To The Moon

OpenAI is reportedly finalizing a $100 billion funding round that includes $Amazon.com(AMZN)$ $Softbank Group Corp(SFTBY)$ $NVIDIA(NVDA)$ $Microsoft(MSFT)$.

The deal will push OpenAI’s valuation to $850 billion, which would make it the 12th most valuable company publicly traded in the U.S., and funding is now over $160 billion.

Every time I hear about one of these big funding rounds, it makes me nervous because the foundation on which these valuations are being built is tenuous, at best. And still, the funding and spending on AI is driving everything from semiconductor stocks to HVAC, energy, and materials stocks higher.

Is the world fundamentally changing, or is this a house of cards?

To be clear, I’ve missed out on a lot of great stocks over the past three years because I’ve been generally skeptical of AI’s financial payoff.

But there’s something about this round, in particular, that doesn’t sit right with me.

If this sounds familiar, it’s because my skepticism is a theme. I write about what I am investing in, but it’s just as important to understand what I’m not investing in and why.

Today, let’s look at why I’m (for the most part) avoiding the AI buildout.

Business Models Matter

At some point, I’m going to get a piece of art for my office that says “Business Models Matter.”

Because they do.

This is what I struggle with most when it comes to AI, because very few companies have a profitable business model built on AI. Historically, that’s not how disruptive tech companies develop. The business model innovation and disruption are core to why tech companies become valuable.

$Microsoft(MSFT)$ didn’t have the best tech; it had the best business model in the PC market as the operating system provider. It was also profitable before going public.

$Alphabet(GOOG)$ $Alphabet(GOOGL)$ had such a good business model that it was wildly profitable before going public, and had it been a decade later may have never gone public.

$Netflix(NFLX)$ had a profitable DVD business before getting into streaming, and it didn’t go into negative operating cash flow territory until it was going for the kill against cable.

$Intel(INTC)$ was the same story, and historically, the business model was proven, and profits were flowing before a company got a huge valuation or went public.

The recent trend of companies going public with high revenue growth and huge losses is new. And it hasn’t worked out particularly well for investors.

For every $Uber(UBER)$ — which hasn’t even beaten the market since going public — there’s a $Beyond Meat, Inc.(BYND)$ , $Virgin Galactic(SPCE)$ , $Lucid Group Inc(LCID)$ , or $Rivian Automotive, Inc.(RIVN)$ , which have all been disasters for investors despite massive hype.

Most of these investments didn’t work because the business model wasn’t sustainable.

The profits projected in the out years never materialized.

But we’ve never seen funding of a private company like this. And there’s not a sustainable business model underneath OpenAI, at least not yet. And if one doesn’t materialize, a huge house of cards could come crumbling down that will extend beyond tech to energy, materials, construction, and more.

The VC Funding Conundrum

One of the challenges for OpenAI is that it’s being funded like a VC company… because it is!

While we don’t know the details of OpenAI’s specific funding structure, the typical structure is for investors to buy what’s known as a SAFE agreement or by buying convertible debt. It looks a little bit like this.

An investor invests at a set valuation that assumes upside in the company. So, if the value goes up, their ownership (in % terms) will stay the same as during the funding round, and everyone makes money.

But if the valuation goes down, investors don’t lose money until all of the value invested is wiped out.

In the lower valuation scenario above, a $160 billion valuation in the future (at IPO, for example) would mean employees, founders, and other common equity shareholders would literally be wiped out!

The incentive is to keep the valuation going up.

Everyone wants the valuation to go higher.

Everyone needs the valuation to go higher.

The vision needs to get bigger to justify continued higher valuations!

But eventually, the valuation needs to be realized, or “exited” by everyone involved. That’s typically done at IPO.

Why is OpenAI talking about going public as early as this year? They need exit liquidity. Investors want their money back, with a return.

They have to strike while the iron is hot and before the market loses faith in the OpenAI story.

Where’s the Business Model Disruption From AI?

And this is where business models and incentives matter.

NVIDIA and AMD are in the business of selling chips, and if they fund a huge customer who will buy their chips, great!

Microsoft is all-in on OpenAI succeeding as an investor and API provider and needs the model to work.

They’re all acting rationally by investing in the company and keeping the funding going.

But where’s the business model underlying the business?

Is OpenAI going to add more monthly subscribers to ChatGPT? Growth has already slowed, and Gemini is now taking market share, so that model may not ever be profitable.

Ads are a possibility, but again, Google and Meta are the competitors, and they have huge ad businesses they can both wield to monetize their AI and existing business models that spit off cash.

They can even put off monetizing their AI tools until OpenAI gives up.

Is an API the right model for others to build AI tools on? Microsoft would love that, but now you’re in a highly competitive business where costs are coming down exponentially, and Google is constantly undercutting you on price.

The problem here is we’re talking about $650 billion+ in capex for the big tech companies this year, and OpenAI has somewhere in the neighborhood of $1.5 trillion in spending commitments.

Who pays for that?

Where’s the disruption?

Where are the new business models?

I’m sure you can think of things you use AI for and how it may make your life/business easier, but is the payoff from this investment counted in the trillions of dollars?

I’m going to pick on Ben Thompson of Stratechery and John Collison from Stripe here, but this was the ideas they threw around about agentic commerce and I thought it was comical given the investment involved to build these products.

Level 1: AI used for web forms. (Apple Pay already does this)

Level 2: Better search. (Google already does this)

Level 3: Persistent user profile. (again, Google)

Level 4: Anticipating our needs. (Instagram has this figured out)

Agentic commerce is one of the most talked-about use cases for AI and a huge source of OpenAI’s potential growth, and we’re talking about filling out web forms, improving search, and basically creating an AI that works like Instagram ads?

Where’s the new business model?

Where’s the disruption?

Where’s the payoff for trillions of dollars of investment?

I’m picking on these two because they follow the industry so closely, and these are the examples they threw out. And the upside from these minor changes in user behavior and value hardly seems worth the trouble.

Is It All a House of Cards?

Here’s the problem:

Everyone is acting rationally.

NVIDIA, Microsoft, AMD, and many others need OpenAI to succeed. They need to buy into the vision Sam Altman is putting out.

One of my favorite learnings from Ben Thompson’s writing is, “Assume people are smart.”

Look at the incentives. Look at the business models. Understand why people do what they do.

At the top of a bubble, the ones writing checks and planning capex aren’t dumb. They’re following their incentives.

Jensen Huang needs to sell more chips and hype AI’s potential as much as possible. Satya Nadella wants to upsell AI in productivity tools. If they are wrong and they lose a few billion dollars on the OpenAI investment, they’ll be fine.

What incentive do NVIDIA, Softbank, or Microsoft have to shut off the funding to OpenAI?

NONE!

But the downstream impact on the economy and the stock market is getting a little crazy. Half of U.S. economic growth is now driven by AI spending. Stocks like Comfort Systems, which does industrial HVAC installations, are soaring because of AI.

Everyone is being rational.

Until they aren’t.

This is why I’m avoiding some of the hottest stocks on the market, which is hurting my returns right now.

I feel like I’m being a broken record by voicing my skepticism at the sustainability of some of these businesses, but I’m looking at how AI is being used inside Corporate America and at investment firms, and I’m struggling to see the financial payoff.

OpenAI getting another $100 billion sounds great, and it sounds like the AI buildout boom will keep going.

Until it doesn’t.

And when the reality that companies have to make money hits the market, there will be a fallout. We just don’t know where or when the fallout will hit.

For SG users only, Welcome to open a CBA today and enjoy access to a trading limit of up to SGD 20,000 with unlimited trading on SG, HK, and US stocks, as well as ETFs.

🎉Cash Boost Account Now Supports 35,000+ Stocks & ETFs – Greater Flexibility Now

Find out more here.

Complete your first Cash Boost Account trade with a trade amount of ≥ SGD1000* to get SGD 688 stock vouchers*! The trade can be executed using any payment type available under the Cash Boost Account: Cash, CPF, SRS, or CDP.

Click to access the activity

Other helpful links:

• 💰Join the TB Contra Telegram Group to Get $10 Trading Vouchers Now🎉

• How to open a CBA. How to link your CDP account. Other FAQs on CBA. Cash Boost Account Website.