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Chapter 1: What climate risks do data centers face?
The SaaS apocalypse was the wrong apocalypse today on Motley Fool Hidden Gems Investing. Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors, Pat Frankel and John Quast.
So we're going to get into the kind of decline, I guess, if you will, of the IT services consulting industry over the past couple of years based on Accenture's earnings that were released earlier today. And we're also going to do something a little bit different. It's a special message from Molly Fool at the end here.
But we're going to start today with a recent report on how climate could be a much bigger factor for data centers than originally thought. Now, Matt, you originally brought this idea to the table with us.
Chapter 2: How does climate change impact data center operations?
So what was the market missing about data centers that this report was bringing out?
Yeah, so there's a study by First Street that was released today. It analyzed 97 different data center markets around the world. So the headline is that nearly 90% of our global data center capacity today, not what's being built, is at an elevated risk from climate-related hazards. Think flooding, think windstorms, wildfires.
So most underwriting when you're buying insurance for real estate, it still uses historical data, which isn't doing a good job of predicting how climate events perform today. I know John lives in Florida. This is why a lot of insurers have exited Florida because the past looking data isn't doing a good job. So data centers are generally expected to operate for 20 to 30 years.
So this could become a big problem, especially as we rely more heavily on data centers for all of our AI infrastructure needs.
Chapter 3: What are the financial implications of climate risks on data centers?
So some of the most exposed markets are international, like Asia Pacific is the worst. But Northern Virginia, which we would call the data center capital of the United States, has an above average level of exposure here. So here's the key takeaway. And this is confirmed by separate research, not just this study. So by 2030,
More than half of data center hubs are going to find their water supplies stressed due to their cooling demand. Data centers produce a lot of heat. They actually create what are known as heat islands by warming the land around them by as much as 16 degrees in documented cases. Now, all of this can be mitigated at least on the building level. You could build buildings to be flood resistant.
That's something that you see all the time in Florida. You can see power sources being upgraded. You can see cooling systems. But the stress on the supporting infrastructure, the power grids, the roads, the water supply in the local area, it's a real problem that's being overlooked. This is...
definitely a topic that's been bubbling up from time to time and kind of manifesting in various ways and also not mentioned like in their report and i think we've all hinting at it too is that data centers are really expensive and so the like the cost of these and getting them right makes a lot of sense you know you're saying flood resistant buildings and whatnot but i'm thinking of like metas
Hyperion Data Center, which is being built in like Northeast Louisiana, that's expected to be a $200 billion facility.
And so, you know, if you have to insure a, you know, a warehouse that's maybe a few million dollars, that's one thing, but $200 billion insurance or like trying to mitigate that risk when you're doing construction is a big deal because over the next 20, 30 years, who knows what's going to happen. So I have a two-part question for you both.
Is there a specific part of the market within this AI infrastructure, data center build out, that you see this report actually impacting? And then on a scale of one to 10, 10 being like the most actionable, how actionable is this to investing in that specific market?
Well, let me just start with the one to 10 scale.
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Chapter 4: Why is the IT consulting industry struggling?
In isolation, I would say this report from First Street is actionably a one. You know, I don't want to say that there's nothing wrong here with the climate whatsoever or anything wrong with the study. But let's be clear. First watch, it's on a mission to connect climate and financial risks together. That's why it exists as a research firm.
So it doesn't surprise me that it's sounding the alarm a little bit here on preparedness for climate risk. And some of the key constituents here would actually push back, including some of those who are building the data centers, saying we're very aware of the climate risks and we're already taking measures to counter those risks.
So I don't think that there's anything really new here personally from the First Street report. Now, that said, I mean, there is a huge build out trend. And there are lots of constraints that we're running up against.
Chapter 5: What did Accenture's earnings report reveal about the industry?
And it's not just climate related. I mean, you look at just the land issue that it takes. We need more data centers for AI, or at least they want to build more data centers for AI. what? A lot of people are becoming increasingly uncomfortable with the land in their city, in their county being used for that purpose. Right or wrong, that is the perception that's growing.
Power is also something that's coming up against the wall, even chips. I think this is an interesting one. There's some, as far as how much compute we want to put in these data centers, Is Taiwan Semiconductor even capable of churning out that many right now? Elon Musk would say no, which is why he's investing in the TerraFab, right? And we need more.
And there's no player out there that can supply everything that we need. So there are many constraints. As far as actionability, when it comes to that, I would say it's more of like a five. Yeah, there are a lot of constraints that are worth thinking about. I think that there's a place in your portfolio to think about smart use of limited resources.
So in my portfolio, for example, I have Badger Meter. This is for water management. That, to me, just makes sense.
Chapter 6: How are AI advancements affecting IT consulting firms?
We need to be smarter with our water, and you can do that with the products and services that Badger Meter supplies. I can see a case for iChon, which is more power management, stuff like that. But then... Man, I also think about if we do run up against some walls here in the build-out, that is kind of an issue because there are some stretched valuations in the stock market.
A slowdown in the build-out could impact those things. So just some things to keep an eye on.
Yeah, so I would say the cooling solutions for data centers in particular are an excellent opportunity to invest in this right here. So Vertiv, ticker symbol is VRT, that's one of the most direct ways you can invest in this. They make power management systems, thermal management systems, and liquid cooling systems, all for data centers.
It's already been one of the best performing AI infrastructure stocks in recent years, but the massive cooling needs, especially as, you know, from the climate related issues are not totally priced in yet. So I'm also at a five or so when it comes to actionability. And the reason is because the need for data center cooling was already an investable trend.
This is not new because of a climate study. This is why stocks like Vertiv have performed so well. This certainly adds to the bull thesis, which is why I kind of split the difference with a five.
I'm perplexed by this one too, because my immediate thought when I saw this was to that point about Meta and its 200 billion, billion with a B facility, I started thinking about insurance. Because how the heck does a single insurance company insure a $200 billion building for something like flood insurance or hurricane insurance?
From an actionability standpoint, I can see this being a huge risk and almost to my thing, it's like a six or a seven, but it's really hard for me to figure out specifically where that risk is located. I'm not looking at like Berkshire Hathaway's Geico doing auto and homeowner insurances. That's going to be an essential or existential risk for somebody like that.
But there is somewhere along the chain of insurance that is going to be tied to these massive data center build out, probably somewhere in the excess and surplus industry. I don't know where it is, but I definitely want to go digging and find out. Coming up after the break, we're gonna talk about IT consultancies and why they're doing so lousy lately.
every tuesday we cover apple news on mac break weekly hi this is leo laporte from the twit podcast network inviting you to join me christina warren andy inaco and a special guest john gruber from daring fireball we're one week after wwdc the reality distortion field has worn off what does apple intend to do with its brand new siri and apple ai where is it going Where has it been?
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Chapter 7: What investment opportunities exist within the cooling solutions market?
Maybe some are going to do well, some are going to fail. But one place that I think is getting not nearly as much conversation related to the doom and gloom is the IT consultancy and IT services industry, because this is an industry that's hurting even worse.
And just as an example, shares of Accenture are down about 17% today as we're taping after the company reported its fiscal third quarter results. It was a story that we heard quite a bit. Numbers for the quarter look relatively fine, but it's the things that didn't really get said that had everyone worried. That's what I think we saw, right, Matt?
Yeah, I mean, as you said, the numbers look fine, and that's a good word for it. Revenue was up 6% year over year, basically in line with estimates. Earnings were up 9%, slightly beat estimates. Operating margins showed a pretty solid improvement. And to be fair, management's showing really good cost discipline. That's why margins are growing. That's why earnings are growing faster than revenue.
But revenue guidance was narrowed to 3% to 4% for the full year from previous range of 3% to 5%, so slightly lowered. There's no more surefire way to make a stock go down than to lower your guidance. Earnings growth is supposed to be about 10 to 11% for the year. It's fine, but nothing to get excited about. The guidance, like I said, is the biggest drag on the stock.
Three to 4% earnings growth, quite frankly, doesn't justify much more than the 13 times earnings it's trading at after this drop.
Yeah, the saspocalypse has been a topic that's often covered in financial media.
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Chapter 8: What is the SEC's proposal regarding financial reporting, and why does it matter?
And certainly we've dipped our toes into it from time to time. It makes for pretty good chatter. And at the same time, there's a lot of people who have stocks in the saspocalypse kind of trade that have not done so well recently. Now, a thesis has kind of had mixed results so far. What we haven't probably spent enough time is on this IT consultancy apocalypse.
Over the past decade, shares of Accenture are up a meager 32%. And that's after probably almost a 50% drop from their highs. And Accenture is one of the best performing IT consultancies over that time. You look at companies like Globant or EXL Services. These are all companies that are doing far worse.
And it's really impacting, not just like any single company, but anybody who's invested in this industry is really hurting.
Yeah, and I mean, Tyler, we've sold some of those in our Hidden Gems services throughout The Fool, and for that reason, because it's an undercovered story, but it is really hurting lately. And I mean, on the other side of it, we've added some stocks that have IT consultancy businesses, but do a lot of other things that are getting ahead of the AI curve.
I'm going to mention one of those in just a minute. But it's, you know, we have been kind of, we've been seeing this for a while now.
Yeah. And this is, I feel like a quandary for most investors because so far the financial numbers for all of these mentioned IT services companies, they're still okay. Revenue's still growing. It's not as good as it was, but I wouldn't say like five alarm fire sort of things. And a lot of the stock decline has been basically drastic changes in market sentiment and stock valuation resets.
So I want to get both of your opinions on this one. And John, I'm going to go to you first. At These valuations deeply depress stock prices. Is there a company in this industry that's worth considering?
Or based on what you've seen from AI and some of the threats we've seen recently, is this just like a no-go area until they can figure out how to compete or build businesses that are more complementary to AI?
Yeah, for me, the IT space is completely uninvestable right now. It's a no-go. Now, that said, I mean, it's just a space that's going to be full of losers, I think. Now, not to say there's not going to be any winners in the space, but I just prefer to avoid the entire space because there are so many landmines out there. You mentioned that the numbers are still okay, and that is a good point.
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