardest thing to know with these multiples is where the market wants it. Here looking at base rates is helpful (peers, history); at the same time, it might be hard given the AI/Blackwell run up that apparently inflated all AI asset prices and not a ton of history behind how AEC or retimer companies have fared.

That is why we sold ALAB at ~$100/share after their earnings and why we did not enter CRDO but laid out (at least a near term) short thesis. We have an investor who is still short CRDO but likely exiting today.

Thanks for reading,

AlphaDoc