A 4x in 4 Years Surfing the Data Center Tsunami? ($TSSI)

TSS is a near net-net yet is rapidly growing and well-positioned to capitalize on the accelerating demand for modular data centers (MDCs).

Total Site Solutions (TSS Inc.) was founded in 1981 in Round Rock, TX. The company offers “technology solutions to clients of all sizes, including OEM/IT infrastructure providers, MSP/cloud service providers, and resellers. TSS helps customers design, build, operate, maintain, refresh, and take-back their enterprise systems…”

In plain English, they help enterprises build and maintain data centers through several services: equipment procurement, rack and systems integration, configuration services, deployment and maintenance services, consulting, etc. They have particular expertise in/focus on solutions for Modular Data Centers (MDCs)—a key segment of the data center landscape I discuss later.

Interestingly, TSS really only has one client: Dell. Dell has comprised 96% of revenue over the past two years, and was the “training ground” for TSS CEO Darryll Dewan. It is therefore unsurprising that TSS is headquartered in Round Rock; Dell is also headquartered there. TSS’s performance is thus a referendum on Dell’s needs for data center related services and especially MDC related support. There is a clear path to a 4x in 4 years for $TSSI.

The Data Center Tsunami

Bulletin: you have been serviced by a data center today. Data centers are the arteries of modern IT, housing the server racks, cooling and power systems, network infrastructure, and monitoring software that allow for cloud computing, edge computing, low-latency trading, and AI. Unsurprisingly, companies that focus on servicing data centers have enjoyed exceptional share price growth as tailwinds in these areas drive data center demand:

TSS may see similar returns if two predictions are borne out:

1. We are nowhere near peak data center demand, and Dell will compete in the MDC market

2. TSS’s top line will multiply several fold as they play an integral role in helping Dell’s MDC operations

Data Center Demand

Data centers are already $90B a year industry and companies like FAANGs are spending vast amounts on CAPEX to meet demand. Just this month, Microsoft and OpenAI announced a $100B investment in a massive data center project. Demand for server components and, in particular, AI-related components, is estimated to grow at a 22% and 39% CAGRs (respectively) through 2026.

All this was aptly summed up in TSS’s recent Data Center Trends report, which is worth reading:

“The explosive development and adoption of generative artificial intelligence (AI) and machine learning (ML) across every industry has revolutionized the data center market. Demand for infrastructure and capacity is at record levels and data center space is often reserved before the facility is completed.”

Dell’s Data Center Activities

Here are notes on different types of data centers including MDCs. This overview of the landscape is useful as a primer before specifically focusing on MDCs.

1. Enterprise Data Centers:

   • Owned and operated by large enterprises or organizations

   • Used for hosting their own IT operations, applications, and data storage

   • Generally located on-premises or in a dedicated facility

2. Colocation Data Centers:

   • Owned and operated by third-party service providers

   • Offer secure spaces, power, cooling, and connectivity for companies to house servers and equipment

   • Customers rent space and resources as needed

3. Hyperscale Data Centers:

   • Large data centers operated by major cloud providers and tech giants

   • Designed for massive scale and high-density computing power

   • Support vast online services, big data processing, and AI/ML workloads

4. Modular Data Centers (MDCs)

   • Prefabricated data centers that can be easily deployed and scaled as needed

   • Offer outsourced IT infrastructure management and maintenance services

   • Located closer to clients and customizable to meet project needs

Dell is heavily leaning into MDCs. I believe this is prescient and one of those areas where, despite current debate, the “future is obvious”—similar to cloud computing 12 years ago. The advantages of MDCs are significant and that they will play a much larger role in the above landscape than they are currently being given credit for.

According to Dell’s MDC report/thesis:

“While advancements in artificial intelligence, edge and high-performance computing help drive innovation across industries, they also put the squeeze on traditional data centers. The new requirements are multifaceted; from more capacity, more power density to the need for the latest cooling technologies and to bring compute closer to data sources. In this climate of demand-driven innovation, time to-market is key. To build or expand an existing data center takes planning and time, and the distinct phases of a build don’t always line up with ideal launch plans. Retrofitting new capacity onto an existing data center can get very costly, very fast and can bring more risk to operations when non-IT personnel are in the IT space. What’s more, the data center would need the flexibility to adapt to changing cooling or network requirements. These ever-rising power demands coupled with less-than-ideal density is pushing the efficiency footprint of traditional data centers to a tipping point.”

Here are some of the advantages of MDCs:

• Rapid Deployment: Prefabricated modular data centers come together much more quickly than stick-built data centers, allowing quick additional capacity. Minimal site prep is needed. Faster deployment also means enterprises can begin realizing returns sooner.

• Turn-Key Service: Using modular data centers means companies don’t have to invest resources into coordinating designers, construction crews and electricians.

• Scalability: Modular data centers work as standalone units or can be joined to multiply computing power. Companies can either guess their needs and build a data center accordingly, or use MDCs to rightsize capacity as needed.

• Versatility: MDCs are far more versatile than traditional data centers as they are more compact and adaptable. They’re great for edge applications or situations where a large data center isn't practical or needed.

• Cost: MDCs may not be cheaper initially, but they do offer long-term cost benefits. The price you’re quoted is more likely to be close to your final cost compared to a traditional construction project, where cost overruns are common. Additionally, by ensuring fewer outages or slow service, companies don’t need to worry about costly downtime.

Precedence Research writes that “the global modular data center market size was valued at USD 22.4 billion in 2022 and is projected to hit around USD 112.6 billion by 2032, poised to grow at a CAGR of 17.52% between 2023 and 2032,” and I see this as a low estimate. Dell recently announced a partnership with NVIDIA that will help it competitively provide on-premises (read: MDC) capabilities. This has been a major catalyst for Dell’s recent share price performance.

I have talked to several industry experts. One was working to construct MDCs, one was a former Dell employee, and one was an expert consultant. The universal response was that current procurement, maintenance, and construction providers for MDCs (e.g. TSS) are severely overbooked, and that this will continue for years, that Dell will invest heavily into this area, and that companies like TSS will benefit.

When we see Sam Altman bringing a nuclear power SPAC to market ostensibly to power data centers, when we see extreme constraints on capacity nationwide, and when enterprises increasingly demand faster go-to-market, it seems obvious that MDCs are going to be an integral part of the landscape. Next, let’s examine how Dell’s MDC efforts will flow through to TSS’s top line.

TSS Segment Overviews

TSS operates through three segments.

The Procurement Services ($38.5M or 70.77% of total revenue) segment helps builders of data centers through negotiating with OEMs, leveraging existing relationships to get better deals, and ensuring the right equipment is sourced for project needs, e.g. meeting sustainability requirements. Growth in this segment is more than an artifact of temporary supply constraints; this article explains how procurement services are a necessary part of the data center construction landscape and a tangible value-add.

TSS’s Systems Integration segment ($8.8 million or 16.18% of revenues) helps with MDC construction through services like server rack and cooling system installation. These are similar areas to those in which SMCI 0.00%↑ and CLS 0.00%↑ operate.

TSS’s Facilities segment ($7.1 million or 13.05% of revenues) includes its consulting and maintenance services. It is difficult to model growth, as this segment involves numerous one-time and “lumpy” payments. But one would expect this segment would also see growth, as it should naturally scale with the first two segments.

Financial Commentary

It’s worth examining TSS’s 3 statements to try and highlight some notable points.

Income Statement

The striking aspect of TSS’s 2023 financial performance is a 77% increase in YOY revenues. This was driven by an exceptional Q4 where revenues grew 120% QoQ. There was a large jump in revenue from the procurement services business segment and an acceleration of services and integrations revenues.

During 2024 I expect even stronger numbers across these first two segments (the third may grow or shrink but its impact will not be outsized regardless). Importantly, because the company is so integrated with Dell, it has exceptional insight into Dell’s future MDC support needs. We gain an advantage by simply listening to TSS’s forecasts as the market is not. Here are two selected quotes from the latest 10-K that I think are worth listening to:

“We are witnessing an increase in demand for generative AI-based computing technology from a variety of technology providers, and we are prepared to scale our capacity to meet an increase in this demand. We have modeled plans to scale our data center rack integration business up to 10x—that is over our 2023 rack integration results, and we are positioned to implement them in 60 days. We expect to benefit from this growing—from this growth beginning in the second half of this year, 2024.” *

“The latter half of 2023 was characterized by supply shortages of AI chips and servers, and challenges procuring fiber-optic and high-speed cables for example. We believe that these ongoing constraints will dissipate as additional production capacity comes online, and we are optimistic that increases in demand for AI solutions will create new opportunities to grow our integration business in 2024 and beyond. As this AI technology and other computing technology evolves, including liquid-cooled solutions, we believe this will drive growth in the data center market and provide new revenue opportunities for us. Despite these ongoing challenges, there has been an improvement in supply-chain issues since the second half of 2022, which, along with pricing adjustments, has helped us growo ur integration revenues by 23% in 2023 compared to 2022.”

*Important note: I am taking this to refer to segment revenue as this language is used interchangeably throughout the 10-K, although that segment does more than just rack integrations.

Balance Sheet

• Fluctuations in cash/accounts payable appear volatile, but this is simply due to the timing of trade credits (essentially interest free loans for COGS) supporting the company’s procurement activities. Trade credits let TSS maintain a cash buffer and pay suppliers when it is operationally efficient to do so.

• TSS has negligible long-term debt and is near to being a net-net.

Cash Flow Statement

• The CFS is hard to parse due to the CAPEX swings inherent in the nature of a business which involves large amounts of trade credits and equipment procurement.

• Overall, one thing that stands out is the fact that TSS is not diluting significantly. It has more than doubled revenues since 2016 while diluting an average of $130k yearly. However it should be noted that there is around $500k of SBC yearly.

Financial Projections and Multiples

Management teams are usually optimistic—but TSS management has telegraphed financial performance before with a high degree of accuracy. For example, in Q2 2023, management communicated that they would be profitable in the next quarter and for the year ended December 31, 2023. This was completely ignored by the market. Over recent months—as this prediction was borne out—TSS’s share price doubled. If this scenario is playing out again, what might this look like for the company’s financial performance and valuation?

Let’s assume a 10x increase in the services and integration segment over the next four years and strong, but slowing, growth in procurement (as additional production capacity returns). Other key assumptions noted to the right side of the income statement.

According to management, “approximately 90% of our revenue is derived from fixed-price contracts. Under these contracts, we set the price of our services and assume the risk that the costs associated with our performance may be greater than we anticipated.” This means that if management projects a certain increase in revenues, it is likely to achieve it. Plus, as I’ve discussed earlier, the future is visible to management due to unparalleled insight into Dell’s initiatives.

Note that I have incorporated what may seem like surprisingly low amounts of dilution. The company has not been historically very dilutive; it has only issued around $150K of new equity per year on average since 2016. Further, it used its significant CFO in 2022 in order to increase capacity for the future. Per the last earnings call, they have increased their capacity potential by 2-3x without the need for further investment.

These assumptions represent a blue sky scenario, so please adjust them as you see fit. There could be far more dilution, or supply constraints around data center/MDC equipment could ease more rapidly than anticipated. Candidly, with such a small company—and without the same level of history and controls that we might enjoy with a larger company—any assumptions should be treated with a heap of salt. Still, you can easily see how optically undervalued TSS is.

There are no public micro-cap comps, but larger companies in similar spaces typically trade at a 8-10x EPS multiple. I do think there is a strong change that TSS ends up trading at a 4x multiple (micro-cap discount) on $1 of EPS within the next four years. This would yield a 400% return. Even if you halve most of these expectations, and assume less multiple expansion, you stand make strong returns.

Ownership, Management, and Acquisition Potential

Fourteen months ago, TSSI announced a new CEO, Darryll Dewan. This is what initially clued me in to the opportunity; it seemed the board knew there was a lot of growth potential and made decisive appointments to capitalize on it. Darryll has 30 years in the data center / IT space, most recently serving as the VP of Global Sales and Marketing at Dell. Looking around on GlassDoor, I estimate he was making (before any SBC) at least $740K per year, so for him to join a $12m company and accept an initially lower salary would be intriguing choice if he did not anticipate substantial upside. On calls, Darryll is sharp and presents a deep understanding of both the industry and the market’s concerns. He has an emphasis on growing shareholder value which is reassuring.

Management currently owns about 30% of all shares of common stock. There are also $1.5m shares worth of dilutive warrants that may be granted to management through warrants, although $1m of these warrants have not yet been approved by shareholders. For what it’s worth, insiders have been making some nominal purchases of stock—around $10k last month.

You may be questioning why Dell wouldn’t simply buy TSS and have it become an in-house team of integrations and procurement specialists. I think that the company is simply too small and illiquid at this point for it to be worth the trouble. These processes take a lot of time and money, and they aren’t guaranteed to go smoothly. However, as TSS scales, and shares become more liquid, Dell may express interest.

Risks

Why hasn’t TSS traded up more? There are several reasons. It is a micro-cap company with a long history and a more recent pivot towards data centers. Shares are illiquid, with spreads of $.04 not being uncomon. There is execution risk with rapidly scaling. But by far the most obvious dampener is that it has only one significant customer. Management has continually spoken about diversifying its customer base, yet I’m unconvinced they will do so meaningfully. If Dell in-housed the services provided by TSS without acquiring them, the company would have little reason to exist. The question investors must ask themselves is whether concentration risk nullifies the positive tailwinds, strong balance sheet, and insight into future earnings enjoyed by TSS.

An Analogous Prior

When researching TSS I was reminded of AEHR 0.00%↑ which I owned several years ago. The company provided wafer burn-in testing for the semiconductors used in EVs. Similarly, they only had one significant customer, ON Semiconductor. For this reason, they were largely ignored for years. However, when that customer’s needs scaled up, orders began rolling in, and AEHR 0.00%↑ was rather successful. It has since traded down as ON’s orders have slowed—but this was all telegraphed as well (see the VIC writeup on AEHR 0.00%↑) and investors paying attention have had ample time to exit.

Summary and Catalysts

TSS enjoys several major tailwinds. The balance sheet is clean; it is nearly a net-net. The fact that it only has one customer is a reason to exercise caution; on the other hand, the deep interconnections between TSS and Dell mean that management has great visibility into future earnings growth. Further, Dell is presciently pursuing an expansion of its MDC activities, TSS’s area of specialization. Rack integration is a massive opportunity. Management is competent and aligned with shareholders.

I will reiterate my predictions:

1. We are nowhere near peak data center demand, and Dell will compete in the MDC market

2. TSS top line will multiply several fold as they play an integral role in helping Dell’s MDC operations

In the blue sky scenario, there is a clear path to returning 4x or more over 4 years. A few more quarters of positive net income to concretize the narrative, and I’ll be excited to see where shares trade.

Disclaimer: The information provided in this article is for informational purposes only and should not be considered investment advice. Investing involves risk, including the potential loss of principal. The author holds a material position of the security discussed. The author is not a registered investment advisor and does not provide personalized investment advice. Always conduct your own research and consider your investment objectives and risk tolerance before making any investment decisions. The author and publisher shall not be liable for any actions taken based on the information provided in this article.