Two ways. Gradually and then suddenly.
Written by Julian Wheeler – Partner and US Equity Specialist
For anyone unfamiliar, my title comes from Hemingway’s ‘The Sun Also Rises’. In the book it is Mike Campbell’s answer to the question of how he went bankrupt. It is also how I believe two current booms will come to an end: capital spending on AI infused technology and the proliferation of Private Credit/Equity over its Public equivalent.
To be fair, suggesting that this will be the conclusion to the first one hardly demonstrates astounding insight on my part, as this is how all these cycles come to an end. Unlike tax or tariff changes, there is no advance warning of lower future requirement – the orders are simply cancelled. Don’t believe anyone who says they have ‘good visibility’ or denies the virtual certainty that their customers are double or even triple ordering what they need during this time of shortage. It is just like investors who inflate their real demand for a ‘Hot IPO’. And yes “AI” will be no different from any other previous zeitgeist: excessive capital spending into a shortage of supply is always followed by a downturn once the demand is satisfied.
And the ‘gradual’ part of this ‘bankruptcy’ began this month. There were two ‘tells’: one came from Coreweave; a company that is invested in, lent to and sold to by Nvidia. Talk about circular finance! I think of them as a “We Work” for compute capacity: all fine when there’s a shortage, not so good when there are alternatives. Their explanation for missing forecasts was due to a delay in parts of their supply chain. As the stock collapsed, the Bulls defended it with, “well don’t worry, just look at the demand” That’s the same as an airline saying it has lots of bookings but no planes to carry passengers, it means a halt to growth, no one cares why when the music stops!
The second revelation came from an assessment of what is implied by Open AI’s own forecast of capex and revenue. It simply doesn’t add up. They must either spend far less than they have committed to do thus far, or, to justify the supposed level of spending they require to generate far more revenue than what they expected to do in 5 years’ time. How much more? They need an amount of revenue about equal to the GDP of the United Kingdom. I know which of those two I believe will happen. Perhaps this is why Amazon, (who ought to know a thing or two about Cloud Computing and maybe the likelihood of getting paid) signed a deal with Open AI for just one tenth of the size of the extraordinary one inked in by Oracle just 8 weeks earlier. The market always knows best – Oracle, having piled on debt to accommodate this Open AI deal is now 10% lower than the day before that announcement.
Now let’s turn to the other process which throughout history has always turned from ‘gradually’ to ‘suddenly’ with very little warning. Credit. And this time around, it will be private credit where there is almost no regulatory oversight. This was fine when it was outside the mainstream and more of a ‘Rich Man’s Club’ back in the day, but now it has reached down to pensions and retail it is only a matter of time before greater scrutiny is applied. With that should come better price discovery, where currently there is room for much discrepancy and potential conflicts when the owner of an asset gets to determine its value. The most blatant example of this surfaced recently where the same loan was valued at 77 cents on the dollar (a distressed level) by Apollo but still held at 91 cents by Future Standard and KKR.
Last month I talked about a bankruptcy or two and Jamie Dimon’s cockroaches. After a brief wobble, calm appears to have returned to proceedings and First Brands was consigned to history. After all it was ‘just a fraud and not symptomatic of the sector’. Ok, can we find an instance where there is no skullduggery involved? It didn’t take long. This month’s exhibit is Renovo Home Partners, a home improvement company which looks to have failed. Just a month earlier Blackrock, only the world’s largest asset manager, had valued their loans to the company at 100% – so they were fully expecting repayment. And now one month later? Zero. Worthless.
Gradually? Nothing gradual there…that was indeed suddenly.
For more background on our U.S. market views, visit the Over the Pond archive.
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