TD Cowen on Data Centers: 'MSFT Pullback Created Opportunity for GOOG & META'

TD Cowen analyst Michael Elias weighs in on GOOG and META stocks following MSFT lease cancellations.

The analyst commented: "Our channel checks at NVIDIA GTC and DCD Connect indicate aggregate data center demand has increased Y/Y despite more pervasive lease cancellations/deferrals by MSFT than initially thought, which created an opportunity for both GOOG and META to backfill capacity. Hyperscale redesigns for higher densities are driving slower DC equipment purchasing, which we view negatively for 1H25 VRT orders.

A clear takeaway from both NVIDIA GTC in San Jose last week and DCD Connect in NYC this week is that aggregate hyperscale data center demand has increased Y/Y driven by the same factors we highlighted in late February. Specific to Microsoft, since publishing our initial note on Microsoft lease cancellations, our incremental channel checks indicate that the list of third-party data center operators affected by lease cancellations has expanded, with leases being terminated in both the U.S. and Europe. In addition to lease cancellations, our channel checks also point to lease deferrals by Microsoft. As we put this in the context of our Takeaways from PTC, Microsoft has both (1) walked away from +2GW of capacity in both the U.S. and Europe in the last six months that was in process to be leased, and (2) has both deferred and canceled existing data center leases in both the U.S. and Europe in the last month. In our view, the pullback on new capacity leasing by Microsoft was largely driven by the decision to not support incremental Open AI training workloads. However, we continue to believe the lease cancellations and deferrals of capacity points to data center oversupply relative to its current demand forecast. As such, we believe the lease deferrals are intended to provide Microsoft with a medium-term runway of capacity in major markets to support cloud/inference workloads, with Microsoft canceling leases for capacity that exceeds its updated medium-term capacity needs.

Positively for third-party data center operators, our checks point to Google stepping in to backfill capacity that Microsoft walked away from in international markets, while our checks point to Meta backfilling capacity in the U.S., as both of these hyperscalers are in the midst of a material Y/Y ramp in data center demand. The ramp in demand from Google is driven by what we increasingly believe is a global capacity shortfall as its internal demand ramped amid its late August pullback from the market (which we highlighted in September 2024) stemming from an internal initiative to increase the utilization of its existing data center fleet. As for Meta, the demand ramp comes as it is meaningfully increasing its data center capacity in support of Llama. Separately, our checks point to OpenAI increasingly looking to procure data center capacity directly from third parties (including both GPU as a Service providers and third-party data center operators) with its recently announced deal with CoreWeave as an example. Furthermore, we are observing notable LT data center capacity ambitions from OpenAI as our checks point to its intention to create multiple Stargate projects with each Stargate representing between 800MW and 1.5GW of capacity, potentially totaling +6GW of cumulative LT capacity needs. As it looks to fulfill its capacity needs, our checks point to the hiring of individuals by OpenAI from other hyperscalers with design and construction experience as well as capacity planning experience, which in our view, points to the potential for OpenAI to begin self-building data centers in the mediumto-long term.

Our Checks Point To A Slowdown In Data Center Equipment Ordering Amid Hyperscale Redesigns To Support Higher Rack Densities, We View Negatively For 1H25 Vertiv Order Volumes

Our channel checks indicate a slowdown in data center equipment ordering, which started in January stemming from the hyperscalers redesigning their go-forward data centers to support higher rack densities as Nvidia continues to iterate on its roadmap, which is pushing rack densities higher. As an example, our checks point to the finalization of a liquid-to-liquid solution by Microsoft (separate of the air-assisted liquid cooling solution for data center retrofits highlighted below) with other hyperscalers undertaking similar redesigns (Google appears to be the furthest ahead from a redesign perspective). However, the derivative implication of these redesigns is that both the hyperscalers and third-party data center operators supporting the hyperscalers are largely unable to place orders for equipment until the new design is set forth as the specific type of equipment needed will vary based on the end design. To that point, our supply chain checks point to delayed data center equipment purchasing decisions with orders for leased hyperscale capacity being pushed out by one to two quarters. Furthermore, when coupled with a considerable degree of equipment warehousing on the part of third-party data center operators in an attempt to expedite speed to market moving forward, we view the result as an NT air pocket in equipment ordering, which we believe is likely to weigh on equipment order volumes for Vertiv in 1H25."

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