Summary Applied Digital has landed a second cloud services customer. This one could potentially bring in as much as $460 million in revenue over 3 years. The Company also announced a shelf offering for up to $125 million in new common stock shares at the market. This is rather significant dilution. While I'm still personally long the stock, I think it's wise to wait for another conference call before adding any long exposure. When I last covered Applied Digital ( APLD ), the stock was working on a 300% year to date rally that was largely fueled by the announcement of a cloud services customer in the artificial intelligence space. That service agreement could provide up to $180 million in revenue over 24 months for APLD. For a company that has less than $41 million in trailing twelve month revenue, it's potentially a big deal. Given what I viewed as an irrational explosion in the stock price since the announcement, I've taken a far more cautious approach and locked in some profit. I detailed why in a May article. There were a lot of comments questioning my pivot from "buy" to "hold" and some of those comments were very good. With the benefit of a month of new information and market performance, those who have steadfastly held APLD shares rather than taking profit have done well. The stock closed the June 26th session at $9.19 - up 400% on the year - and that's after a retrace from a high of $11.62 on June 23rd. Data by YCharts Of course, this is just price moves. There have been a lot of new developments for Applied Digital since my May article and we'll try to unpack them in today's update. Second Cloud Services Customer On June 23rd, Applied Digital announced a second cloud services customer in the AI industry. This time, the agreement has the potential to be for substantially more revenue than the first one with customer #2 potentially leading to as much as $460 million over 36-months. Similar to the customer #1 announcement, details on the agreement with customer #2 were very limited. There was no figure given for baseline revenue expectations, no timetable, and unlike the first announcement there was no prepayment mentioned regarding customer #2. While Applied Digital isn't publicly naming who these customers are, on June 24th, APLD CEO Wes Cummins tweeted a link to a Bloomberg article titled "These Are the 10 AI Companies to Watch Right Now." In the tweet, he indicated both of Applied's cloud services customers were mentioned in the Bloomberg post: Wes Cummins Tweet 6/24/23 (Twitter) While some readers may not be able to access the Bloomberg link because it has a paywall, the following are the 10 companies mentioned in the article: OpenAI Stability AI Runway Hugging Face Cohere Anthropic Character.AI Midjourney Scale AI Abnormal Security With the exception of Midjourney, which is self-funded, every single one of these companies has at least 9-figures in funding and billion dollar valuations. Most of them have multi-billion dollar valuations. Comments on Cummins' tweet requested more details regarding exactly who Applied Digital has agreements with, Cummins responded with this: I would love to announce them and eventually we will. There is some sensitivity on our customer’s side right now. Basically don’t want to rock the boat with their current provider until our capacity is ramped. This is an interesting comment for a variety of reasons. In my opinion, it does add an element of concern knowing Applied Digital's clients are already being serviced by other providers since we don't actually know what the baseline revenue expectation is from these agreements. For me, it reads a little too close to "if you build it, they will come." But I recognize you can't realize revenue from capacity you don't actually have. Applied Digital has been attempting to scale that capacity and recently energized its Ellendale, North Dakota facility in March. Between the company's Ellendale and Jamestown sites, Applied Digital has 280 MW of total hosting capacity in the state of North Dakota. There is an additional colocation services facility in Garden City, Texas. According to Applied Digital, the company has 240 MW online servicing crypto mining customers with an additional 246 MW planned. Revenue vs Projections In a recent filing , Applied Digital is guiding for 4th fiscal quarter 2023 revenue of $22 million - which is below market expectations. The degree of the miss varies depending on which financial resource one chooses to use: APLD Rev Estimate (Yahoo Finance) Citing 7 analysts, Yahoo Finance was projecting over $30 million in revenue for the current quarter while Seeking Alpha's $23 million estimate was far closer to what Applied Digital is now guiding for. Regardless, $22 million is an underwhelming figure given all of the lofty revenue figures that have been shared in recent cloud services client announcements. Customer Months Revenue Potential Quarterly Rev Potential Cloud Client 1 24 $180,000,000 $22,500,000 Cloud Client 2 36 $460,000,000 $38,333,333 Source: Analyst calculations By my count, the recent cloud services client revenue agreements could produce as much as $60.8 million in quarterly revenue potential before factoring in the revenue from hosting Bitcoin (BTC) miners. If we call that $20 million flat going forward, at roughly $80 million in quarterly revenue, Applied Digital is trading at 2.8 times future sales. This would be a significant improvement in valuation since my last APLD article and would put the company very much in line with sector median. But again, it prices in perfection and doesn't take into account changes to one of the most important inputs in the valuation multiple, shares outstanding. Dilution Coming We've known since shortly after the first AI cloud services client announcement that dilution has been on the horizon and after market on June 26th we received some clarity on that front. Applied Digital entered an agreement to sell up to $125 million in common stock at the market. At current share price levels, this offering would amount to roughly 15.5 million shares sold on the open market: Data by YCharts And there will probably be more dilution to come judging by the $175 million shelf announcement from mid-May. This dilution is unfortunately necessary because Applied Digital doesn't have a lot of cash and doesn't benefit in the upside of Bitcoin price increases to the degree that a self-mining operation might. Other Risks I think it also has to be mentioned that Applied Digital's CEO and CMO apparently are or have previously been in a personal relationship with each other. According to Applied Digital, there was an internal investigation into "a threat, but not a formal assertion, of a sexual harassment claim" by Regina Ingel, the company's CMO. According to filings : Based on information obtained through the investigation, the Audit Committee determined that the relationship between the parties was consensual and the allegations of workplace harassment are unfounded. The Board has reaffirmed Mr. Cummins's role as Chief Executive Officer of the Company and will consider any additional actions that may be appropriate with respect to this matter. I'm choosing to be delicate with my assessment of this; when I see things like this, I get nervous as an investor and I'm going to leave it at that. Summary I want to reiterate, I'm still personally long APLD shares. Though much fewer shares than before. I expect the share price will come back down in the weeks ahead. Even if one takes the view that Applied Digital will be able to reach the maximum potential of these AI cloud services agreements, it's going to be expensive to continue building out the capacity to do so. But to be clear, I don't think this is necessarily bad dilution if the capital raised is used for scaling operations for clients with known demand. But from here, I think we need another earnings report with a fresh conference call before we get too ahead of ourselves.
