Don't Get Too Excited About AI Headlines Hype. Here's Why

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2:05All right, folks, welcome to the Investing for Beginners podcast. Today, we're going to talk about maybe some timely news, some things that are going on in the news. So we're going to talk about some of the AI power plays. There's some deals going on with OpenAI. They're partnering with companies like AMD, NVIDIA, as well as Oracle. And so we thought maybe we would touch on some of those. Let's start with how this CapEx super cycle is starting to make its way and how AI could be driving a lot of this. Do you have any, I guess, initial thoughts on some of this? There's big numbers getting thrown around.

2:45Very big numbers, right? Yeah. Hundreds of billions of dollars being tossed around. I think the one that is interesting to me is the Oracle deal that certainly got a lot of hype. And I think they were offering a$400 billion deal between OpenAI and Oracle. And Oracle stock jumped huge on the news of this. And on the surface, it looks really interesting and it could be awesome. but I think if you dig a little deeper, it may not be as appealing. The first concern would be, I've heard that people say OpenAI is not profitable yet. So if we're talking about$400 billion, the first concern that pops in my head, how is OpenAI going to pay for it?

3:39Yeah, for sure. That's a big promise to make. and Oracle is going to be banking on that revenue to help sustain them and pay for the investments they're going to have to make. I've read some articles from Ben Thompson who writes for Stratechery. He's probably one of the leading tech guys out there that some of the projections for OpenAI's revenue for 2025 is around$12 to$13 billion, which is nothing to sneeze at, but it's certainly not in the Amazon, Apple, Google, Walmart realm of three, four, five hundred billion dollars. So I guess that's one of my concerns is are they going to be able to scale to that point where they can pay Oracle that much money?

4:29Let's say it's CapEx which I don't know the specifics of if it is or not but if we talk about like a Walmart or an Amazon that has 500 billion in sales, they're not doing$500 billion in CapEx. Tell me how you get from$12,$13 billion in sales. We're not even talking about the costs for OpenAI to run their business. $13 billion in sales to $500 billion. I mean, I understand it's spread out over multi-years, but it just sounds very optimistic on OpenAI's part to assume that, yeah, we're going to have all the financial resources to be able to make a deal like this. Yeah, it certainly does. If you listen to the talking heads on the markets that OpenAI or AI in general is taking over the world, and while it does have a lot of benefits and it is helping people, I think the scale part of it, I don't think we're there yet, and I don't think we're going to be there yet.

5:33And one of the big concerns I have to your point about what Oracle is in particular is that to receive that amount of money, they're going to have to invest on their end because what they're trying to do is provide infrastructure for open AI because they feel like open AI feels like they have demand that they need to meet. and they're being constrained because they don't have the capacity to do what they want to do, which is why they're going around trying to make these deals with all these businesses, which, okay, I get. But the hard part for us as investors is that OpenAI is not a public company.

6:14They're a private business. And so we don't have insight into that demand. We don't have people talking to the business, analysts or other people talking to the business, telling us what the demand is. We don't have a financial statement. We don't have a 10Q. We don't have even an AK to say, hey, this is what's going on. So it's a bit of a black box, right? And so we have to depend on Sam Altman and his being above board and honest about that. I don't know about saying he isn't or is, but we have to put a lot of faith in that what he's projecting to these companies is in fact true. And the part that I worry about, especially if you're going to think about investing in Oracle as a potential play on this AI demand that is apparently skyrocketing, again, not saying it's not, but the concern is that to Andrew's point, they're going to have to spend a lot of money.

7:18I don't have exact numbers here, but I know they're going to have to spend a lot of money to build out this infrastructure to be able to achieve the targets that OpenAI is setting for itself. And so the concern as a potential investor in Oracle is what kind of return am I going to get on that money? Just like if we plunk down our money to buy Oracle, we're worried about what kind of return are we going to get on that investment. The Oracle people running it, Larry Ellison and everyone else, I would think that they would be very concerned about how much money are we going to get? What kind of return are we going to get on this$300 or$400 billion that we could receive from OpenAI?

8:00And if you dig a little deeper, you'll notice that Oracle doesn't generate a ton of free cash flow at the moment. Their revenue is not awesome. They don't have the financial wherewithal to build out the CapEx based on their current position in the market. And so to do that, to fund that, they're going to have to do things like take on more debt, or they might have to dilute their company, sell shares on the open market. Those are two of the three main options they have. And as an investor in Oracle, how much are you willing to bet that not only can they build out the infrastructure in a timely enough manner that it helps open AI not be restrained if they are indeed restrained.

8:49And how quickly can they do that? And how quickly can they recoup their money? I read earlier today that this deal doesn't start until 2027. So they have roughly a year and a half to start building out the infrastructure to do all this for open AI. So that's one of my, I guess, bigger concerns as an investor. and that's something that you probably aren't hearing in the news or at least if you just read the headlines and go wow this company's revenue projection gross grew by 359 that's pretty awesome right but uh what what is the reality under the hood and how do you need to think about this going forward those are all questions that i'm asking myself i'm asking like hey is there anything going on in the next few months where uh certain parties would be benefited by seeing big investment numbers.

9:39I saw my calendar and my Google calendar, there's an election day next month. So I don't know if this is all related or not, but. Yeah, yeah, it could be. Yeah, very true. Yeah, that's a very, very good, that's a very good catch. How do you think that could impact what we're talking about right now? You think it'd be a plus or a minus if you had to guess? I think it's pretty clear we came into this conversation uh i came into this conversation pretty minus on this whole thing um i'm i i feel like uh history has been unfairly treated by investors and the stock market on wall street because you have so many people who want to look at the history of charts you know oh the stock market did this in 2001 and we're in the exact same thing you know and that's never the case.

10:32However, that doesn't mean we can't learn from history. And if the four most important words in investing or the four most dangerous words in investing are this time it's different, if you look back at previous technologies, big technological booms like the dot-com bubble, and I'm sure this is such a tired topic, but just hear me out for a second. In the dot-com bubble, there were also lots of big numbers being thrown around and a lot of ordering. And in fact, the ordering, all this backlog, which what Oracle is talking about is backlog, like to Dave's point, it's 2027. What ended up happening in 1999, 2000 is the infrastructure tech companies ended up overestimating how much capacity they would need.

11:19And so the entire industry was double ordering, triple ordering, because everything was in shortage. And so because they all overestimated all of the backlog that investors were betting on, a lot of that ended up not materializing. And so you had not just a pop from the valuations, obviously a lot of these stocks were expensive, but you also saw the way they were pricing the stocks come down because investors were pricing it based on what the backlog was rather than what's actually been booked. And so if we see that kind of situation in AI, where, to your point, Sam Altman or any one of the big thought leaders is overestimating demand, then what does that do to the backlog and how much of that does get converted to revenues?

12:07Because in normal times, in a mature tech company like a Cisco or something like that, you see their backlog and that pretty reliably turns into revenue. You see the remaining performance obligations for Google Cloud and a lot of that turns into revenue. maybe not even a lot, maybe all, right? In normal times, backlog equals revenue. But if we are in a situation, and I don't know because I'm not close enough to the company people who are making these projections, if it is overinflated, if it is overly optimistic, then it's going to be really, to your point, painful for investors who are betting on these big headline deals.

12:45AMD, I think, being another one that investors are getting really excited about. So I look at backlog and I look at those investment numbers and I have a heavy shade of skepticism because I've seen what happened. I've studied, I wasn't aware of it. I'm too young to have been an investor at that time, but I've studied it and I know that backlog doesn't always equal revenue when things get overly optimistic. Those are all great points and And it reminds me of what Charlie Munger preached all those years about incentives. Again, I'm not casting aspersions on somebody like a Sam Altman, but there is definitely an incentive for him to prognosticate or to predict that these big numbers are going to come to pass.

13:39And what does he stand to benefit or how does he stand to benefit from this idea? And he stands to benefit from the ability of other people to give him the platform to do what he wants to do or what he hopes the company can do in the future and without having to pay for it himself. And that is, I mean, for him, it's a pretty sweet deal, right? And it could be an amazing deal for them. We could be looking at the next, you know, air quote, next to whatever kind of company and whatnot. but history is littered with the hopes and dreams of investors and companies that didn't pan out exactly the way it did.

14:26This could end well where OpenAI does good and maybe doesn't do Amazon-level numbers at this point, and it could still do okay, but the hype is the thing that scares me, is that the projections are, to Andrew's point about the 2000 bubble, if you will, is that everybody thought that it was going to change. And they were right. They were just early, like a lot early. And that's one of my concerns about this. What if you could get a 25 % match on every dividend you earn? Well, now you can. When you earn dividends on the Plink app, you'll receive a 25 % cash boost up to$250 bonus per year. That means if you earn$1 ,000 in dividends, that's$250 more in your pocket.

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16:59Bitcoin services provided by Block Inc. brand. For additional information, see the Bitcoin disclosures at cash.app.legal.podcast. What's the best way to get started in the market? Download my ebook for free at stockmarketpdf.com. Maybe we could talk about this and think about this and how these ideas could impact some of the companies that we do own. Somebody like a Microsoft or a Google or some of the big cloud players, how some of this CapEx spend and the impact of AI could impact them. Sure. Yeah. Yeah, well, maybe break down the three cloud hyperscalers. Explain like I'm five years old if you're not somebody who invests or has even looked at those stocks.

17:44One of those businesses, how do they make money and why is it a good place to be? Okay. Yeah. So I guess the three main ones that most people think about would be Microsoft with Azure, Google with their Google Cloud, and AWS for Amazon. And those are the three main hyperscalers. And these are the largest cloud platforms that allow other businesses to operate their businesses on these platforms. A good example of that would be Netflix, which uses AWS to power their platform. So a Netflix business doesn't really operate very well or nearly as well without AWS. And so these companies, in particular Amazon, Google, and Microsoft, in some varying cases, they make a large or a very large portion of their revenues and profits from these cloud businesses that are all built on data centers that have these chips in them that GPUs in particular or other chips that the companies themselves are making that allow these businesses to operate.

19:00And so they're basically the platforms. I guess the easiest way to describe it for a five-year-old is they're the platforms that allow other businesses to operate on. Yeah, like you go on a netflix.com, You're not able to view that in LA or in New York or in Texas or on your phone or on your iPad unless there are data centers powering that. In the old model, companies had to have their own data centers that were on IBM, had IBM servers on their campuses. now, to your point, these disruptors, the AWS, the Azure, the Google Cloud, they host the data centers and then they use their economies of scale to allow Netflix and Facebook and whoever else to rent space.

19:56So in IBM's case back in the day, they had to buy these expensive servers. Only IBM could make use of that. So there are bound to be inefficiencies. But if you're an AWS or you're a Google Cloud, you're able to rent it to multiple people. Those servers are always running, always being efficient because people are using that capacity. So it's definitely been one of the huge innovations of the past 10 years. And those numbers, if you look at their revenues and their profits, they're all profitable now. Those are real numbers. And that's real growth that's happening. That has happened already. Yeah, very much so.

20:39And they've been growing very, very quickly. And the infrastructure to build out the cloud systems has been ongoing for a while, but the revenue explosion for these platforms has been more recent. I would say in the last eight to 10 years, it's been more recent. and companies like AWS for Amazon and Azure for Microsoft were the early leaders. And now Google has stepped into the arena and they have certainly upped their game quite a bit and they've improved a lot. They're still behind the other two, but they're closing the gap quicker. And it's impressive to see the build-out of these platforms and how well they've been adapted and how well they work.

21:26it all happens behind the scenes and it's very seamless and it is an amazing thing to think about so to get there though they've had to spend a buck or two and i guess what are your thoughts on the capex that they've spent and maybe how how the companies funded that and also how the returns on those investments have been so far and probably will be going forward yeah to your point it has been a very expensive build-out. The returns on the cloud have reduced the ROIC for both Microsoft and for Google. In the past, Microsoft and Google had very high ROICs. We're talking about software company-type ROICs, 35%, 40 % in that range.

22:14And since they've really been aggressive in these cloud build-outs, the ROICs have dropped down to the 20-ish. Now, you can look at that in a couple ways. You can say, all right, this is inefficient spend because it's reducing ROIC, in which case I would say that's a fair statement. And if you're not bullish about cloud computing, then certainly if a lot of the demand for cloud computing is driven by AI and that is something that's being overblown, then sure, you would expect that to become a worse situation down the line, especially if you see the bubble quote-unquote pop. Another way to look at it, however, is Microsoft and Google, owned by Alphabet, they have core businesses and they have these cloud computing businesses.

23:04So they're two very different businesses with different business models, which makes for different financials. Software is very high margin and sometimes that can lead to a higher ROIC, especially if they're growing organically and not growing through acquisition. Google, similar story. They have the advertising unit and that has generally higher margins than Google Cloud. So you can ask yourself, is it just a higher growth rate on a business that doesn't have as high of ROIC? That's another question you can ask yourself. And then the last thing would be, if ROIC continues declining, then yeah, maybe you start to become worried, especially if ROIC is not earning higher than the cost of capital.

23:51But is an ROIC of 20 % still acceptable to you as an investor? I don't know what your benchmarks are for ROIC, but for me, 15 % ROIC, if you're reinvesting everything in the business and you're earning 15%, that's a good ROIC because you're growing 15 % a year. That's a very rare feat for businesses to do. So going from 40 to 20 sounds really bad for an ROIC perspective, but coming from somebody who owns these businesses, I see the positive side, the optimistic side. And so I tend to think that that decline is not necessarily a bad thing and doesn't necessarily mean that these are inefficient spends.

24:38But I'm happy to be wrong, and that's why I diversify. Yeah, right. And that's exactly why we diversify, because a lot of this is still unknown. And as they continue to build out for these continuing ongoing cloud plays, but not only that, but also the AI that they're competing against as well, there's been a lot of news about the ongoing spend for companies. We haven't touched on Meta, but they're certainly in the mix of spending a lot of money on CapEx for AI. And I know there's been some discussion about Microsoft and Google as well and what their expectations are ongoing for the CapEx spend.

25:23And one of my concerns about it, while I'm very optimistic about the companies like Andrew is, one of my concerns is that I've read and I haven't been able to verify if this is true or not, but I've read this from a few other sources that the investments in the GPUs, for example, from NVIDIA might be air quote outdated sooner than we think. And so this could end up being a situation where companies are having to spend a lot of money to renew the cycle of their data centers or the chips in the data centers faster than maybe normally you might think of for investments like this. And you started to see some of this when companies are changing their depreciation schedules for how long their investments are depreciated.

26:17And when they start ratcheting it down instead of going up, that tells me that that means they know that they're going to have to continue this cycle. And that's one of the things that does concern me a little bit about what's going on with more related to AI than necessarily cloud businesses, but it's all kind of intermingled. And one of my concerns is if this is an ongoing, if Microsoft, are we going to have to, I guess, what's the word I'm looking for? Model Microsoft spending 80 billion in CapEx every single year, as opposed to what we've seen with Amazon, for example. It's not related, but it kind of is where they would spend a whole lot of money to build out their infrastructure, i.e.

27:01their warehouses or the vehicles that they use to transport all the goods you order from Amazon Prime, for example. They spent a lot of money in that infrastructure, but it was a big upfront cost. And then they can benefit from that for hopefully many years before they have to spend big on that cycle again. And I guess the question I'm asking myself is, as I invest in Microsoft and Google and continue to be very bullish on the businesses, do I also have to expect maybe lower margins that I've seen in the past? And is that just going to be an ongoing part of the investment in Google is a lower ROIC?

27:38But to Andrew's point, 15, 20, 25 % ROIC is nothing to sneeze at. And if those companies can continue to invest at that high level of rate, far outseeds their cost of capital, then I'm more than happy to continue to keep funding that bet. But it is something I just have thought about and want to try to keep in the forefront of my mind is how is this CapEx spend cycle going to continue? And is this the new AirQuot normal? That's a very, very, very good point. I would bet, if I was a betting man, that the valuation multiple probably compresses if this CapEx ends up being, to your point, maintenance CapEx rather than growth CapEx.

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