The Faith Based Boom

Back in the days when young punk bankers were still tolerated to harass research analysts about their stock ratings, estimates, and targets, I was a young punk Morgan Stanley banker doing just that. It was the telecom/.com boom, but in its very late innings, maybe as late as 2000. I sat across from an analyst covering a telecom company growing fast and bleeding cash. The analyst was worried. He had lost faith that the company could reach break-even before running out of cash and his note downgrading the stock to “Underweight” had already been written. I made the case that the company would be fine as long as the capital markets remained open and the company could continue to issue debt and hopefully not too much equity. To my side was a Managing Director in telecom banking, who from the corner of my eye appeared quite pleased and maybe even impressed by the argument I was making to the analyst. My self-contentment ended abruptly as the analyst, far senior to me, began shouting: “That’s the f…ing point, the capital markets may already be closing”. He was right of course. The company was one of many telecom providers, soon to be worthless, that had raised billions to build out fiber and switches to support the burgeoning internet. The end came fast as it became clear to everyone that investors were no longer willing to fund a buildout that had become a glut. Revenues were decelerating and cash burn rates were rapidly accelerating.

Today’s environment bears a key contrast of those days in the sense that the while losses and debt are similarly mounting, the capital markets remain wide open. Anthropic, one of the few entities that drive the majority of the demand for the AI infrastructure buildout, reports about $1.75 in operating losses for every $1 of revenue, which, of course, excludes the $10 in capital expenses to facilitate that achievement. According to recent reporting, the company intends to spend over half a trillion dollars on compute commitments over the next decade. Yes, the company is growing extraordinarily fast, but that rate of change is not your friend, with market share shaky and its pricing power somewhere between unproven and nonexistent. In other words, the company may be fine as long as the capital markets remain open and Wall Street pretends to understand the home-run productivity miracle the technology will provide. Maybe it will all work out. After all, the market is smarter than I am. Maybe the faith in the AI revenue ramp will remain unshaken. I have my doubts.

This morning, Apollo’s Torsten Slok put out a short note questioning where all this end-market demand will come from. He wrote:

“The analysts covering tech expect the sector’s operating cash flow to more than double to roughly $2.4 trillion by 2028, an increase of over $1.2 trillion. Meanwhile, the analysts covering the other sectors in the S&P 500, which are tech’s customers, expect those companies to add much less operating cash flow. In other words, the tech silo is betting on a future in which demand for AI and tech services explodes, while the silos covering the companies that would pay for those services see a much more modest outlook. Both cannot be right at the same time. The bottom line is that either tech’s customers will generate a lot more cash than their analysts expect, or tech’s cash flow forecasts are too optimistic, which raises the question of who exactly will be writing all those checks to buy AI services.”

Why is corporate America broadly going to ramp spending further on AI when those companies are estimated to see little to no benefit from that spending? How do Anthropic and OpenAI get corporate America to pay more for a service that has, so far, generated nebulous returns?

An analysis just published by Stijn Van Nieuwerburgh, Financing the AI Buildout estimates that for the compute providers (the hyper-scalers, the neo-clouds and the data-center providers in general to earn a 10% unlevered rate of return, revenue from AI compute will have to grow to 9.2% of GDP by 2032. Put another way, data center revenue would need to grow by 45% for the next seven years. Oh, and not just grow fast, but also the analysis generously assumes these companies continue to deliver 50% operating cash flow margins. All of that relies on Anthropic and OpenAI being perpetually blessed by investors to incinerate literally trillions of dollars. That is where we are. Anthropic may well IPO and achieve a market cap of $2 Trillion, but how one achieves the confidence that optimism will remain is beyond me.

I recently wrote an essay that posited, as have many, that the US economy rests almost entirely on the shoulders of the AI buildout. But that is too broad. The US economy relies entirely on investors’ willingness to underwrite Anthropic and OpenAI to fund the AI buildout, despite the painfully obvious risk that they will never generate cash.

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