The AI Demand Bubble with Ed Elson

0:02Speaker 1:A zone media.

0:05Speaker 2:Greetoms and salutations. It's me ed Zetron and it's better offline. That's right. We are back with Prof. G. Markets ed Elson, and we're here to talk about the naughty little buggers and the magnificent seven, primarily the Big four, but really the big three, the Amazons, the Googles, and the Microsofts of the world. Ed thank you for joining me again.

0:36Speaker 3:Thank you so much for having me. I'm very, very excited to be here.

0:39Speaker 2:Yeah, so tell me. They just reported earnings, and as you well know from the conversation we just said, I got some points to make about it. But when you brought me through how they did.

0:48Speaker 3:On their earnings, absolutely, So let's just run through what we learned on Microsoft Microsoft, and we saw pretty good growth. Billion dollars in revenue up eighteen percent. Amazon similar story, two hundred billion dollars in revenue up twenty percent. Meta's revenue increased twenty eight percent. I mean, on its surface, this was pretty good. Yeah, you just look at the numbers, even the net income which exploded for many of these companies. But of course that's not really what matters here. What really matters is how is the AI trade actually working out.

1:28Speaker 3:There are two main questions that we really want to understand when we look at these big tech companies. The first question is how much revenue did you generate from your AI business? Specifically, that's what we really want to know the answer to. And then the second question is how much of that revenue came from two relatively unstable companies financially specifically open ai and Anthropic. Those are the two questions I want to know the answer to. I know you want to know the answer to. We didn't get those answers. They didn't really tell us, and what they did tell us was not very helpful, kind of papering over the reality, which makes you think maybe the reality is something that they don't really want us to see.

2:11Speaker 2:So that's the funny thing as well, Like before we get to the meat of what you and I both know we're going to discuss, there was also these weird massive equity gains, So the net income part of earnings is now not super useful because in all three cases of Amazon, Google, and Microsoft, they all posted massive equity returns based on the increasing value of open ai and their shares of either or both open ai and and Anthropic.

2:39Speaker 3:Right, Yes, yeah, a wrinkle in there that I'll address, But we'll start with Amazon and Google. The answer to that question is yes, Amazon's net income so their earnings exploded two hundred and forty five percent. That's crazy growth, more than tripled. Google's exploded two hundred and ninety eight percent. Again, crazy growth. How did that happen? What's going so right? What could we dig into it? Exactly? The answer in Amazon's case is that eighty five percent of their net income came from unrealized gains in their stakes in Anthropic and Open AI. So essentially, they basically looked at that company, they said, Okay, I guess it's worth this amount of money.

3:19Speaker 3:I guess it's worth a trillion dollars, and they marked that up and then that was reflected in their earnings. And then in Google's case, eighty seven percent of their earnings came from their unrealized gains in their stakes in Anthropic and SpaceX. So those earnings of those companies you can't really take seriously because they're not reflecting the fundamental underlying health of the business. They're reflecting the optimism associated with the valuations of these AI startups and these frontier labs.

3:50Speaker 3:So that's the first problem is the earnings themselves are not really reliable in Amazon and Google's case. We'll get to Microsoft in a second. The other problem is that that then funnels down into how we value companies. Specifically, one of the most important valuation metrics in investing is the price to earnings multiple. That is how we figure out how expensive or cheap a company really is. We look at their earnings, and we look at the price of the stock, and we compare of the two match up. Now, as of the end of last week, which is when I did this analysis, Amazon was training at nineteen times earnings.

4:27Speaker 3:Google was trading at seventeen times earnings. The S and P the overall market currently trades it around twenty five times earnings. So if you were to look at those multiples on Amazon and Google, you'd say, oh my gosh, these companies are crazy cheap. It is time to buy. But of course we know that actually, no, those multiples have been massively skewed and compromised again by those unrealized gains by those paper games.

4:52Speaker 2:And just to be in this state earning like that. Comparison is always based on net income.

4:56Speaker 3:Yes, it's based on net income is equivalent to earnings, so we look at their pe multiple and their way down. I mean, you look at last year. Amazon was trading throughout the year at around thirty two times earnings. Google was trading around thirty one times earnings. So you look at nineteen and seventeen, you go, oh, my gosh, what's happened. They're so cheap. They're really cheap right now. That's not the case. So what we have to do if you want to actually get an understanding of how to value these companies is you need to subtract out the gains that they have registered in open ai, anthropic and SpaceX.

5:30Speaker 3:You need to create basically a new metric. And we did that and we found that the true multiple for Amazon when you're just for that is actually thirty times earnings, and for Google it's thirty one times earning. So no, these stocks are not cheap right now. Now a lot of people will say, well, are you factoring in the fact that maybe there is some value in those companies and did you put that in the numerator? Blah blah blah. There are a lot of nitty gritty things that we need to do, And the answer is no, we didn't.

5:58Speaker 3:But that's the kind of a now is that Wall Street needs to be employing right now. And the trouble is the more that we see these stakes in these little AI startups and these businesses, and the more that it starts to skew the actual earnings of the companies, it makes it a lot more difficult for us to actually value which companies are cheap, which companies are expensive. And of course it is in that complexification and in that obscurity that bubbles arise. This is the problem that we saw in the financial crisis. It's the problem that you and I have addressed when it comes to the data center SPVs. It's not necessarily that the SPVs are illegal.

6:37Speaker 3:The problem is that they are hard to track, they're opaque, They're not reflected on the balance sheets of these companies, which means that Wall Street and the underwriters and the investors when they look at the data, they're not looking at data that really tells them the reality of what is going on. So that is the problem with the earnings. That's the problem with the pe multiple. I will pause there and we will get to Microsoft, which actually didn't have to report an increase in their in their earnings due.

7:04Speaker 2:To their I thought they had an anthropic bit that did that three point two billion dollar game there.

7:09Speaker 3:Sorry, yes they did do anthropic, but when you look at I mean, anthropic is a smaller investment for Microsoft. Their big investment is, of course, open Ai, which did not show up in their net income. Their net income rose by about thirty percent. If we were to look at the open Ai steake, you would think that it would explode by around three hundred percent, like Google's earnings exploded. That didn't happen due to an interesting gap accounting principle which I can get into in a moment if you'd like me to do it now, why not?

7:43Speaker 2:Why not go into it?

7:44Speaker 3:All? Right? So why didn't Microsoft's net income explode? Why wasn't their stake in open Ai reflected in their earnings? And the answer is that their investment in open Ai is so significant that because of stupid accounting laws and gap principles, they are required to report that that stake differently. So instead of reporting the alleged value of open Ai in their earnings, instead, what they have to do because their stake is so large, and so I guess the law says you need to report this differently. Instead, what they have to do is they have to report their share in open AI's profits. But of course open ai has no profits. So that's actually why Microsoft had to take a six hundred million dollar hit on their earnings to reflect their share of Open Eyed losses in the second quarter. In the second quarter, so in a funny way, when accounting laws require you to report your AI investments correctly, it actually reveals that these big tech companies are actually losing money from AI. But when the accounting laws have loos and they're flimsy, it allows them to say, oh, I made money on this stuff. So it's an interesting

9:00Speaker 3:wrinkle there. And yes, their anthropics stake, they were able to kind of bs that in their earnings, but they weren't able to do it with Opening Hour, which is why they took that six hundred million dollar hit. If we just play this out over the next quarter, in the following quarter, what we can start to see is that actually these investments are not as sexy as the as the net incomes on Amazon and Google would make them see.

9:23Speaker 2:And the other thing with Microsoft that I found interesting, and I mean I'm a curious little criticism went and looked. They mentioned they had annualized revenue, sorry, annualized run rate for AI and Q three fiscal twenty six, which was last quarter. Just for the listeners, their fiscal year begins on July first of the year beforehand, so their fiscal year twenty six begun July first, twenty twenty five. It's annoying. But their last quarter they said, oh, we're here, thirty seven billion run rate for AI, and in this quarter they didn't, right, they just didn't mention it. And I think what it is is the I don't know, Ben from the Ben and on Me show once said the space it's like the way to understand the stock market is imagine the thing that would piss you off the most happening.

10:05Speaker 2:So there you go, because it's so frustrating seeing everyone saying the AI bet paid off, the AI bet paid off. Look number go up so big even though they gave us less information this time, they are obfuscating the information.

10:22Speaker 3:Yes, exactly. If AI were going as well as a lot of people say it's going, then you would expect these companies to simply report their AI revenues and brag about it. But instead they don't do that. Instead, what they do is they report their compute revenue, which, to be fair, is growing, but that was a business's business that existed long before AI. That's not their AI revenue. And when they do report their AI revenues, they usually report it in arr their annual revenue run rates.

10:51Speaker 2:And Amazon actually did that in this quarter. Instead it's a twenty five billion dollar run rate, which is two point oh eight billion dollars. But he's the other thing that people seem to miss as well. You know what also happened in this quarter anthropics compute spend accelerated because it's revenue. It's revenue accelerated, like it's a very obvious like between. So this quarter would refer to what's it's June, May April, right, Yeah, that is that's when Anthropic, I think, claim they hit thirty billion annualized run rate, like they are spending so much more in compute than their actual revenue.

11:27Speaker 2:I wouldn't be surprised. And this we'll get into if most of this run rate came from Anthropic and Open Ayes spend. But again, jingle jingle, the keys are here. Look at the run rate, look at it.

11:40Speaker 3:Back to it. I think just for just for your orders to understand why run rate is a bullshit metric. I mean this is sort of like this is the classic metric that is reported by startups where their their revenue is very choppy, and so what they'll do is they'll pick their best month and then they'll just times it by twelve and say, this is how much we are expected to make over the course of the year. I'll just like point out with my business. You know, my podcast generated double the revenue in June that it generated in May. We had a really good jem Now I could just annualize that number. I could just times it by twelve and say, oh, that's how much money we're going to make this year. But of course that would be bs and I'm not going to do that to you. I'm not going to lie to you. But this is what they are resorting to instead of just reporting how much money they actually made off of AI. Instead, what they do is they pick a random month and then they say, oh, if we times it by twelve, then that will be a good number. And that's what they are starting to report. It's very but that was very yesie, yeah it is.

12:41Speaker 2:And that's the one that Microsoft declined to report this month, which means likely that. So the thing is, I'm guessing that they're referring to a month within the quarter, but we actually don't know. We don't know if it's thirty days, twenty eight days, we don't know if it's four weeks times fifty. We truly don't know what it'd be like four weeks time thirteen. It's just they never disclosed this. But I think it's just a failure of the media and analysts on this one, because I feel like if these companies felt any pressure to actually be honest with their investors, they I don't know, would do anything other than this.

13:17Speaker 3:Yes, well, I think it's actually interesting. Meta is an interesting example of this. Meta is one of the few companies where the analysts are actually trying to ask management the tough questions because it is so obvious what the problem is. The problem is that their free cash flow is declining. It's down ninety one percent, and the reason that it's declining is because they're spending just godgantuan amounts of money on this AI infrastructure. Now, for the other companies who are doing that, they already have these cloud businesses like Google Cloud like aws like Microsoft Azure, and so Wall Street kind of understands generally how they are expected to generate a return on building all of those data centers. Wall Street can stomach that with Meta, it hasn't been outlined whatsoever. You and I talked about this.

14:08Speaker 3:They later kind of folded and admitted that they were just going to build their own cloud business. That was what we thought was going to happen. But when the analysts asked Mark Zuckerberg point blank what the actual plan was in terms of ROI, how are you actually going to generate a return on all of this AI data center spending? He didn't give them an answer. He didn't distress the cloud plans. He didn't address any of the reports about how Meta was in early talk to cell compute to Anthropic, which I know you have covered at length.

14:38Speaker 3:He basically just avoided the question. And I think that tells you something about Mark Zuckerberg and the extent to which he gives a shit. He doesn't really, he doesn't.

14:49Speaker 2:Can't believe he literally cannot be fired.

14:52Speaker 3:That's right, which is back to the governments exactly.

14:56Speaker 2:I mean, it feels like we're in the golden age of grift like it feels like we're just in an era where the only reason this is happening is because they know they can get away with it. There's no it's not like. I've read multiple I would say, like five different articles on Meta, Google, Microsoft, Amazon and their earnings and the only reason anyone is slightly critical of Meta is because their revenue growth wasn't as good as it is it was expected to be. That's the only reason it's not. It's not like analysts are point blank saying, hey, you haven't told us what your AI strategy is, you may have wasted that. They're not being blunt with them.

15:35Speaker 2:They're just like, hey, hey, Mark, when you get around to it, would you mind telling me why you spend like like two hundred three hundred billion dollars and you want to spend one hundred and forty five billion dollars this year? When you when you got a minute, don't worry. I know you're busy.

15:52Speaker 3:I actually disagree with you on that. Meta keep pushing them. I think I think that this has been recognized by the market by Wall Street. Took them a while, I'll give you that, but I think that in the case of Meta, they actually are starting to ask those questions. And I think the problem is that the other companies, because they have those cloud businesses, they're kind of refusing to ask the tough question, or not even the tough question, the obvious question of to what extent are you dependent on Open and Anthropic two companies which are losing gargantuan amounts of money, two of the most unprofitable companies in the history of companies. And that's literally a fact. You can look up the list of the most unprofitable companies ever and you'll notice if you do the math, Open, Aye and Anthropics should be in that list. So I think that they are not doing that homework, that hard work of digging into the numbers and asking that difficult question when it comes to especially when it comes to Google, and especially when it comes to Amazon. But I do think that they are worried about Meta's total lack of

16:56Speaker 3:interest in laying out how they plan to generate any returns on this whatsoever.

17:13Speaker 2:Well, that's the thing though, I will push back again a Meta. Sure they are asking the questions, but they're not point blank saying, hey, you've not shown it. They're not. And even the media, the media is absolutely not like they're saying, oh, there's concerns over AI spend a few higher than usual. That's strange. It's this kind of like plodding. Ah, I guess maybe we should find something out. And the analysts are pushing these questions now. But as we speak, and in two days this will come out, so we know it's down again. But MAT has already recovered six percent. Today, it recovered a couple percent. It's already on course to recover all of the losses. So it's not like anything changed.

17:59Speaker 2:But as we discussed before we got on here, there are some analysts who have tried to work out or have estimated the actual concentration of revenue for Amazon, Google and Microsoft for open AI and anthropic spend. And as we were just discussing, so Ross Sandler over at Berkleys he estimates that seventy three percent of all Amazon's AI revenues in both twenty twenty six and twenty twenty seven will be anthropic and open AI's compute spend ChRI.

18:27Speaker 3:It is completely an openly number.

18:29Speaker 2:Insane. It is insane. So I found this a couple of days ago. I'd been working on it and I thought, well, it can't be that bad elsewhere except the look at ubs of Stephen Jews As he said this back in so barcleays Is back in March. Stevens was in June and he said that forty sorry, it's twenty seven percent of all Google Cloud revenues, so not AI revenues. All Google Cloud revenues for twenty twenty six are estimated to be open AI and anthropic, and then forty four percent in twenty two twenty seven. That is completely fucking insane, Like that is just this is this is to me such a huge scandal, And I mean I could also mention that well that there's also a Wells Fargo report that says that Microsoft's same deal seventy three percent is anthropic and open AI have their AI revenues Michael Churan over there. And it's like, I feel like I'm going a little insane because when you read these numbers, you're like, oh, these are from major investment analysts. How are they not calling like, hey, mister Fargo, mister Fargo, I read these numbers, and you should really check these out because we might

19:36Speaker 2:be in trouble. And I think and friend of the showcase goa really helped me nail this down. I think it's these people are only capable of thinking two quarters in the future. Like they they can think of twenty twenty eight. They can think of twenty twenty seven, but they can only do so in terms of the last two quarters. Number has gone up. Open Ai and Anthropic are still solvent, so number will keep going up. It isn't a problem that the revenue is centralized because number keep going up. But to me, this is potentially one of the largest corporate scandals in tech history. Maybe I'm being dramatic, but this is We're talking over nine hundred and ninety billion dollars of capex now, and most of it is for these two companies that can quite literally not afford to pay unless one of those three companies gives them the money.

20:28Speaker 3:Yes, this is a huge, huge problem. And you were saying that the analysts weren't and the media weren't doing their job in terms of asking meta questions about having going to generate a return. I sort of pushed back on you on this one. The silence is deafening from the analysts and from the media. There is a very very obvious concern when it comes to the businesses of the largest and most systemic companies in the world, the companies on which the portfolios of every America are entirely predicated, on on which the entire stock market relies on. And that is how much of your business depends on two companies, Open AI and Anthropic. And you are one of the few people who has been doing significant work into uncovering that answer. And you have looked into some of the research that has come out of Wells Fargo, Barclay's ubs.

21:25Speaker 3:And we should give those analysts credit for crunching those numbers and doing the work of figuring it out. But the numbers are insane. Open and Anthropics seventy four percent of Microsoft's AI revenue. That is very, very unsustainable. We talked about diversification in markets, the importance of having a diversified portfolio. The same thing goes for business. You want to have a diversified revenue streams that indicates strong, healthy, sustainable growth. None of these big tech companies have anything close to diversified revenue streams when it comes to AI, and so you have to ask the very obvious question, what would happen if one of those two companies Open A and Anthropic went under. And you also have to ask the question, what is the likelihood that one of those two companies, open Ai and Anthropic could go under.

22:19Speaker 3:What is the likelihood that they would not be able to make good on those payments that are propping up the growth of these big tech companies, specifically when it comes to their revenue. And the answer is it's actually pretty fucking high. Yeah, because you look at the financials and they are ugly, as you've talked about at length, and we can get into but I want to pass it back to you now.

22:39Speaker 2:The thing is a fun story. A couple of days ago, Amazon, they were meant to give open Ai another thirty five billion dollars if they went public or reached the AGI. Well none of those, none of those, none of those things happened, of course, but they still gave them the thirty five billion dollars a couple of days ago. And that's crazy. That's a really crazy number, especially because that is well, let's just go and have a look at these numbers in rossandle Barclays. That is, so thirty five billion dollars is roughly let's see, Yeah, it's a little bit, it's around how much AI revenue Amazon has made this year, so forty point one nine five Actually yeah, yeah, it's a three point four billion dollars less sorry, more than Amazon is estimated to make on AI this year in totality including open Ai and Anthropic spent. So that's good, just handing themselves money, just handing it to open AI and Anthropics so they could hand it back. They already gave five billion dollars to Anthropic, They already were on course to give them another twenty billions sometimes this year.

23:50Speaker 2:Google already give ten gave ten billion dollars to Anthropic this year has another thirty billion. They ow, this is not a real This is not a real economy, is not growth. No one's actually doing business here. It's just people handing money to each other and being like, yep, look how profitable we are. Even though that does not even doesn't seem like it's exploding margins either, it doesn't seem like it's having much of an effect at all. But what's really concerning is everyone's excited about these companies because of their cloud growth, and it's really beginning to look like most of that revenue growth is coming from this spend. Yes, which is terrifying.

24:31Speaker 3:It's almost all of it is coming from those two companies. Earlier, you said that them not reporting that their revenue is coming from open Ai and Anthropic alone, that that is something of a scandal. I think that is just irresponsible. I think of it less of a scandal. The part that I do think is a scandal is the circular financing aspect of it. It's the fact that those two companies are also the two companies in which big tech invested billions and billions of in order to keep them afloat, and that is the only reason why those companies are surviving. Yes, it's Silicon Valley and venture investors, but a lot of that investment is corporate investment coming from big tech. It's coming from Microsoft, it's coming from Google, it's coming from Amazon.

25:15Speaker 3:And so the idea that the largest customers, the customers that are driving the majority of these companies' revenue growth, are also the companies in which those companies had invested in that is a very very obvious conflict of interest, at which point it starts to get into actual scandal territory. I don't think that calling the circular financing epidemic, I don't think calling that a scandal is overkill. I don't think that's a stretch too far. I think it really is a scandal, and I think it's actually shameful the way Jensen Huang has talked about it, where he was asked this question about the circular deal making and he said, I don't think it's circular at all. He simply denied it, and he didn't come up with an explanation as to why it wasn't circular. He didn't come up with any real excuses. He just said, no, that's wrong, bs, I don't like what you're saying, and then he just moved on.

26:07Speaker 3:And that is a real problem. That's when you start to see that actually, these these executives either are either they're just blindly ignoring what is happening, or they are actually lying. I mean, I think that it's it's reasonable they assume that Jensen Wong told a lie when he said that he didn't think that what they were doing was circular, just to like go back to the question of would open eye go under, because that's that's the real life, that's how this.

26:36Speaker 2:Goes down, yes, And that's that is also a point that people are now readily discussing. It's no longer fringe economic theory from a crazy person called Aird. It's now something that people want to discuss and are worried about. Yes, I think, but it's like yeah, but they discuss it in this way that is like I don't know, like if a neighborhood restaurant shut down, like it's like, oh, you know, yeh, you know, these things happened. Business is tough.

27:12Speaker 2:I wish I was kidding, but I've tried to talk to reporters about this and try to be like, hey, look, this company is really holding up the earth. Yeah, like they are quite consequential to the future revenues and multiple companies, and they're like, yeah, but you know there's other demand. And that's the thing. When the big thing that the piece I'm working on will be out by the time this goes out, says is like, yeah, the other problem with seventy three percent or so of AI revenues for Google, Amazon and Microsoft being open AI and anthropic is and just be clear, this progresses over the years of estimates.

27:49Speaker 2:It's not like they say, okay, demand will even out. That suggests that there isn't demand for AI. Just rit large that there is not demand, at least not at the scale that's been promised, and definitely not at the scale that will saytiate all of these data centers get it's not possible when you look at these numbers. And this is not me just being like, oh, I work some stuff out with some markles. These are actual financial analysts.

28:18Speaker 3:Yeah, and these are Yeah.

28:21Speaker 2:It's genuinely terrifying because it's it's not just how bad it will be and yes, we'll get back to open eye dying in a second. It's the fact that everyone's kind of just looking at it and be like, as all right.

28:34Speaker 3:So I think, yeah, I think it was really the actual philosophy was revealed in your Bloomberg interview. And you know, I don't mean this disrespectfully to the interview. I thought it was actually a great interview, and I thought they did a really good job. But I forget her name, but the interviewer said something that said something quite important to you, where she said, I just want to make sure you understand. I just want to make sure we're all on the same page here. The people who run these companies are very smart people. And that was the beginning of the question which would go on to say something like, are you really sure about all of this?

29:12Speaker 3:And I think that is the hesitancy that you're seeing when you talk to media outlets, when you go to the New York Times, And I think that's the hesitancy among all of us, which is that to say that this company might not actually work out, which is not an insane thing to say by any stretch of the imagination when you look at their financials and when you look at their numbers. But to say that it might not work out is to say that the people who are running that company and the people who are investing in that company aren't the smartest people in the world.

29:41Speaker 3:And today that is a bold thing to say. It is a bold thing to say that Satie and Adella might not know what he's doing. It's a bold thing to say that Sam Altman might not know what he's doing. It's a bold thing to say that Mark Zuckerberg might not know what he's doing, which is quite crazy to me, considering that just a few years ago he spent more than eighty billion dollars trying to build the Metaverse, which was a total failure, total dead on arrival. He renamed his company to Meta because he thought that this was the future. He was so so wrong about that. So the idea that these people can't be wrong, or that they can't spend money incorrectly, or that sometimes they might actually not be great capital allocators, that is total lunacy.

30:27Speaker 3:It is a total fantasy. But for whatever reason, people don't want to believe that. People get uncomfortable when you start to suggest that. And that, I think is why people get uncomfortable when you say the things that you say, because it suggests maybe these guys don't know what they're doing.

30:42Speaker 2:Well, it's that. And also, let's just let's just say this right now, looking at the Barclay's numbers in front of me, open AI dice tomorrow. That is, let's look at it. Twenty eight percent of Amazon's AI revenue next year gone goodbye, just evaporated, and indeed twenty seven percent for the next two years as well. If anthropic can open air if one of them dies, what that's like twenty percent let's see open aiyes, a well, it looks like about twelve point five billion dollars of Google's twenty twenty seven AI revenue just like gone evaporated and otherwise their other AI revenues are pretty flat. It looks like Vertex Vertex kind of increases, but again that's through selling anthropic and open aies models. It's I don't think people realize that there's a great charts coming in this article as well. How much of AS yours revenue as well is just open aiy spend And it's let's see, let's take let's take a look at this chart of as your revenue as well sixty two percent. Let's see, Yeah, it's about seventy two percent, sixty eight to seventy two percent in fiscal year twenty twenty six, and as much

31:51Speaker 2:as seventy four percent in twenty twenty seven. If these companies die, they lose most of the AII revenue evaporated. And that's not including the amount of money that comes through as your AI renting out their models. Yeah, like, and people are just like, yeah, you know, if that happens, there'll be more demand. I have this guy who's a very well meaning guy. He's on Twitter. He's a semi conductibuller analyst. You always respond and say, look, all useful compute will be bored, All useful compute will be bored.

32:19Speaker 2:It will always be born. And I'm like, yeah, but if open ai dies, it is the largest consumer of AI compute. What happens that, well, it'll get bored. Yeah, And it's just insane to me. It is genuinely bonkers to me that no one like I guess, I guess what it is taking a step back is looking at what you said as well. Is it's they don't want to follow the argument to the logical endpoint because it's all of these smart people were stupid, that's right, and also everyone was wrong, wrong in a way that he's going to be very difficult to back out of.

32:53Speaker 3:That's right.

32:54Speaker 2:And also that they will like to just let's be clear.

32:59Speaker 3:Yeah, that's the problem now. So I'm in total agree with you on all this. I want to take things to their logical conclusion further and I'm going to say so, but I don't know if you're going to be that excited about what I'm going to say. That's fine because when I think about this, what would actually happen if AI were to basically just die, if open Ai actually die, and if Anthropic actually died. And I think there's a good reason to believe that, which we can get into we can get into their financials and just rehash them because they are very important. They're systemic to the ecosystem.

33:32Speaker 3:But I sometime I like to think, Okay, what would a world look like where the AI thing just didn't work out? And I have to say a lot of that anxiety actually is priced in right now when it comes to big tech. And I just want to point you to the pre Big Mornings multiples. Yes, the price to earnings multiples of big tech at the beginning of twenty twenty three. I went back and looked at this. This was right before that AI trade took off. If you look at the price of earnings multiples, you look at Microsoft, it was trading at twenty six times earnings.

34:07Speaker 3:Amazon was trading at eighty times earnings. Meta was trading at thirty one times earnings. If you look at the pe multiples today, and by the way, I looked at this as of last week, at the end of last week, right after they've reported their earnings, so they could have changed by now, I'm sure they have. Microsoft's multiple is lower than it was. It's at twenty five, not that much lower, but it is lower Amazon. Amazon's is significantly lower. And this is the real pe, the one that I adjusted, not factoring in their investment gains, on their and their anthropic and opening. I stakes it's trading at thirty times earnings.

34:40Speaker 3:That's lower, and Metas is significantly lower. It's trading at twenty times earnings compared to thirty one before the AI boom. So I think one thing that we should recognize is that in some places, in some areas of the market, I think there are people on Wall Street who are actually quite anxious. I think there are a lot of people on Wall Street ed who are reading your newsletter. I truly believe that, and I think that that perspective, the bearish perspective, and the acknowledgment of how this could all implode. I don't think that it is completely driving the market. I think there's more optimism than there is pessimism, but I do think that it is somewhat being reflected.

35:22Speaker 3:And that is to say, if this all were to blow up, I don't think these stocks wouldn't crash. They would certainly crash, but I do think that it wouldn't be as horrible as it might have been, say in two thousand and eight, when the housing bubble was truly elusive to almost everyone. That is my conjecture, and I'm sure you might disagree with me on it, but I do think we should recognize the extent to which there is some anxiety that is beginning to be reflected in some asset prices.

36:09Speaker 2:So one pushback, yeah, and I think it's a critical one, is that even though the price thre earnings and all that reflects a little bit lower and it's showing some anxiety, it still is a price factored into which factors in the idea that these companies will keep growing. Yes, And I think that that is a critical problem because I'm not sure, at least in the case of their cloud businesses, whether these companies are growing anymore when you remove open AI and anthropic right, I don't think it like I'm not just talking like. I don't think Microsoft, Google, Amazon and Meta. Though I think Meta could die in ten years.

36:46Speaker 2:I've thought that for a while. I think that they're just bits falling apart. But I don't think they're dying. I think their stocks are going to get their asses beat. But the problem is going to be not just that AI didn't work. That's what's going to be the first problem. The second one is when they go, right, well, open ai isn't paying you anymore, and suddenly your your revenues are down and your growth has slowed. Hey, Google Cloud has stopped growing. It's stopped growing pretty much at all.

37:14Speaker 2:It's in fact, it looks kind of flat. What's the deal with that? And it's because Anthropic and open AI's computees compute spend was propping up the growth. So while Wall Street might be saying, oh, well, if AI doesn't work out, I think what they mean is that they think AI won't work out and be the next big thing, but there will still be big revenue generating businesses from this, which is not the case. I went and looked at the Wells Fargo estimates and Turin and what's interesting for Microsoft is that in fiscal year twenty twenty seven, so the next year, they estimate the Microsoft three sixty five copilot will make ten billion dollars a year in and your revenue, which is pathetic. Yeah, that's like a a what like a third of intelligent cloud. It's le I mean, it's a little bit less than they estimate the as your AI will make, which is predominantly made up as selling open AIS models.

38:15Speaker 3:I mean, they said one of their bragging points on that earning score was that they have thirty million copilot paying copilot us. Yeah, but what they don't really talk about is the fact that that's part of a larger enterprise bundle, which only makes up about eight percent of their total Microsoft three sixty five subscribers. So basically what they're telling us, they're trying to brag. But ultimately I read that and I go, oh, so you only converted eight percent of your user base. That was the share of your users who are down to try this AI product that you say is going to change the world.

38:50Speaker 3:So to that point, I don't think that the strength that they are projecting in their consumer AI business is anywhere near what they'd like us to believe.

39:00Speaker 2:Well, on top of that, the Wells Fargo estimates estimates estimates, someone will get me on that one. In the comments, they only estimate that they made three point eighty five billion for the entire fiscal year twenty twenty six from three sixty five copilot. The know the thing with thirty million paid seats. They're discounting this to Tim bucktoo, like this is this is being their discounting it to hell, and I mean pretty much anything like like pretty much anything that Microsoft cells has discounts, especially when it comes to Microsoft three sixty five. But again, the hogs lapped it up. They love their slop. They love being given a new big number so that they can interpret him when they again, not really sure what these analysts were doing, because I don't know. Again, I think I've said this already, Like if I was working at Wells Fargo and I had these numbers, I would be calling my boss's boss.

39:54Speaker 2:I'd be like, hey, guys, hi, we have a problem. Because, like I said earlier, it's not just that Microsoft, Google and Amazon have pathetic AI revenues outside of open AI and anthropic It's that if they have pathetic revenues, if they as the largest holders of AI compute, as with the ones with the best pricing power, with the best teams, ostensibly with the most experience building AI data centers and providing AI compute, if they can barely scrape together what like what like, let's see, so it's seventy seventy three seventy four percent of so like they have this meager little little shrivel of their AI revenues is from diverse revenue.

40:38Speaker 2:If that's the case, then there is not demand for a compute. It's not that there's only a little. It means there's none. It means there's actually, like there is a couple billion. Because again, when you look at the other providers, Core Weave, who are their biggest customers, Anthropic, Meta and open Ai. Who's Iron's biggest customer? Microsoft? Nebuis Microsoft? What's Microsoft doing with AI? Not very much? Not actually very much at all. They are providing compute to open ai and conning people into buying Copilot. Yeah, it's just it's astonishing because this is bigger than them. It's bigger than them. It's the one hundred night gigawats of planned data center capacity. It's all of these data centers being built everywhere. I it like I'm stuttering because it's like the ramifications of this at everything I've kind of feared, which is that AI demand does not exist at scale, and most of these data centers don't go paid for.

41:36Speaker 2:And that's even if Anthropic and open ai like succeed in surviving past twenty twenty seven.

41:43Speaker 3:Well, I think you said something important earlier about the growth and that is if if this AI thing doesn't work out. It's not as if Microsoft and Amazon and Google and Meta won't have a business anymore. They had a business before AI, and the business was pretty big and doing pretty well. What it does mean is that these companies won't actually be growing anymore. They won't be growth companies. And I think this gets to the heart of what AI has been all about, and that is that the big tech companies in late twenty twenty two, when chat GBT was released to the world, they suddenly realized, oh my gosh, innovation is happening without us. There are other companies on the scene, there are other technologies, and we don't have a part in it. And so they decided, Okay, what are we going to do. We're going to do whatever we can to take whatever semblance of technology exists in that company and then bolt it onto our own companies.

42:46Speaker 3:We're basically going to inject that optimism into our own faces as if it were botox, to convince the market that we are in fact young again, that we are growing, that we're hot, that we're innovative, and that you should come and put your money in us because we're not just a company that's going to continue to generate cash. We're a company, We're a generational company. We're a company that's going to significantly increase profits at an exponential rate over ten twenty thirty years. That is the story that they wanted to tell the markets, and they wanted to tell it so desperately that they were willing to actually go and invest in those companies like open Ai and Anthropic and also SpaceX, which we haven't mentioned that much, but it actually plays a role in all this, and then have those companies come back and then buy our chips, give us back the money, and then we're going to use that and use that as a story to tell the world that actually we're young again, that we are growing.

43:44Speaker 2:And everyone by proxy to spend money on ai compute to compete with our exact compete with us in with the companies that we invest in.

43:53Speaker 3:We will obliterate our balance sheets in the process. And that's where things are getting get really ugly. But is that really start to lose cash and we're starting to see it Amazon negative free cash flow, Google negative free cash flow as of this quarter. But that's really what they're doing here. They want to be young again. But if you look at these companies, these companies are old. These are mature companies. Their heyday is behind them, but they don't want to believe that. They want to live forever.

44:25Speaker 3:They are the Brian Johnson's of the world of technology. And so I think, what's going to happen if this thing doesn't work out. I think there's a highlightlihood that it won't because of the financials of opening iron anthropic and how dependent the whole world has become on them. I think what will happen is the companies won't go under the big tech companies. I think what will happen is Wall Street will look at them and they'll say, you're not a growth company. You're a mature company. And that means that we're going to assign a mature multiple to your earnings. We're not going to have the days.

45:00Speaker 3:I think that'll look like something in the range of fifteen to twenty times earnings. So that's why, by the way, Meta I'm not so worried about, because Meta is actually in that range. I think if you look at the company, I think Wall Street is looking at it and saying, this is a company whose growth prospects are unlikely at best. So I'm not so worried about Meta. The companies I'm more worried about is a company like Google trading above thirty times earnings by the way. A company that's gotten way out over at skis from a multiple perspective, which is really surprising to me is Apple. And I think that's because people have actually gotten nervous about the AI trade and so they said, Okay, Amazon still has cash on the balance sheet. Apple is trading it nearly forty times earnings. The way that they have been able to dupe the market into thinking that they are a growth company when they haven't come out with a new product in ten years, and the ones that they've tried to come out with and tried to sell have completely flopped.

45:54Speaker 3:They canceled the Apple car, the Vision pro was a total disaster. I mean, that's that's very clearly not a growth company.

46:02Speaker 2:But I think that's the quest funny thing is with Apple as well, is that they've managed to keep going by just not blinking on the AI trade. Except the AI trade fucked them over because of the increasing cost of ram right, because of everyone buying into I mean, that's the other thing. It's like the increasing this is the other So actually this is a good bridge from what you were just saying. The other problem with this as well is yeah, you're saying these companies will be assigned growth like the multiples associated with old, old, boring companies.

46:33Speaker 3:Wearing old mature.

46:35Speaker 2:But again I don't think that factors in a the fact they're not growing, but b the fact that they have hundreds of billions of assets. Now they're just burdened with debt endless debt. Microsoft has been kind of smart in the amount of debt it's taken on. It's nowhere near as encumbered. But who knows at this point. But Google's done a massive equity sale or they plan to do a massive equity sale.

46:59Speaker 3:The more on tilt they get in order to pursue this botox future of being young. Again, this is the more dangerous, the more dangerous that the larger the threat to their entire existence becomes. So I will agree with you if they continue down this road of I'm not just going to pay for the botox with the cash that I already have in my bank account. I'm going to take on significant amounts of debt, significant amounts of leverage and margin in order to pursue that dream because I'm so obsessed with pursuing it and I need to do it because I have to be young again. If they take that to its end, to its logical conclusion, as you say, then yeah, we can start talking about will these companies implode? And I think Oracle is an example of a company where they have done that. They have genuinely done that, and its prospects are genuinely terrifying.

47:50Speaker 3:We're starting to see it with some of these other companies. We're starting to I was shocked that Google was willing to come out with a quarter of negative free cash flow. I was shocked that Amazon was willing to do that. So it does appear that they're starting to lose their marbles on this front. They're so obsessed with the mission, they're so obsessed with the AI future that they are actually acting irresponsibly. But I don't think that we're quite there yet. I think the signs show that they're going to continue to do this. I mean, if they continue to load up their balance sheets with debt, who knows what the future will actually look like. But this is so far that they're not quite in a place where They're fully going to collapse and implode, would be my read of the situation at present.

48:36Speaker 2:I fully agree. By the way, I don't actually think the Big Three collapse. I think Meta is already on the down spiral. I think they really I think their product is collapsing, and the things that I continually hear from that company suggests that, like the culture is screwed. But nevertheless, for the short term, at least the next five years, I think that they will be fine. They're not going to have a fun time of it when this ends again, when it comes through like logical end points in the way that people don't want to discuss them.

49:04Speaker 2:Oracle is now spending all of its revenue, just more than its revenue on AI capex, just for open AI. And I mean, the New York Times just just fucking ripped me off, by the way, Like there is a sentence in there about fallen Angels that is like bordering on identical to my piece. Fucking New York Times. Man, if you're listening from the Times, go read the Oracle piece. Go read my fallen angel bit from the open Aye bubble. You tell me if I'm crazy. But nevertheless, people are having this conversation like, Wow, Oracle, they're kind of unprofitable.

49:36Speaker 2:That's not good. Wow, that's not good. But then they stop short of saying the thing that they don't want to say much like everyone else. Now when to talk about this bit, which is, yeah, if Oracle doesn't work out the AI trade, it dies. Yes, It's revenue has been flat for fifteen years adjusted for inflation, it has. The crazy thing is I wrote about this a couple of weeks ago. The crazy thing about Oracle is that they actually would be on the decline already, but whenever they slow down, they buy more companies. They use the quiet companies. They're like, they're really strange.

50:09Speaker 3:Yeah.

50:10Speaker 2:But nevertheless, though, no one wants to talk about the fact that Oracle will die. And honestly, seeing these numbers, yeah, Oracle will die.

50:17Speaker 3:It's it is a it is a genuinely it is a genuine possibility. It's it's not over high. But it's not dumerism, it's it's it could genuinely happen. I think we should give credit to one group of people who actually do seem to be pricing in that possibility, and that is the credit default swap traders. Oh yeah, whichever ones have driven those CDs is up to where they are. I don't know where they are.

50:42Speaker 2:And that's just exactly the listeners that's just betting on whether Oracle will die. It specifically betting on whether it will defeat default on its debts.

50:51Speaker 3:Yes, whether it's the insurance that you pay on the on the possibility that it will default, and the price of that insurance is going up. People are beginning to realize in that market, specifically, that the possibility is real, that it could actually happen. And I mean, I think there's a question as to again whether they're too late on that. Weren't the signs there before? Couldn't we have started to see this coming not today, but six to twelve to eighteen months ago. And I think that would be the contention of your readers and your listeners who have been hearing about this from you for a very long time. And then suddenly everyone decides, oh, maybe it's a problem. Maybe we'll start to write some articles on this, maybe we'll start to see those spreads widening on the cdswats.

51:39Speaker 3:But we should give them their props. You know, some investors seem to be acknowledging the situation.

51:48Speaker 2:Yeah, well, you know what, Ed, I think that's actually a good spot to end it. People can find you on prof G Markets what you're working on at the moment, because you should write up that botox thing. It's an incredible idea. It's a banger. Please run with it.

52:05Speaker 3:That'll be my next newsletter. Let's see. I'm working on a newsletter where we're talking about what happened in South Korea last week. That'll go out on Tuesday of this week, so that's tomorrow. I don't know when this episode will come out, but if you want to come follow my work, go to Profty Markets. We're on YouTube. I cover the markets every single day of the week, or at least Monday through Friday, and we talk about everything. We have people on from all walks of life, from different sides of the market. We try to have bulls on, we try to have bears on, and we'll certainly be having ed Zeitrin on in the future as well, because we love them and we love this analysis.

52:39Speaker 2:We love the heads. All right. You'll find me on the monologue this week as well. Haven't worked out what it's going to be. You'll probably be about this. Thank you zever for listening. Subscribe to the newsletter Premium as well as my main source along with the podcast. I love you all, Thank you for listening. Thank you for listening to Better Offline. The editor and composer of the Better Offline theme song is Matasowski. You can check out more of his music and audio projects at Matasowski dot com, M A T T O S O W s ki dot com. You can email me at easy at Better Offline dot com or visit Better Offline dot com to find more podcast links and of course my newsletter. I also really recommend you go to chat dot Where's youreaed dot at to visit the discord, and go to our slash Better Offline to check out our reddit. Thank you so much for listening.

53:34Speaker 1:Better Offline is a production of cool Zone Media. For more from cool Zone Media, visit our website cool Zonemedia dot com, or check us out on the iHeartRadio app, Apple Podcasts, or wherever you get your podcasts.

54:01Speaker 2:The Spish