All content copyright © 2010-2024 Frank Revelo, www.frankrevelo.com
(Written 19 Sep 2024)
Venture capitalist gives AI company $4 billion, receives equity.
AI company spends $3 billion cash on cloud services (Microsoft, Amazon, Google) and $1 billion on salaries and other expenses.
Cloud services company spends $2 billion cash on Nvidia chips, $700 million on salaries and other expenses, $300 million cash profit.
Nvidia spends $1 billion cash on TSMC to make chips, $800 million on salaries and other expenses, $200 million cash profit.
TSMC spends $900 million to make chips, $100 million cash profit.
Thus, Of original $4 billion cash, $600 million cash profits, $3.4 billion salaries and other expenses.
AI company declares it has breakthrough product (but no revenues). Investors desperate to buy AI company stock, so venture capitalist sells 30% of AI company equity at IPO for $30 billion. AI company thus valued at $100 billion total.
AI company trades 10% of equity (valued at $10 billion) for more cloud services. Cloud services company possibly trades some AI company equity for more Nvidia chips. Both cloud services company and Nvidia assumed to have excess capacity/chips on hand, so no need for more cash expenses, hence entire $10 billion AI company equity counted as non-cash profit, by either cloud services company or Nvidia.
Assuming stock price to earnings (P/E) ratio of 30, then stock prices of cloud services company and Nvidia boosted by 30 * $500 million = $15 billion due to cash profits, plus 30 * $10 billion = $300 billion due to non-cash profits. TSMC stock price by 30 * $100 million = $3 billion, due entirely to cash profits. Plus publicly traded AI company stock of $30 billion. Hence original $4 billion venture capitalist cash investment boosts stock market by $348 billion total, or 1:87 ratio. If original venture capitalist cash investment were $100 billion spread among multiple AI companies, then stock market inflation would be 87 * $100 billion = $8.7 trillion.
Numbers above are made-up and exaggerated, of course. Analysis merely shows that what amounts to vendor financing, using inflated AI company equity as substitute for hard cash, can wildly distort earnings and thus inflate stock market into massive bubble that will burst once it becomes clear that AI company will never be profitable. Drop in TSMC stock price will be small, drop in cloud services company and Nvidia stock prices will be large, AI stock price will go to zero or near zero.
A few days ago, Chinese company named DeepSeek released a competitor to USA AI systems. Development and operating cost of DeepSeek system is allegedly a fraction of what USA systems cost, plus DeepSeek system is open software, so its inner working open to examination by anyone for free. Yesterday, Nvidia stock market valuation crashed by almost $600 billion in response to DeepSeek release.
Neither Chinese nor USA systems likely to ever make much money, because few barriers to entry in AI and hence innovators will constantly be disrupting existing companies and profits will be destroyed by price wars. On the other hand, taking a short position against Nvidia stock would have been immensely profitable for DeepSeek and perhaps earned back all development costs 10 or 100 times over in a single day. Parent company of DeepSeek is a Chinese hedge fund, hence familiar with short selling. Nvidia stock price rebounded today, however valuations for all USA AI related stocks continue to be inflated, in my opinion, so continued opportunities for profitable shorting, at least by those (like DeepSeek) who are able to control exactly when the bubble pops and thus avoid short squeezes.