How to Tackle Supply Chain Disruption

[00:00:00] Gary Fischer, PE: So we’re gonna move into another really interesting topic that’s kind of a hot topic out there, and that’s supply chains and how to tackle supply chain disruption. So we’ve got Hunter’s back and Todd and Hunter are gonna take it from here. So turn it over to you guys.

[00:00:14] Todd R. Zabelle: Yeah, maybe I just frame this a little bit and then I’ll hand it to Hunter and then I’ll come back in.

[00:00:21] Todd R. Zabelle: Hunter and I actually met through another friend that we generally have our business associate and It’s fascinating what is going on in the world of supply chain. We’ve had many discussions about all sorts of things including Neon. But there is a significant issue that’s going on out there Hunter and a couple other people.

[00:00:48] Todd R. Zabelle: And as I said put together a collaboration to figure out how to solve this problem. So I’m gonna hand it over to Hunter and let him present then I’ll follow up with some ideas as well.

[00:01:00] Hunter Newby: Thank you. Yeah, so when Todd asked me to do this, my original thought was that I would be presenting about supply chain impacting data centers.

[00:01:08] Hunter Newby: Which turns out I was gonna talk about the internet and in the future of internet exchanges, but the data center supply chain issue is how we met. Initially, and yeah, it’s a real thing. It’s something that in the industry that I’m in has been present now you know, in everyone’s face recently.

[00:01:27] Hunter Newby: I would say even over the summer as I was asking my bankers on a regular basis if they were seeing any supply chain disruption issues that were coming or that had, you know, appeared that would be impacting multiples, which is like at a macro level what I’m thinking about often.

[00:01:50] Hunter Newby: And every week it was like no, we’re not seeing anything. You know and that’s because I’m out in the market running a process on a facility that I’m a partner in up in Canada. And as we’re going out to run that process, you know, I’m just trying to keep my eye on everything. And about two months ago they mentioned that you know, some people were starting to talk about it within their organization.

[00:02:09] Hunter Newby: You know, they’re a global investment banker Houlihan Lokey and then they started asking and you know, saying to me that their people in London were saying, oh yeah, you know, there aren’t gonna be any deals done for the rest of the year, so it’s time for us to all go on holiday.

[00:02:28] Hunter Newby: And then that was about a month ago and now that’s here. And in a big way the cost of capital has gone up. I’m sure everybody knows that interest rates have gone up. But the supply chain sourcing issues really started a while back. And it has a lot to do with macro picture things that no one that are in our industry necessarily, can really control.

[00:02:49] Hunter Newby: And one of ’em was the availability of optical hardware and then separately high-end generators, like multi megawatt, one, one and a half, two, two and a half size gens and the chip boards and the complex synchronization phase harmonic boards that go with that stuff.

[00:03:11] Hunter Newby: And that all rooted back to the need for silica and etching on those chips, and that all went back to neon, as Todd just mentioned. And what nobody really knew what we found out was that one of the largest neon production plants in the world is based in Ukraine. And it was shut down as soon as the conflict began, and there was so much concentrated there that all the other sources of it couldn’t make up for it.

[00:03:38] Hunter Newby: Because they could only increase production by like one percentage point, whereas somewhere on the order of 30% was taken offline in the world. This created a domino effect of problems that took several months to actually get baked in, but when it finally did, it slowed down the supply chain.

[00:03:57] Hunter Newby: So that impacts people like myself in the industry in a couple of ways. One, new data center construction. You can’t really finish a job if you don’t have all the parts, which sort of points back to the last presentation, which I was watching, listening and thinking. I can totally understand how this would be applicable and it’s great to know all this information ahead of time.

[00:04:19] Hunter Newby: There’s another sort of macro level issue. In one particular region in the United States, in the world which is very important, which is Loudoun County, Virginia also known as Ashburn, Virginia where the local utility company there just told everyone without any notice that they couldn’t deliver any more power because they had no distribution.

[00:04:42] Hunter Newby: They basically ran out of the ability to deliver power in the world’s largest data center. Which carries over a sustained gigawatt of drawn used power every second and that has a certain detrimental impact to projections of certain data center companies that are publicly traded. That if they can’t get power, they can’t turn up customers and they don’t generate revenue, not the revenue that they projected anyway.

[00:05:08] Hunter Newby: And that actually caused a major data center operator publicly traded REIT to miss earnings. So there you go. Full circle on why it’s important to actually know way ahead of time what’s about to happen. So you got these combination issues, right? Lack of power, lack of neon that leads to lack of chips, that leads to a shortage of optical hardware and generators.

[00:05:32] Hunter Newby: Generators impact data center construction completion, and then new product available for the tenants of those, like the hyperscalers and others that build the cloud that everyone runs all these applications on. But also similarly people that are in deals that are waiting for customers to move in, those customers can’t move in and accept their space and power, which means that they don’t start getting billed, which means that you’re missing revenue targets and everything’s getting pushed out.

[00:06:00] Hunter Newby: And that just happened across the board in the entire industry. That was a pendulum swing. It was 180 degrees. And it’s a little alarming to say the least. Where now, you know, I could tell you the multiples were cresting over 30x, which I was super happy about. We’re really strategic, you know, subsea meets terrestrial fiber interconnection facilities, which is something that I really focus on.

[00:06:30] Hunter Newby: It’s like a specialty and I love those multiples. That’s great and now, you know, multiples are coming down because the cost of capital and the supply chain delays have created effectively distressed data center assets. Which is almost unheard of. And now capital will chase those deals. To use a term, not my own, just repeating it, there’ll be bottom feeders looking for deals.

[00:06:53] Hunter Newby: So it’s going to pull capital back from going into Greenfield development, which goes back to my presentation about solving these problems in America and other places where the internet just physically isn’t and needs to be. So there’s a macro, macro picture above all of that, and it’s like, well, why is all of this happening?

[00:07:15] Hunter Newby: Why is the conflict in Ukraine happening and why are some of these other issues occurring? Like why are interest rates going up so much and so fast? And There are a lot of reasons I don’t wanna touch on all of them. But there are certain things that are happening in the world right now in a macro picture that are without question occurring and need to be considered in the bigger picture.

[00:07:41] Hunter Newby: I’ll give you two examples. One, the supply chain globally was impacted because of shipping. And shipping was slowed down intentionally because shipping containers were being investigated, let’s just say. And that all has to do with human trafficking, which is a huge problem, and it’s being stopped.

[00:08:04] Hunter Newby: And that had to basically involve every port in the world and every ship, and a lot of stuff didn’t get delivered. Because these ships were being stopped and searched, and there’s plenty of documented evidence of that, but it’s just not compiled and presented in such a way to explain that that’s what’s causing things to be delayed.

[00:08:22] Hunter Newby: Or at least partially, but a big point. And then the other more macro picture, which I was alluding to earlier, is really the supply chain of money. And I use the term money kind of broadly, the supply chain of fiat currency. If you applied that slide in the prior presentation on the WIP, the WIP of currency are you producing enough currency fast enough that it arrives just in time?

[00:08:49] Hunter Newby: I guess from a central bank’s perspective, they’ve been doing that on an unfettered basis for quite some time. And that too is now well, it’s to say it’s being impacted. What you have to do is get outside of the US and you have to look at the BRICS, the BRICS nations that are adding countries almost on a weekly basis.

[00:09:09] Hunter Newby: And you have to look at the direction that they’re moving in, in terms of monetary policy and actual currency money, actual asset backed money. So Russia has put the ruble back on gold. And that’s a fact. And that’s been over a year now and many other countries are doing the same. Ghana just announced that they are, Zimbabwe as well and many others.

[00:09:34] Hunter Newby: And they’re all joining the BRICS and they’re all doing bilateral financial transactions, not in Federal Reserve notes anymore, which is something that of course was unheard of. But now they’re doing it. So how is that having an impact on the United States and the Federal Reserve notes and I will, you know, just say for the fact that who maybe people don’t know, the Federal Reserve Bank is not part of the United States.

[00:10:01] Hunter Newby: It’s a private entity and they’ve controlled money for over a hundred years in the United States, and that is changing. And you just have to look at the BRICS and see what they’re doing and see how they’re moving back to assets. And yeah, there’s a big component of it that’s physical and there’s also a big component of it that’s blockchain and there’s a network requirement for that, for secure transactions.

[00:10:22] Hunter Newby: And that gets into the whole Starlink conversation. We don’t have enough time for all of it, but the macro, macro picture is those things are happening, and that’s having an effect on the cost of capital and the availability and access to capital, which is going to impact investment and infrastructure and everything else.

[00:10:37] Hunter Newby: But in my data center lens, that’s already happening. So then I would say to all my friends that are operating, owning operating, invested in data centers what can you do about all this. You just sit back and throw your hands up in the air and say, oh my God, this is way over my pay grade. There’s nothing I can do about it.

[00:10:58] Hunter Newby: And I’ve been listening to a lot of my friends that are in exactly that position. And, you know, these are the C level people that run the world’s largest data center operations. And after I was introduced to Todd and I heard about what he does and what SPS does and what this group is about, I was like, wow, that’s a perfect fit.

[00:11:16] Hunter Newby: I need to introduce Todd to all my friends and have them engage him to look at their entire operation and see where they can create efficiencies and save to create margin improvement to counterbalance the things that are impacting them that they can’t control. And that’s really the message.

[00:11:39] Hunter Newby: So there you go. I tried to keep it quick Todd .

[00:11:44] Todd R. Zabelle: Well, thanks, Hunter and let’s take a look at some of the things you’re talking about. Interestingly enough, we had some other friends submit this to a couple journals and they said, hey can you change it from data center to other situations?

[00:12:01] Todd R. Zabelle: And we said, what we’re gonna talk about here is universal. So hopefully you can all see my screen. One thing that I think most people that are involved in supply chain realize is there’s three flows that we’re trying to think about, and there’s information flows, maybe that’s the world of blockchain and things along that line.

[00:12:19] Todd R. Zabelle: Think of a river or whatever. There’s money flows that Hunter was just talking about. It’s a very important element of the supply chain. And then what I’m gonna talk about is physical flows, right? Lot of consternation in the data center world about the ability to get supply when it’s needed.

[00:12:39] Todd R. Zabelle: And it is definitely impacting share price and if you’re, as I learned from Hunter a while back, a private equity guy that went all in on data centers and you’re running a fund that has that kind of exposure things aren’t always as good as you had hoped. So, as we said, there’s a lot of pain going on right now and the implications are significant.

[00:13:05] Todd R. Zabelle: Hunter, let me ask you a question. When we had that call, was it a week or two ago, what is the cost of downtime for a data center? Do you remember what Suzanne said? A million a minute. Is that what you said?

[00:13:19] Hunter Newby: Yeah, it’s a million a minute. And then there’s also a latency component.

[00:13:24] Hunter Newby: A millisecond right, is a hundred million dollars. And that’s an Amazon number stat. Their own, that if they’re down, it costs them a hundred million dollars. So yeah,

[00:13:36] Todd R. Zabelle: So a million, a million dollars a minute to not be operating. So this is serious. We’re all operating within these data centers.

[00:13:44] Todd R. Zabelle: All of our stuff goes there personal and business wise. So I’m gonna propose a framework here that we came up with when Hunter called and said, hey, how would you look at this problem? We sat back and we had a talk here and came up with these ideas that I’m gonna share with you. First of all, let’s separate supply into three types.

[00:14:02] Todd R. Zabelle: There’s construction materials, steel, concrete, so on and so forth. There’s equipment and the equipment might be things like generators that are a little bit more sophisticated than concrete. And then we have equipment that goes in the data center way of storage and CPUs, right? And then we have consumables.

[00:14:22] Todd R. Zabelle: And Hunter alluded to the consumables. We have heard a story of a data center being built and water wasn’t gonna be available. And that’s the critical part. Hunter’s talking about data centers being built where electricity is not available, right? power. So three types of supply that we need to be thinking about for data centers specifically.

[00:14:40] Todd R. Zabelle: So I’m not certain this is much different from other other industries. We were having some discussions with a large Telco a few years ago and they said their biggest problem was getting the power hookup to their devices when they deployed them. So think about it that way. And there’s three types of disruption that we might be dealing with when we talk about supply chain.

[00:15:02] Todd R. Zabelle: There’s force majeure, clearly the operation, quote unquote, in the special operation in Ukraine is causing problems as is the human trafficking here in the Bay Area in San Francisco. We had some port strikes a while back, industrial action. We’ve seen weather be an issue, right? So force majeure is one element.

[00:15:25] Todd R. Zabelle: But I’ll propose a couple others, you might wanna think about false demand, right? We’ll talk about what that means. And then capacity constraints. So acts of war, we talked about what these are. You can do risk assessment and plan for them and you’re gonna have to deal with them to a certain extent.

[00:15:48] Todd R. Zabelle: But there are things you could do and we’ll talk about that in a sec. But when you’re dealing with force majeure, there’s really, really three options. If you’re not gonna assume, come what may, and I’m just gonna put my head in the sand. And this is bringing it back to the production side. You could buffer it with inventory.

[00:16:03] Todd R. Zabelle: So you could have a stock of stuff just in case, right? You could buffer with capacity. I have the ability to rapidly make things. Okay, or probably what’s the wisest thing we would be to do is to have a combination of both, but you need to figure out what exactly is that, that you would do to have a combination of both.

[00:16:24] Todd R. Zabelle: Right? So I go back to some of the stuff that James was talking about earlier, is you have to have the ability to, again, assume you’re not gonna have your head in the sand to model these things and analyze them, perhaps even simulate them to figure out what would happen if we get exposed to one of these.

[00:16:42] Todd R. Zabelle: Because inevitably you are gonna get exposed to some of this stuff. Again, you know, how much should you have and where should you put it. When you start having multiple projects around the world it gets a little bit more complex because you’re pretty much dealing with the same suppliers based on the design, right?

[00:17:03] Todd R. Zabelle: So again, this is more of a deployment model these data centers and thinking about what do I put where and how much, and what cost is a critical, critical element. Sources of false demand. You know, there could be a strategic competitive move. We know that one tech company decided to buy a lot of generators at one point to get competitive lockout against other tech companies.

[00:17:32] Todd R. Zabelle: So they just basically wrote a big purchase order for a lot of generators. And it wasn’t necessarily because they needed them at the time. They just wanted to make sure other people perhaps couldn’t get them, or at least that’s what the other guys told us. They were a little bit upset about that. There is supply chain buying too much.

[00:17:48] Todd R. Zabelle: There’s immense pressure on companies when their producers and their assets are needed to produce things such that the supply chain people are not gonna get in the way of a CEO whose personal net worth is based on the share price by not getting enough capacity deployed. Right? So they’re gonna ensure that they’re not in the middle of that conversation.

[00:18:10] Todd R. Zabelle: Or at least getting that phone call from Tony because they’re gonna have enough stuff there. And we’ve heard that on the energy side as well. We were talking with one of the oil and gas players who was telling us that, you know, there’s the supply chain. Just make sure there’s enough pipes, they’re just not gonna run out of pipes cause it’s not gonna be their problem.

[00:18:28] Todd R. Zabelle: And then there’s local projects receiving it too early, right? And so, yeah, that’s kind of the behavior that a lot of people exhibit. I wanna make sure that I have everything I need. James Choo is always saying he’s hearing that they’d rather be looking at it than for it, right? And so when we start to put this false demand in there, it gets interesting as to what’s happening.

[00:18:50] Todd R. Zabelle: And so then it becomes a game and win as much as you could win. I dunno if you’ve ever played this game or not, but the simulation basically shows you the more you try to win, the more you lose. And so specifically for the data center industry and maybe for others, there’s a lot of people that are playing win as much as you can.

[00:19:08] Todd R. Zabelle: Another way to look at that is, a little bit interesting as well, James alluded to this earlier, you know, and Iris did too in the matching problem. So here’s basically the matching problem, right? If you have a bunch of generators, that’s probably good, but they’re kind of unless you have buildings to put them in and all the other stuff you need to actually operate a data center so you know how much of the stuff you’re gonna buy.

[00:19:27] Todd R. Zabelle: And then with some of this stuff, it gets outdated pretty quick because of the technology refresher cycle. Right? So the matching problem, again with Iris and then James talked about, comes into play.

[00:19:43] Todd R. Zabelle: It’s all about getting the right stuff at the right time based on what you need, not just having extra stuff, right? So our hypothesis is, and I’d love to be challenged in this that there’s more supply than we know. Maybe we don’t have the supply chain problems that we necessarily think we have. And that might go back to some of these factors that we’re talking about here, where there’s a lot of false demand going on in there.

[00:20:13] Todd R. Zabelle: And I used a word the other day that I thought I shouldn’t use, but the people that we presented to, which were a lot of people involved in the data center business hoarding and panic buying. And they said, no, those are good words, you should use those because that’s what some of us are doing. I said, okay.

[00:20:30] Todd R. Zabelle: So our hypothesis is probably more how do we know that? Because we’ve been out to the majority of the players that supply the data center industry on behalf of various data center companies and have built the production system models to see what’s going on there. All right and we’re seeing a lot of inventory in a lot of places other than being installed or having been installed at data centers that are operating.

[00:20:53] Todd R. Zabelle: So again, our hypothesis is not something that we dreamed up or a challenge, it’s actually because we have the data from looking around out there. All right? This happens to be a facility here that has two of the major players flowing through it.

[00:21:11] Todd R. Zabelle: They’re making the same kind of data center, if you will, but you can see the process is totally different. And the data center design is obviously different. That is you know highly proprietary stuff. But we have the insight into these production systems, if you will. I believe this one’s for power modules or something where we begin to see what’s happening, right?

[00:21:29] Todd R. Zabelle: And we see the opportunities for optimization. So really what people probably need to start with is getting some transparency of when are their strategic competitive moves happen. When are we buying too much and one of the projects receiving it too early? Right. So I think enhanced transparency would be a step in the right direction.

[00:21:52] Todd R. Zabelle: Yeah, how big is the opportunity? This happens to be a customer that we worked with before and they made a presentation years ago at this symposium. These are smart people, they had 252 process steps, they got it down to 97. The reliability from zero to 38% got to 98%.

[00:22:13] Todd R. Zabelle: Duration from PO to install they set at 71 days as a target. That was at 65-220, that was down to 49. And then a cost per a skid in this particular instance, one from 800k to 509k. So there’s plenty of opportunity in there by applying this production thinking that’s been talked about all day, whether it’s on the modeling optimization side or on the control side.

[00:22:38] Todd R. Zabelle: So I’ll leave it at that and now open up if there’s any questions. We’ve got a couple minutes, otherwise, I’ll hand it back. Okay, I don’t see any questions necessarily coming in. Okay, well Hunter thank you very much.

[00:22:55] Hunter Newby Thank you

[00:22:88] Todd R. Zabelle: And hopefully some people have some things to think about with regard to supply chain and with that I will hand it back.

[00:23:05] Hunter Newby: Appreciate it. Thank you.