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Big backlogs, cloud cash shield server makers from economic turmoil – for now

As with all good things, it won't last forever

Analysis It's been a rough month for big tech. Meta, Alphabet, Microsoft, and Amazon Web Services (AWS) all reported slowing demand across their core businesses, made worse by a less than rosy outlook on the future.

With hyperscale and cloud customers among the most voracious consumers of datacenter equipment, it might seem natural this quarter's results would spell doom and gloom for suppliers. But while demand for PC and consumer electronics may be headed for a cliff, that doesn't appear to be the case just yet for datacenter equipment vendors, Dell'Oro analyst Baron Fung tells The Register.

First, despite weaker than expected results, the hyperscalers and cloud providers continue to invest heavily in infrastructure. "Meta has a tendency to keep increasing its capex, especially if conditions look challenging," Fung says, adding that despite an otherwise rough quarter for the Social Network, CEO Mark Zuckerberg hasn't deviated from this strategy.

As we reported last week, Meta is in the middle of an infrastructure investment cycle as the company looks to build more headroom into its datacenters. And they're not alone. Earlier this month, Oracle announced it was adding "tens of thousands" of Nvidia A100 and H100 GPUs to its public cloud.

Meanwhile, AWS, GCP, and Azure continue to bring new cloud regions online almost monthly. "We are seeing a bit of a slowdown, but again, these companies are looking long term," Fung said.

This is likely why chipmakers like AMD and Nvidia are so optimistic about the datacenter market, especially considering the beating they're taking in the consumer space. Intel remains the one outlier here. On top of seeing revenues fall 20 percent from this time last year, the company's datacenter group fared even worse, falling 27 percent year-over-year in Q3. But it's worth noting that Intel's latest Xeon CPU is now more than 1.5 years old.

The impending launch of Intel's Sapphire Rapids Xeon family, which is expected to offer higher core counts, probably isn't doing the company any favors as customers hold off on picking up Intel-equipped kit until it's available, Fung notes.

While Fung anticipates cloud and hyperscale spending to remain strong for the next few quarters, he does expect things to slow down sometime in 2023. However, it won't be as a result of the recession or supply chain woes. Instead, he argues cloud providers are due to start their normal digestion cycle – a period of reduced spending and increased focus on implementation and optimization.

Battling backlogs

Continued demand for datacenter equipment over the next few quarters is likely to further extend an already lengthy backlog of sales for vendors like Dell, HPE, Lenovo, Supermicro, and others. But that's not to say the datacenter market is out of the woods just yet.

"This backlog ranges anywhere from entire datacenters that are being delayed to networking gear, servers, and so on," Fung says. "Customers are still really hungry to get their hands on equipment."

These backlogs are unlikely to resolve themselves until lead times for essential semiconductors improve dramatically, he explains, adding that it's the small, low-value components that are causing the biggest headache for OEMs at this point in the semiconductor crunch.

Instead of trouble getting hold of CPUs, GPUs, or memory, the biggest difficulties come from things like metal-oxide-semiconductor field-effect transistors (MOSFETs), diodes, and capacitors, which are essential to building complete systems or peripherals. The availability of one of these components can mean the difference between shipping a system or not. The good news is lead times for these components are showing signs of improvement, falling to just 26 weeks, according to Susquehanna's latest report, but that's still far from the 10-14 weeks analysts consider to be healthy.

These backlogs, combined with higher average selling prices, are serving to insulate OEMs from any economic turmoil at least until the middle of next year, Fung says. "I looked at previous economic cycles – the recession of 2009, 2000 – and in those periods, there is also always a very sharp downturn in IT spending. We do expect a similar downturn for next year, but it's just that there's a really big backlog that's masking overall demand."

However, that could change if IT customers, faced with deteriorating economic conditions, start canceling orders. "We haven't really actually seen customers canceling anything yet. I think many are still keeping the orders, given the long lead times and not wanting to lose their place in the queue," he adds.

Heading into the middle of 2023, Fung expects these backlogs to subside as supply and demand come into some semblance of equilibrium, something that will likely come as a relief to those waiting months to replace critical equipment. ®

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