Juggling Dynamite

OpenAI currently has a market value of $500 billion, with annualized revenue reported at $10 billion per year. It is not expected to be profitable for another 4 or 5 years and is preparing to raise tens of billions of dollars in debt to fund infrastructure plans.

Moody’s has recently flagged the extent to which Oracle’s future data centre business relies on OpenAI and its unproven path to profitability.

The FT connects the circular business models that are fomenting epic FOMO in capital markets, in OpenAI’s computing deals topping $ 1 trillion. Here are some takeaways:

To fund its expansion, OpenAI has raised huge amounts of equity and started to tap debt markets. It secured $4bn in bank debt last year and has raised about $47bn from venture capital deals in the past 12 months — though a significant chunk of that is contingent on a tricky negotiation with Microsoft, its biggest backer.

OpenAI’s arrangement with Nvidia is likely to help investors get more comfortable making large loans.

The chip giant, which recently surpassed $4tn in market cap, has routinely used its mammoth balance sheet to invest in companies within its supply chain or among its top customers.

The beneficiaries of these deals in turn use the new liquidity to buy more Nvidia chips or borrow money.

Nvidia has invested in CoreWeave, which is also a customer and supplier. CoreWeave has also raised raise more than $12bn of debt secured against its Nvidia chips.

…OpenAI and its growing number of partners are betting AI usage will keep growing exponentially. If growth plateaus, or even slows, the investor enthusiasm that has boosted share prices on the back of these deals could quickly falter.

One Silicon Valley investment veteran said: “The company is in a far more capital-intensive business than Google or Microsoft ever was, and was born with no cost discipline.”

Amazon founder Jeff Bezos and Oracle founder Larry Ellison “only found religion” and drastically cut business costs, “after nearly going bankrupt”, the investor added.

The graphic below provides a visual representation of all this and reminds me of the 19th-century children’s rhyme “Pop Goes the Weasel,” where the chasing monkey ends up having to pawn ‘pop’ their coat for cash in the end.

“Round and round the mulberry bush,
The monkey chased the weasel.
The monkey thought ’twas all in fun,
Pop! goes the weasel.

Doubtless, AI will continue to evolve with both beneficial and detrimental impacts. But how will investors in today’s highly correlated and extraordinarily inflated valuations fare from here? There are only a handful of historic comparables, and all of them included periods of legendary pain and loss. Maybe this time will be different.

Valuations are timeless mathematical measures that assess investment risk, but if participants are ignorant or don’t care about evaluating investment risk, do valuations matter? We each make that decision based on our investment choices, knowingly or not. The discussion below considers this and more.

Has the growth of indexing broken the market? What fundamentals are important when the market doesn’t care about value? In this fireside chat, Michael Green and David Einhorn of Greenlight Capital discuss the impact of indexing on fundamental stock picking and how Greenlight’s methodology has changed in recent years to meet this new reality. Here is a direct video link.

Footnote to this discussion: POD shops mentioned are ‘point of distribution’ shops. In reality, most retail participants get their investment recommendations or ‘advice’ from POD shops of one form or another. CHATGPT explains as follows:

In large financial firms — especially banks, broker-dealers, or investment managers — a POD refers to an organizational unit or branch through which products and services are distributed to clients.
A POD shop, then, is a sales or advisory operation focused on product distribution — not manufacturing (asset management) or research.

In other words:

• “Manufacturers” design investment products (mutual funds, ETFs, structured notes, etc.).

• “POD shops” are the distribution arms that place those products with end clients or advisors.

• The focus is sales and client servicing, not portfolio construction or fiduciary advice.

The AI infrastructure boom is the most important economic story dominating the news. However, the numbers don’t add up, and that realization is starting to spread. Read more in,  This is How the AI Bubble Will Pop:

Tech companies are projected to spend about $400 billion this year on infrastructure to train and operate AI models. By nominal dollar sums, that is more than any group of firms has ever spent to do just about anything. The Apollo program allocated about $300 billion in inflation-adjusted dollars to get America to the moon between the early 1960s and the early 1970s. The AI buildout requires companies to collectively fund a new Apollo program, not every 10 years, but every 10 months.

The term ‘hyperscaler’ should be a warning sign to the financially savvy. Demand moves in cycles. Any company or sector that grows exponentially and adds financial leverage to do so is on a well-worn path to misallocated resources and waste. The spend is real, while profits remain largely elusive and aspirational.
That’s why you’re starting to hear some people wonder if the AI build-out is turning into the mother of all economic bubbles.

Tech capital expenditures have been ballooning as a percentage of economic growth (as shown below since 2023), as AI spending sucks capital away from pretty much everything else.For equity and credit investors who think they are diversified, the overlap and interconnectedness with the AI bubble are increasingly inherent across a multitude of sectors and securities.

Real Estate Investment Trusts (REITs) are one example, explained in the segment below:

“if you look inside at any large REIT in the United States today, somewhere between 10 and 22% of it is already directly data center related. So if you’re a conservative investor with a, with a REIT in your portfolio, because you’re saying, you know what, I don’t care about any of that crazy tech stuff.

I’m going to be over here safe as houses, commercial real estate or whatever else, getting real estate income. Go have a look inside your REIT, see what’s actually in there today. Two years ago, there was nothing in there related to data centers; in some of the largest ones today, we’re up to 22% that is directly data center-related.

So you’re soaking in it. You’re already in there, my friend.

The entire discussion is well worth listening to.

• How AI capital expenditures break down
• Why the AI build-out is different from past infrastructure projects, like the railroad and dot-com build-outs
• How AI spending is creating a black hole of capital that’s sucking resources away from other parts of the economy
• How ordinary investors might be able to sense the popping of the bubble just before it happens
• Why the entire financial system is balancing on big chip-makers like Nvidia
• If the bubble pops, what surprising industries will face a reckoning

Add leverage and stir has been the recipe for economic expansion at all costs; thus, the seeds of a credit implosion have been planted (again). We reap what we sow, and so it goes.

In this episode of The Weekly Wrap, Steve Eisman interviews Lakshmi Ganapathi from Unicus Research. They discuss why U.S. consumers are struggling. From rising auto loan delinquencies to ballooning credit card debt, consumers everywhere are feeling the pressure. They also discuss Opendoor, meme stocks, and the impact of AI. Here is a direct video link.

CNBC’s “The Exchange” team discusses the state of the U.S. labor market and data that shows layoffs are the highest since 2020, with Andy Challenger, senior vice president of outplacement firm Challenger, Gray and Christmas. Here is a direct video link.