The AI Demand Bubble with Ed Elson

29:08And 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. 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.

29:48I 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 dealmaking. 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. And that is a real problem. That's when you start to see that actually these executives either are either they're just blindly ignoring what is happening, or they are actually lying.

30:26I mean, I think that it's reasonable to assume that Jensen Huang told a lie when he said that he didn't think that what they were doing was circular. Just to go back to the question of would open AI go under? Because that's how this goes down. Yes. And that is also a point that people are now readily discussing. It's no longer longer fringe economic theory from a crazy person called Ed. It's now something that people want to discuss and are worried about. Yes. 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, these things happen.

31:15Business is tough. i'm 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 they are quite consequential to the future revenues of multiple companies and they're like yeah but you know there's other demand yeah and that's the thing when the big thing that this that the piece i'm working on it'll be out by the time this goes out, says is like, yeah, the other problem with 73 % 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.

31:55It's not like they say, okay, demand will even out. That suggests that there isn't demand for AI. Just writ large, that there is not demand, at least not at the scale that's been promised and definitely not at the scale that will satiate all of these data centers like they get it's not possible when you look at these numbers and this is not me just being like oh i'll work some stuff out with some articles these are actual financial analysts yeah yeah these are yeah it's genuinely terrifying because it's it's not just how bad it will be and yes we'll get back to open ai dying in a second it's the fact that everyone's kind of just looking at it be like, ah, it's all right.

32:40So I think, yeah, I think it was really, the actual philosophy was, was revealed in your Bloomberg interview. Um, and you know, I don't mean this disrespectfully to the interviewer. I thought it was actually a great interview and I thought they did a really good job, but, um, 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 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?

33:17And 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. And today, that is a bold thing to say.

33:51It is a bold thing to say that Satya Nadella 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$80 billion 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.

34:32That is total lunacy. 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. well it's that and also let's just let's just say this right now i'm looking at the barclays numbers in front of me open ai dies tomorrow that is let's look at it 28 of amazon's ai revenue next year gone goodbye just just evaporated and indeed 27 for the next two years as well if anthropic and open air if one of them dies what that's like 20 let's see open ai is a what it looks like about 12.5 billion dollars of google's 2027 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 ai's models it's i don't think people realize that there's a great charts coming in this article as well how much of azure's revenue as well is just open ai spend and it's let's see let's take let's take a look at this chart of azure revenue as well 62 let's see yeah it's about 72 68 to 72 in fiscal year 2026 and as much as 74 in 2027 if these companies die they lose most of their ai revenue evaporated and that's not including the amount of money that comes through azure 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 he's a semiconductor bullet analyst he always responds and say look all useful compute will be bought all useful compute will be bought it will always be bought and i'm like yeah but if open ai dies the largest consumer of ai compute what happens that well it'll get bought 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 end point because it's all of these smart people were stupid that's right and also everyone was wrong wrong in a way that is going to be very difficult to back out of that's right that's also that we they will like to just Let's be clear.

37:05Yeah, that's the problem. Now, so I'm in total agreement with you on all this. I want to take things to their logical conclusion further. And I'm going to say some, 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 OpenAI actually died, and if Anthropic actually died, and I think there's 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.

37:38But I sometimes 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 price to earnings multiples. Yes. The price to earnings multiples of big tech at the beginning of 2023, I went back and looked at this. This was right before the AI trade took off. If you look at the price to earnings multiples, you look at Microsoft, it was trading at 26 times earnings. Amazon was trading at 80 times earnings. Meta was trading at 31 times earnings.

38:18If 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 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 25. Not that much lower, but it is lower. Amazon's is significantly lower. And this is the real PE, the one that I adjusted, not factoring in their investment gains on their Anthropoc and OpenAI stakes. It's trading at 30 times earnings. That's lower. And Meta's is significantly lower. It's trading at 20 times earnings compared to 31 before the AI boom.

38:54So 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 acknowledgement 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. And that is to say, if this all were to blow up, I don't think these stocks wouldn't crash.

39:35They would certainly crash. But I do think that it wouldn't be as horrible as it might have been, say, in 2008, 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.

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42:17So one pushback, and I think it's a critical one, is that even though the price through earnings and all that reflects a little bit lower and it's showing some anxiety, it still is a price 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 OpenAI and Anthropic. Right. And 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 10 years, I've thought that for a while.

42:56I think that it's 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, OpenAI isn't paying you anymore, and suddenly your revenues are down. Yes. And your growth has slowed. Hey, Google Cloud has stopped growing. It's stopped growing pretty much at all. it's in fact looks kind of flat what's the deal with that and it's because anthropic and open ai's computes 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.

43:53And what's interesting for Microsoft is that in fiscal year 2027, so next year, they estimate the Microsoft 365 co-pilot will make$10 billion a year in annual revenue, which is pathetic. Yeah. That's like a third of intelligent cloud. I mean, it's a little bit less than they estimate the uh azure ai will make and which is predominantly made up of selling open ai's models i mean they they they said one of their bragging points on that earnings call was that they have 30 million copilot paying copilot users 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 365 uh subscribers so basically what they're telling us that 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 that was the share of your users who were down to try this ai product that you say is going to change the world so to that point i don't think that they the strength that they are projecting in their consumer ai business is anywhere near uh what they'd like us to believe 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 3.85 billion for the entire fiscal year 2026 from 365 co-pilot you know the thing with 30 million paid seats they're discounting this to Timbuktu like this is this is being they're discounting it to hell and I mean pretty much anything like like pretty much anything that Microsoft sells has discounts especially when it comes to microsoft 365 but again the hogs lapped it up they love their slop they love being given a new big number so that they can interpret it 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 i'd be like hey guys high 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's like let's see so it's 70 like 73 74 percent of their revenues so like they have this meager little little shrivel of their ai revenues is from diverse revenue if that's the case then there is not demand for ai 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, CoreWeave, who are their biggest customers?

47:01Anthropic, Meta, and OpenAI. Who's Iron's biggest customer? Microsoft. Nebius. Microsoft. What's Microsoft doing with AI? Not very much. Not actually very much at all. They are providing compute to OpenAI and conning people into buying Copilot. Yeah. It's astonishing because this is bigger than them. it's bigger than them it's the 190 gigawatts of planned data center capacity it's all of these data centers being built everywhere i it like i i'm stuttering because it's like the ramifications of this are 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 and that's even if anthropic and open ai like succeed in surviving past 2027.

47:51Well, I think you said something important earlier about the growth. And that is 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 2022, when ChatGBT was released to the world, they suddenly realized, oh my gosh, innovation is happening without us.

48:38There 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. 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.

49:13We're a company, we're a generational company. We're a company that's going to significantly increase profits at an exponential rate over 10, 20, 30 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 OpenAI 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.

49:52And convince everyone by proxy to spend money on AI compute, to compete with us with the companies that we invest in. We will obliterate our balance sheets in the process. And that's where things are going to it really ugly. The companies 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.

50:32They want to live forever. They are the Brian Johnsons 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 high likelihood that it won't because of the financials of opening Ion 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 of...

51:08I think that'll look like something in the range of 15 to 20 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 30 times earnings. By the way, a company that's gotten way out over its 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.

51:44And so they said, okay, Amazon still has cash on the balance sheet. Apple's trading at nearly 40 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 10 years and the ones that they've tried to come out with and tried to sell have completely flopped they canceled the apple car the vision pro was a total disaster i mean that's that's very clearly not a growth company but i think that's the question the 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.

52:23Because 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. Boring, old, mature. 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 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 google's done a massive equity sale they plan to do a massive equity sale the more on tilt they get in order to pursue this botox future of being young again, the more dangerous - You've got to write that up.

53:17The more dangerous, 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.

53:54They have genuinely done that, and its prospects are genuinely terrifying. We're starting to see it with some of these other companies. I was shocked that Google was willing to come out with a quarter of negative free cash flows. 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.

54:33But so far, 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. 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 their product is collapsing. And the things that I continually hear from that company suggest that the culture is screwed. But nevertheless, for the short term at least, 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 to logical endpoints and the way that people don't want to discuss them, Oracle is now spending all of its revenue, just more than its revenue, on AI CapEx just for OpenAI.

55:23And I mean, the New York Times 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 OpenAI bubble. You tell me if I'm crazy. But nevertheless, people are having this conversation like, wow, Oracle, they're kind of unprofitable. 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. And I want to talk about this bit, which is, yeah, if Oracle doesn't work out the AI trade, it dies.

55:59Yes. Its revenue has been flat for 15 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 just acquire companies they're like they're really strange yeah but nevertheless no one wants to talk about the fact that oracle will die and honestly seeing these numbers yeah oracle will die it's it is a it is a genuinely it is a genuine possibility it's it's not overhype it's not doomerism 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.

56:46Oh, yeah, the CDS people are. Whichever ones have driven those CDSs up to where they are. I don't know where they are exactly right now. And that's just betting on whether Oracle will die. That's betting on it dying. Specifically betting on whether it will default on its debts. Yes. It's the insurance that you pay 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.

57:23Weren't the signs there before? Couldn't we have started to see this coming not today, but 6 to 12 to 18 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 CDS swats. But we should give them their props. Some investors seem to be acknowledging the situation. Yeah. Well, you know what, Ed? I think that's actually a good spot to end it.

58:01People can find you on Prof G Markets. What are you working on at the moment? Because you should write up that Botox thing. That's an incredible, it's an incredible idea. It's a banger. Please run with it. Okay, I'll see that. 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 Prof G 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 Zitrin on in the future as well because we love him and we love his analysis we love the Eds alright you'll find me on the monologue this week as well haven't worked out what it's going to be it'll probably be about this thank you as ever for listening subscribe to the newsletter premium as well as my main source along with the podcast.

58:59I love you all. Thank you for listening.

59:10Thank you for listening to Better Offline. The editor and composer of the Better Offline theme song is Matt Ossowski. You can check out more of his music and audio projects at matosowski.com. M-A-T-T-O-S-O-W-S-K-I.com. You can email me at ez at betteroffline.com or visit betteroffline.com to find more podcast links and of course my newsletter. I also really recommend you go to chat.wheresyoured.at to visit the discord and go to r slash betteroffline to check out our reddit. Thank you so much for listening. Better Offline is a production of Cool Zone Media. For more from Cool Zone Media, visit our website, coolzonemedia.com.

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