The circular financing underpinning AI took a step into the big league last week with the decision by chip makers Nvidia, AMD and Broadcom to act as $5 billion cornerstone investors in Meta Platforms' $25 billion stock sale.
The investment came just before rising concerns about the scale of the finance needed for artificial-intelligence infrastructure hit AI stocks hard. The three chip makers on Friday gave up all their gains for the week as tech stocks stumbled.
Circular financing would worsen any downturn. And buying shares in a company raising money in part to buy your product is as circular as it gets. The companies are essentially doubling down on AI bets, making AI stocks even more volatile because good news is better for them and bad news worse.
Meta wasn't having a problem raising money. It upsized its initial stock offer after strong demand alongside a large sale of other types of shares. So while the company certainly needs money, it didn't need it from its suppliers. Why, then, were they precommitting to buy?
It could just be because they can. Since the chip makers are flush with cash, why not transfer some over for a stake in Meta's future?
That motive runs afoul, though, of basic investment theory. If a company has too much money, it should hand it back to its shareholders, not try to pick stocks on their behalf. The shareholders can pick and choose between the AI giants, rather than leave their choices to Nvidia Chief Executive Jensen Huang, smart as he is. Let him focus his genius on making better chips.
That leaves a troubling answer: Meta is such a big customer that it has power over the chip makers. On this read, their stock purchases are part of a pay-to-play needed to ensure the hyperscaler buys their chips at all.
This would be an inversion of the usual vendor financing behind the circularity in AI, which is led by chip makers financing weak data-center operators on condition they use their chips.
If such an inversion is what's at work -- and it looks like it could be -- it shows competition in chip supply is stronger than many thought. If Meta is able to play fierce rivals AMD and Nvidia off against each other, it must be happy with both products. With Alphabet's tensor processing units and Amazon's Trainium chips also competing for AI, it will become harder for the big chip-makers to demand premium prices.
Now, the $5 billion in total put into Meta stock by the chip makers is small beer in the heady world of AI finance, even if it is pay-to-play. But it's part of a worrisome growth in interconnections between AI companies, which increasingly means problems at one firm will create trouble elsewhere.
Most of this comes on the debt side, where both chip makers and the giant "hyperscalers" -- Alphabet, Amazon, Meta and Microsoft -- have been using strong credit ratings and cash piles to help weaker suppliers of computing power, or compute.
The basic principle of vendor financing is familiar from the car dealership. If you can't afford the shiny new Beamer right now, BMW will lend you the money. You get the car, it gets the sale, and you pay off the loan with interest. Everyone's a winner.
The structures being used to back chip sales are more complicated, and in many ways look a lot more risky. In some cases, rather than lend money, it is as though BMW teamed up with a bank, promising to buy back the car for a minimum price if a subprime buyer defaulted on a loan. At the same time, it is ramping up production to meet all the new demand from subprime borrowers suddenly able to access reasonably priced car loans.
What could possibly go wrong? It isn't just that the subprime borrowers might not repay. It's that if they run into trouble, it's probably because of something that affects everyone involved, such as an economic downturn or weaker-than-expected demand for compute.
Then the lender, or guarantor, isn't just on the hook for problems at one data center, but lots. This would probably come alongside a collapse in demand for new chips and a flood of secondhand chips or cut-price compute hitting the market.
This isn't theory. It happened in 2001 to the telecom-equipment companies, which ended up writing off billions of dollars in vendor financing when flaky dot-com customers failed to pay.
Money booked as revenue didn't reflect real demand because it had round-tripped, going out as a loan only to come back the same day to boost sales figures. The equipment these gear makers had sold ended up on the used market and undermined sticker prices, just when sales were already struggling.
Hopefully the chip makers are less focused on sales and more focused on credit quality than the telcos were. The chip makers and hyperscalers also have solid balance sheets, which is why they're able to finance weaker customers and suppliers in the first place.
But if things do go badly, it will become clear that they've doubled down on their AI bets -- and at enormous scale.
Two examples stand out among many involving Nvidia. It is the second-biggest shareholder in data-center operator CoreWeave, whose shares are down 23% this year. CoreWeave is a huge customer of Nvidia, and Nvidia has promised to rent any spare compute it has until 2032. CoreWeave is treated as distressed credit by investors; its 2031 bonds are trading at more than 10 percentage points above Treasurys, up from just over 4 points in June.
The second is in Ohio, where Nvidia has provided a $105 billion backstop for the monster data center being built for OpenAI by SoftBank's SB Energy. As in many states, data centers in Ohio have become politically contentious ahead of the midterms.
Like a carmaker financing its customers, this is fine when it works. The chip maker gets both an extra sale and the interest -- or, in this case, gains on the stocks they bought.
If it doesn't all work out, though, they end up on the bad side of a double-or-nothing bet.
Demand for their processors collapse because the compute market is saturated, and the money they lent for past sales doesn't all get paid back. Worse, they will be on the hook for the guaranteed residual value of old chips.
This is worrying investors. "What's scary is the circularity both in fixed income and the equity world should there be a correction," said Kasim Kutay, CEO of Denmark's Novo Holdings.
This interdependence also makes the market less diversified. Shares of companies that depend financially on each other should move more closely together.
Shareholders should pay a bit less to cover these growing risks -- and think about how exposed they would be if the stumbling AI trade topples over.
Comments