AI: Industry leans into the AI 'Risk-On' trade. RTZ #578

...AI R&D and Capex accelerate to deliver AI at Scale in 2025 and beyond

As we evaluate 2024 for this AI Tech Wave going into the year, couple of things are clear in terms of big tail winds. Up and down the AI tech stack.

One is the conviction amongst the large tech companies on AI continue to Scale in software and hardware (mostly Nvidia driven) capabililties, and that Scaling is worth the hundreds of billions in AI data center and power capex investment ahead. Oh, and the road to AGI is through the next levels of AI reasoning and agents, through bottom up infrastructure innovation.

Indeed, as I’ve articulated before, we may be looking at a trillion dollar plus investment in AI data centers, power and other supply-constrained inputs ahead. This despite Wall Street’s debates and uncertainties on the financial rewards from it all. For now, AI is a ‘risk-on’ trade going into 2025.

Again, we haven’t seen this scale and scope of investments in prior tech waves. Axios recaps and summarizes the landscape well in “Tech dollars flood into AI data centers”:

“Big Tech is spending at a rate that's never been seen, sparking boom times for companies scrambling to facilitate the AI build-out.”

“Why it matters: AI is changing the economy, but not in the way most people assume.”

• “AI needs facilities and machines and power, and all of that has, in turn, fueled its own new spending involving real estate, building materials, semiconductors and energy.”

• “Energy providers have seen a huge boost in particular, because data centers require as much power as a small city.”

• "Some of the greatest shifts in history are happening in certain industries," Stephan Feldgoise, co-head of M&A for Goldman Sachs, tells Axios. "You have this whole convergence of tech, semiconductors, data centers, hyperscalers and power producers."

This ‘capex’ is more accelerated than traditional capex, especially in terms of depreciation given the rapid advanced in underlying AI chip and other hardware. And that is what investors have to do additional calculus to their risk/reward calculations:

“Capital expenditure is an old school accounting term for what a company spends on physical assets such as factories and equipment.”

• In the AI era, capex has come to signify what a company spends on data centers and the components they require.

• “The biggest tech players have increased their capex by tens of billions of dollars this year, and they show no signs of pulling back in 2025.”

And it’s important to note that the underlying AI technologies are still ‘Science Projects’, where fundamental innovations are iterated on quickly to create scalable commercial AI products and services. Google and OpenAI’s ‘12 days of AI Shipmas’ hard work on AI Reasoning and Agents released this week, is a case in point.

“The capex bonanza for data center growth is separate from the R&D that companies spend on chips and new AI technology.”

• "R&D expenses are funding expanded investments in AI integration as well as the rising costs of training AI models," says Eric Hanselman, a chief analyst at S&P Global Market Intelligence.”

• “As for capex, "spending on the equipment needed to fill data centers has accelerated dramatically," he says.”

And the voracious need for AI talent, along with regulatory pressures is driving an M&A driven environment into 2025. Especially with potential new changes in the executive and legislative branches.

“What's next: At the Goldman Sachs Private Innovative Company Conference held in Las Vegas last month, bankers presented a slide that read: "For Big Tech, is Capex The New M&A?"

• “If the answer is yes, the worry is that data center spending fails to earn future investment returns. That will play out in the future.”

• “Also in the future is the potential for acquisitions when capex spending eases. For now, Goldman's Felgoise believes that the data center build out is in its first phase. Larger-scale M&A is expected in phase two.”

• "When winners emerge, they will start to consolidate," he says.”

And the industry is still leaning into the ‘risk-on’ trade:

“The fortunes being spent today on data centers for AI are jaw-dropping, but tech leaders are actually worrying about spending too little.”

• "When you go through a curve like this, the risk of underinvesting is dramatically greater than the risk of overinvesting for us here," Google CEO Sundar Pichai told analysts in August.”

“The bottom line: Tech CEOs view their investments in data centers as all-purpose bets on the future.”

For now, we’re in a ‘full speed ahead’ on AI Scaling and AI investments going into 2025, in this AI Tech Wave. It’s AI ‘risk-on’ for now. I’ll have more to say on what else to look forward to next year, but this backdrop is useful to keep in mind. Stay tuned.

(NOTE: The discussions here are for information purposes only, and not meant as investment advice at any time. Thanks for joining us here)