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January 10, 2022
Initial public offerings from semiconductor companies are so rare that when networking chip designer Credo Technology filed its prospectus with the Securities and Exchange Commission, it’s worth taking note.
The San Jose-based chip company elected to file its S-1 the first business day of 2022, Jan. 3. It has yet to announce a share price, or exactly how much it will raise — using the standard placeholder value of $100 million, which it will update as it gets closer to listing day. As a private company it has raised more than $200 million from investors such as BlackRock, Samsung, Cisco, and Walden International.
What does Credo do?
Founded in 2008, Credo makes chips and components that help hyperscale data center operators like AWS and Microsoft as well as 5G wireless network operators that move large amounts of data around at high speed inside their facilities. In its prospectus the company describes itself as serving the data infrastructure market, which increasingly demands more bandwidth capacity while consuming less power.
Specifically, Credo designs application-specific integrated circuits, or ASICs, and optical display signal processors. Beyond chips, Credo also sells active electrical cables for intra data center connections.
Credo said in the S-1 that the large and growing amounts of data and network traffic generated every year require increased bandwidth, and “we expect rising demand for our products as speed requirements increase over time. Additionally, we intend to continue to develop new offerings that will expand the capabilities of our portfolio and address a broader section of the total wired connectivity market.”
How does Credo make money?
Even though the products Credo makes fit into the increasingly complex data center infrastructure market, the business itself is straightforward. The company makes money primarily in two ways: selling its various networking chips and components, and licensing some of its technology to customers. The company said it sells products to both vendors and customers directly.
Credo disclosed that it sells its active electrical cables to Amazon and Microsoft. And it said that it was “engaged with” five of the top seven hyperscale data center operators — in the U.S. the largest are Amazon, Microsoft, Google and Facebook.
Credo is a fabless company, meaning that it relies on chip manufacturers to fabricate chips and doesn’t build or own manufacturing facilities of its own. In the prospectus, Credo said the approach allows it to focus on engineering and design as its core business, and dole out less cash for capital spending. Fabless companies have come into favor on Wall Street, as they reduce the risk of running into manufacturing stumbles like the setbacks that have damaged Intel.
- Credo’s revenue grew 9% to $58.7 million last year, from $53.8 million in 2020. In the last six months the company has reported, the company’s top 10 customers accounted for about 88% of its overall revenue. Credo said in the prospectus that a small group of customers will likely continue to generate the bulk of the company’s sales.
- The bulk of Credo’s revenue was from product sales, which generated revenue of $27.5 million last year, up from $11.6 million a year ago. Its IP license segment shrunk considerably to $17.2 million from $33.7 million a year ago.
Credo has turned a modest profit in the past.
- But Credo swung to a loss of $27.5 million last year, from a 2020 profit of $1.3 million. The prospectus said that the company has a history of generating losses. Adjusted for stock compensation expenses, which are non-cash charges that companies must include in standard financial results, Credo lost roughly half as much money, $13.9 million, in 2021.
- As of Oct. 31, Credo had $71.1 million in cash and equivalents.
What could go wrong
- The company has a significant amount of exposure to China. Because Credo has operations in mainland China and Hong Kong the company has to contend with the unpredictable legal system as well as potential government intervention in Credo’s China operations, if it deems it appropriate to advance its political, societal or regulatory objectives. Political instability in Hong Kong could hurt the company too.
- The good news is that most of Credo’s revenue comes from outside of China. According to the filing, in fiscal 2021, Credo generated 0.3% of sales in China, and 7.7% of revenue in Hong Kong. The company also owns very little in the way of assets in China or Hong Kong.
- Since a big chunk of the company’s business depends on the capital spending plans of hyperscale data center operators such as Amazon and Microsoft, a slowdown could hurt Credo. Global macro-economic conditions have triggered a reduction in capital spending plans on data infrastructure equipment, the prospectus noted.
- Global economic downtowns also contribute to the cyclicality of the semiconductor business. Typically during a recession there is a significant amount of excess production capacity, and chip companies have a high level of inventory. Too many chips flooding the market tends to hurt prices, which could damage Credo’s profit.
- Credo doesn’t make its own chips, which means it relies on contract manufacturers such as TSMC and others. A surge of demand for chips has pushed the manufacturers to their limits. But it has also given fab companies such as TSMC the ability to raise prices. According to the prospectus, TSMC said it was going to increase prices of its most advanced chips 10% and less-advanced chips by 20%, effective in late 2021 or early 2022, which will cut into Credo’s profit.
- The chip manufacturers can also grant or eliminate capacity to Credo which could become a limit on how many chips it can sell. And since Credo doesn’t have long-term supply agreements in place with TSMC, it’s possible that could make it harder for Credo to deliver products ordered by a client.
- TSMC and other Taiwanese suppliers are critical to Credo’s supply chain. If China-Taiwan relations deteriorate, it could have significant consequences for the company.
- It’s worth noting that the company has an unusual structure and is technically domiciled in the Cayman Islands, which carries its own batch of risks, mostly for investors.
Who gets rich
- At the moment, Credo’s prospectus doesn’t include who is selling stock for the IPO. But the company’s venture investors have included BlackRock, Walden International, Samsung Oak Holdings, Everest Investment, Cisco’s venture unit, Skylark Partners, and A&E investment.
- To keep Amazon as a good customer, Credo issued a warrant on Dec. 28 that gives Amazon the right to buy just over four million shares of regular Credo stock for $10.74 a share. According to Credo’s SEC filings, the warrants have an assumed valuation on the issue date of $1.5 billion. But Amazon only gets the warrants if it buys a certain value of products from Credo (the exact amounts are redacted in the filing).