"It's A Confidence Game": AI Financing Warning From Jim Chanos

If AI monetization gets pushed out and if it's not a 2027 2028 occurrence but 2030 or whenever then Oracle will have fundamental financial problems. You have a much riskier construction of the

demand than you did in the telecom and.com era. The unprofitable companies

and.com era. The unprofitable companies as a percent of the spend is higher in this cycle than it was in the telecom cycle. As long as as those unprofitable

cycle. As long as as those unprofitable companies can keep raising money to keep paying those bills, that's fine. But if

we get a credit crunch or we get a 2001202 pullback in sentiment, you're going to see a lot of that spending drop and drop pretty quickly. It's just added risk. The risk levels for all these

risk. The risk levels for all these companies are much higher than they were now. I think in a way that's worse than

now. I think in a way that's worse than 1999 2000.

>> Today's episode is brought to you by Tukrium. Learn more about how

Tukrium. Learn more about how agricultural commodities can play a role in your portfolio by clicking the link in the description. Today we've got a very special interview. I am joined by

Jim Chenos of Chainos and company investor shortseller. Jim welcome to

investor shortseller. Jim welcome to monetary matters. The first question I

monetary matters. The first question I want to ask you is many of the investors in AI and in data centers in GPUs. What

do you think are some of their widely held beliefs that they are convinced is true that you are doubting whether it is true or not?

>> Thanks for having me. So our view on the data centers is is is somewhat bifurcated. We know the actual data

bifurcated. We know the actual data center legacy data center business pretty well. We put a a big short on it

pretty well. We put a a big short on it in mid 2022.

And one of the things that struck us about the the cloud data center business, the old legacy data centers, which are much smaller than the the new ones we're talking about, is just what a

what a crummy business it was. It was a very low return on capital business, highly capital intensive. The data

center companies capitalize a lot of things that we believe should be expensed. They're negative free cash

expensed. They're negative free cash flow. I could go on and on and on and

flow. I could go on and on and on and and we're still short those companies.

And so as as the AI story has progressed, the latest hot area is data centers in including now a view that we're going to be putting data centers

in space, which I sort of joked about a year ago. it it of course in this market

year ago. it it of course in this market as jokes become true. But what we we really pointed out was that that hosting GPUs is not a great business. It's it's

basically a commodity business particularly as everybody's building them. And our view to clients has been

them. And our view to clients has been the magic and the money is going to come from what the chips produce ultimately,

not where they reside. and that that if you're going to make a bet on AI, you should make it on either the pure AI companies like OpenAI, XAI, Anthropic,

or you should you should bet on the hyperscalers and more on that later, but but investing in that Bitcoin miners that are converting to data center

companies or or meto companies that are jumping in or just the the the so-called Neoclouds, which are basically just

landlords. to me seems problematic for

landlords. to me seems problematic for for two basic reasons. Hosting hosting

GPUs or CPUs is inherently a low margin, low return on capital business, number one. And number two, you have to make a

one. And number two, you have to make a bet if you're actually buying the GPUs yourself, you then have to make a bet on depreciable lives, which is one of the big controversies. and how long until

big controversies. and how long until you have to replace the GPUs because your tenants want something bigger and better. And we can argue about that. I I

better. And we can argue about that. I I

I have my own views. We use fiveyear life with 20% residual value. It it

could be six years, it could be three or four years. Time will tell.

four years. Time will tell.

>> So if we had to say there's three different kind of stacks of this AI, there's the the hyperscalers who are selling things that are produced in the data center. There are the companies

data center. There are the companies that sell things to and make the data center. Nvidia would be the most obvious

center. Nvidia would be the most obvious of of this. And then the third are the companies that own the data center. It

sounds like a a lion share of your skepticism and perhaps bearishness is concentrated in that in that third sector. How much would would that be

sector. How much would would that be concentrated in let's say the S&P 500?

Because a lot of them are the hyperscalers uh which is the first category as well as Nvidia which is the second. So when we do our model short

second. So when we do our model short portfolio for clients, we we advocate that it always be hedged and that's how we ran our business since our fund

business since 96. So I always joke I'm sort of long those companies because we we own the indices and they just make up such a huge part of the S&P and the and

the NASDAQ. And so in effect, you know,

the NASDAQ. And so in effect, you know, I'm advising people to be long Microsoft and Nvidia and and uh and Meta and and

and Google. So it's really it's really

and Google. So it's really it's really the as you point out, it's the companies sort of the second or third derivatives of the companies that are that are trying to basically either recast their

business or build a new business around owning the data centers and operating the data centers. That's the area we know well and we think is not a particularly good business. And where

does Oracle come into this?

>> Oracle is kind of a hybrid. You know,

they they're they're a hyperscaler and of course they have a legacy software business that's profitable, but they're if you look at the the the five hyperscalers that are building out data

centers, which are Microsoft, Meta, uh Google, Oracle, and Amazon, they are one of the two that don't earn their incremental cost of capital. And that

includes the numbers that were released last night. So in their zeal to sort of

last night. So in their zeal to sort of catch up to the others, I mean they're they're expanding their balance sheet really really quickly but don't have the income and cash flow levels that someone

say like Meta or Microsoft do. Meta and

Microsoft by the way according to our work are the only two hyperscalers that are right now anyway earning above their cost of capital on their incremental

capital spending. and and now that can

capital spending. and and now that can change obviously as AI output hopefully gets monetized in a better way down down the road but but Microsoft and Meta can

easily handle their investment uh their investment load. Um whereas Oracle and

investment load. Um whereas Oracle and and interestingly Amazon are at the bottom of that that stack in terms of their inability to at least monetize yet

their their massive investments in in AI equipment and hardware and and locations. is to tell me about Meta. I

locations. is to tell me about Meta. I

had it ref heard it referred to as a hyperscaler. I because I thought that

hyperscaler. I because I thought that meant you know providing clouds to to other people. I thought Meta was just

other people. I thought Meta was just spending all this money to improve Instagram and all these other things or are they they are selling the data to other people? Well, they they're they're

other people? Well, they they're they're integrating AI and building out massive data centers, including I think they're doing the big one in Louisiana, if I recall, with the controversial

accounting, the SPV accounting. So, they

they too are are building out most likely for their own internal capacity, their data center capital plan. And

again, they're monetizing things through in effect selling ads to Instagram and Facebook users. And Microsoft is doing

Facebook users. And Microsoft is doing it through their corporate customers.

So, at least for the time being, that they're the two that are that are able to sort of finance this from their own cash flows. The others are going to need

cash flows. The others are going to need external financing.

>> And that is a remarkable statement, Jim, because for so long, these Magnificent Seven companies have just been so profitable and have grown so much with so little capital requirement. Now,

these these they're just chewing up capital and their free cash flow is, you know, steadily going down quarter over quarter. Are you envisioning a future

quarter. Are you envisioning a future where some of these companies free cash flow might go negative, meaning basically that their operating cash flows are are lower than the amount of money that they need to to invest.

>> Well, that's already happening with Oracle. So, they've they've gone free

Oracle. So, they've they've gone free cash flow negative. I think it will erode. And again, the idea is is that AI

erode. And again, the idea is is that AI monetization from output will, you know, hit hit an inflection point in 2027 or

2028 and then and then profits will flow. We'll see. I mean, I I you know, I

flow. We'll see. I mean, I I you know, I I don't know and I I don't think anybody else really knows. We'll just have to see. That's the bet. The bet is a big

see. That's the bet. The bet is a big one. And for some of them, it's a bet

one. And for some of them, it's a bet your company bet, which they never had to do before. The underpinning of your question is correct. in that you basically had assetike businesses based

on intellectual property that just gushed cash flow and now you have basically you know the second industrial revolution if you will where where the

next round of technology improvement is really capital intensive and that's a change >> and how are you assessing that return on invested capital you you can you sort of pick a company but let's say 10 years

ago when Microsoft was investing in building data centers for its you know earlier cloud clients. I presume the return on invested capital was quite high. What does the return on invested

high. What does the return on invested capital in this new AI data data center world look like?

>> Most of them don't break out their actual pure data pure AI revenue and costs and you can only look at the aggregate and and just make some assumptions about their spending and and

look at their look at their stated returns. And it gives you an idea of

returns. And it gives you an idea of magnitude and direction. it's not going to be precise and and you know Amazon would be the better example I think

because AWS you know very early on was unprofitable for a number of years until it hit its stride about 10 years ago and

so so the bet might be a correct one we'll just have to see and and so what we do what we're looking at right now in

in the analytics I just discussed is what is the increase in adjust adjusted operating income year-over-year and then

annualize that and then what is the increase in the capital base year-over-year and and uh as the denominator the increase in operating

income annualized would be your numerator and and how is that trending is it going up or is it going down and so for example last night Oracle reported and their incremental increase

in operating income divided by their incremental increase in capital year-over-year was about 8.5%.

That's below their weighted average cost of capital. It's positive, but basically

of capital. It's positive, but basically it's it's telling you so far they're destroying value. Now, for Microsoft,

destroying value. Now, for Microsoft, that same number is almost 40%.

So, it gives you a pretty good idea of of of so far who's kind of winning in this and and who's, you know, spending a lot of money for not a lot of return.

But again, like Amazon, that can change.

So, we'll just have to see and keep monitoring it. As I like to say,

monitoring it. As I like to say, predicting the future is hard. So, um,

people are doing it. The difference now is is they're committing a lot of dollars to these projects about predicting the future and that's a new risk, >> right? And 8.5% it is positive as you

>> right? And 8.5% it is positive as you say, but doesn't sound terribly high. I

think the uh, you know, long-term Oracle bonds are have a 6.5%. And so there's a there is a spread to harvest there, but I'm sure with cost of equity and stuff it's uh >> with cost of equity it's above that.

Yeah.

>> Yeah. Um and that is what the return is for Oracle right now where things are white hot and all of this money is being raised in venture capital to back

companies like OpenAI and Anthropic that are the customers of of these things which is why the uh that the money is so good right now.

>> So so it could it could look worse when things get a little when things cool down a little bit.

>> Yeah. So that's the that's the that's the sort of left side of the tail, right? Is that that these returns are

right? Is that that these returns are all based on on in many cases selling to unprofitable companies and and and as

long as as those unprofitable companies can keep raising money to keep paying those bills, that's fine. But if we get

a credit crunch or we get a 2001202 pullback in sentiment, um you're going to see a lot of that spending drop and

drop pretty quickly. So it's just again it's just added risk. The risk levels for all these companies are much higher than they were now five or 10 years ago.

>> So of the giant companies in the S&P 500, it sounds like the ones you have the most concerns about are Oracle, Amazon, and Meta. If you had to rank those three from least concerned to most

concerned, which would it be?

>> No, we would we would we would be we're most concerned right now about Oracle in that whole group and and um that that's pretty much our only negative view on

the whole group is is Oracle because it just their their spend plan is just so enormous um relative to returns. Amazon

has a lot of other businesses and we think that our analysis of Amazon is is skewed a little bit and and the rest in effect as I say we're long through our

hedges. So the only the one of the only

hedges. So the only the one of the only one of the hyperscalers of the mega caps that we would be concerned about right now is Oracle. But but we're short lots of others I say secondary and tertiary

plays.

>> And yeah, Oracle stock over the past few months has been suffering and it's credit default swap for five year has has widened out significantly. How much

of this do you think is a potential you you earlier said bet the company you know a potential existential question because okay you know if Google or Microsoft is going to waste hundreds of billions of dollars like ultimately they

they will be okay but Oracle is borrowing all this money and it's it's you know it's investment grades but it's you know for a long time hovered on that investment grade kind of line you know I mean do you think that there could be

some substantial credit issues for Oracle >> I mean I if if AI if AI monitors ization gets pushed out and if it's not a 2027

2028 um you know occurrence but 2030 or or never then Oracle will have will have you know fundamental financial problems.

It's not at that level yet but certainly certainly they will they will be under a lot of stress if they continue to borrow money to do

their buildout as opposed to use equity.

I have to think at some point they might they might have to reconsider and and start issuing equity to keep the balance sheet in check. So far it's been mostly done with that.

>> And what fueled the the surge in Oracle shares during the second quarter in the early summer before the the you know quite drastic correction we've had what fueled that surge was I think it

reported earnings and its remaining performance obligations surged from 137 billion to 455 billion.

>> Yes. which some people think of as oh this is just you know future demand and this is what's going to be revenue and and earnings in the future so it indicates incredible demand. What do you think about that number? How

concentrated is it among one customer mainly open AI?

>> Yeah.

>> Yeah. It's not a gap metric. It's not a real backlog. It's you know it it's if

real backlog. It's you know it it's if everything goes right and they they continue to to deliver you know our revenue should be this over the life of

the the contracts. I mean again I I the stock reacted positively to it but again this data center and and hyperscaler and AI stocks were all reacting in the

second quarter to those kinds of announcements. It wasn't just Oracle. I

announcements. It wasn't just Oracle. I

should make that clear. I mean any company that that came out and said oh we're going to build data centers went up 50 to 100% during that period. So I I

I I look a sconce at at the RPO number and and I think investors should give it a wide birth.

>> All right. Now let's talk about the you know lesserk known smaller companies the so-called neoclouds. These are

so-called neoclouds. These are cororeweave, nebius, former bitcoin miners like iron. Tell us what role do these sorts of companies play in the

ecosystem and why is your concern and skepticism concentrated in this area?

because again these are these are the guys that are hosting the GPUs not not benefiting from the GPU output. So it

gets back to my my first comment to you that that we think the money and the magic is going to be made from what the chips produce, not where they sit. And

and I just think that that hosting hosting GPUs or owning them and renting them out to to third parties is just not a particularly good business. it's

commodity business and it it it these are landlords. They're not tech

are landlords. They're not tech companies and I think that that's that's the basic difference here. And with

everybody rushing to build out data centers, you know, it's a supply and demand story, right? You're going to have more and more people who will be having facilities. There seems to be

having facilities. There seems to be this canard out there that that well if you have land and power you have a monopoly or you have an oligopistic

situation where you can charge you know ridiculous rents and and nobody else can can get them and all you need to do is look at Iron's Microsoft deal which was

trumpeted at the time as as this great deal and if you sort of drill down and analyze the returns it was a mids singledigit return on capital deal. And

and so, you know, if that's what a monopoly type type provider gets because they have access to power and land right now from a really good credit, I mean,

you know, yawn, who cares? And and so I think that that's that's the core of our our negative view on these neoclouds and Bitcoin miners is that they're all

jumping into a business that's basically commodity, low return, ultimately business.

>> Tell us. So you're very familiar with the old school data center stocks. Um I

don't think you mentioned them but you know they they might be stocks such as Equinex, such as Digital Realy Trust.

You said earlier that they they capitalize expenses that they should go through the operating line and they overall earn low returns. So how would you estimate overall like the returns of that business? you know, not the stock

that business? you know, not the stock price, but just the overall like economic returns of those two companies, publicly traded companies as well as the uh, you know, the privately traded, you know, private equity landlords that, you know, are quite big in this business

too.

>> Yeah. So, so again, the the digital realies and the Equinex's are just colllocation businesses basically. Um,

Equinex has an interconnected business, but but for the most part, these are these are just simply companies that provide the real estate, provide the backup power, provide the the the power

itself, the cooling, you know, what have you. And you could just look at at the

you. And you could just look at at the stated returns and that's based on sort of 15 to 20 year depreciable life for

the assets. And using that figure, their

the assets. And using that figure, their returns are really really low. They're

they're low single digits for digital realy, mid single digits pre-tax for Equinex. But what what really gets

Equinex. But what what really gets interesting and what the reason why we're still short them is if you actually look at the cash flow statement, you'll see massive amounts of

capex that continue and it's not new bills. most of it is is for the existing

bills. most of it is is for the existing data centers, but they have this little accounting game they play because they're REITs where they claim that that

90% of that spend is growth capex and not recurring capex and and everybody sort of says see oh there you know don't count that capex because it's for

growth. Well, the accountants let them

growth. Well, the accountants let them call it growth capex. If it's in an existing system and you can either acquire a new client or raise prices on

existing clients, then you can capital you can categorize it as growth capex, not recurring capex. But if the HVAC system goes down at a data center, it

goes down. You have to replace it. How

goes down. You have to replace it. How

you categorize it, you know, is sort of semantics. And if you can persuade, you

semantics. And if you can persuade, you know, your auditors that, well, it's we'll be able to raise prices and maybe get one new customer by putting in a new HVAC system, you know, it's growth

capex. Meanwhile, these companies aren't

capex. Meanwhile, these companies aren't really growing. I mean, they're growing

really growing. I mean, they're growing revenues mid single digits. They have

20% vacancy rates. It it's ridiculous.

And and they they both digital realy and Equinex have capex greater than EBIT DA.

So they're financially stretched as well. So they're in effect borrowing money and issuing stock to pay interest and dividends. And that's just

never a good position to be in.

>> And is the reason that these companies kind of exist because the large comp companies, you know, Microsoft and the Microsofts of the world basically don't want to have this on their balance sheet.

>> I think that's a really good point. I

Yes. The answer is is that it's excess capacity and in the in the cloud world you might have the right geography because of the need for clients to

access data quickly latency. So so that does matter more so than in in the AI data center business for example.

However, you rais a really good point and that is is that increasingly we see with Microsoft's announcements, with the Meta announcement and Blue Owl and their

financing, more and more of the hyperscalers want to get these assets off their balance sheet and and lease the capacity from somebody else and let

somebody else take the actual, you know, capital intensity risk. Um, and I think that's a really interesting interesting point that we've made to clients is note now how many of these companies are

trying to not have this stuff on their balance sheet.

>> So let let's now talk about core which I think is the biggest and the most indebted of these so-called neoclouds at at core is their basis their business is owning the data center or what what else

is is their business other than that?

>> Their their their business is not owning the data center.

They're like a virtual. They're they're

leasing the data centers from others and owning the GPUs >> and then selling that compute to the clouds.

>> Yeah. Yeah.

>> To the hyperscaler. Yeah.

>> All right. And what do you think about the returns on those business?

>> Yeah. So that that's a bet strictly if you're just basically in the in the GPU middleman, if you will, you know, that's

just a bet on on depreciable lives. And

and I think that that's that's what you need to, you know, that's the that's the bet that that you're buying these things and leasing them out and

that five or six years is is is actually too conservative that you'll be able to earn money on them for 10 years or 12 years. And and that's the bet you have

years. And and that's the bet you have to make if you're if you're a core investor. The bet there is that those

investor. The bet there is that those chips last for a long time so that every year you're not depreciating that much.

If it's if the chips last for 10 years, you only depreciate 10% as a cost every year. But if they last for three years,

year. But if they last for three years, you you have to depreciate a third of what you spend, which is a lot.

>> Right. Right. And and and again, the question gets back to your comment and that is if these chips last so long and Microsoft is is depreciating its chips

over six years. If these things last longer than six years, why is Microsoft leasing the capacity from you?

>> That's a good question. So explain what is the depreciable lives that the core reefs the Microsoft of the world are putting on the chips that they're buying and then then expensing and what do you

think is a more appropriate depreciable life?

>> We're using somewhat in our modeling we're using something similar to them.

So they're using six years as I recall and and number of the hypers skills really increased that lately from 5 years to six years. We're using five years with a 20% residual value. So the

numbers, you know, are are somewhat similar ballpark and and and again I I'm just looking at rental rates for GPUs and

other things to get some third party verification on this. You know, there's an there's a there's an an index on Bloomberg quoting spot rental prices. I

think it's down 28% year-over-year currently. That's

currently. That's >> that's the Hopper GPU rental index.

>> Yeah. Yeah. And and and you know, that's one one check. You have some of the chip companies themselves, CEOs have said five years, six years seems right.

People believe that if you use them three 365 days, 24 hours a day, that the physical life is not much more than six or seven years, uh they only last 10 or

12 if you're, you know, not using them um at 80 to 100% capacity. So, we'll

see. We're going to again, it's one of these things where where we're going to see. I would not want to be betting my

see. I would not want to be betting my company on, you know, 8 10 12 year life on these things. I think that that's that's an asymmetric bet that that you're going to lose on. And conversely,

if it's two or three years, then all these companies are in trouble. So,

we'll have to see. I you know, it's it's something obviously we and other investors are monitoring pretty closely.

But again, that that's that's the bet there that that simply, you know, they're smarter than everyone else and have figured out that these GPUs have incredibly long lives. and they said

something on their last call about, well, we're still, you know, renting some of these chips out after the term

is over and at at basically 90 95% of the last uh deal. And I I'm I'm highly skeptical of some of those comments, whether they're cherrypicked or

whatever, but there'll be enough GPUs out in the marketplace, you know, within a year or two that we'll have a pretty good idea of what rental prices are, >> right? I don't really understand the

>> right? I don't really understand the technology at all, but Nvidia is just such a a a dynamo in terms of improving their architecture basically every year.

So there was Hopper and then this year we have Blackwell from Nvidia. Next year

we're going to have Reuben maybe maybe the next year if that we're going to have Fineman. What you were talking

have Fineman. What you were talking about on on Bloomberg is the Bloomberg Hopper GPU rental index. So this is the old uh Nvidia GPUs and it shows that that the cost to rent these has gone

down by so much. So what what you're saying is does not in any way contradict the very rosy outlook of Nvidia is transforming the world with AI. You I

mean it sounds like you kind of agree with that but because they are it's so transformative and year after year just the old GPUs are not that exciting and valuable anymore and therefore they you

the people who buy those should depreciate it at a faster rate and a higher depreciation cost. That's what

you're saying, >> right? And and and again, you know, when

>> right? And and and again, you know, when when when Corewave or others say, well, we'll we'll simply use the old chips for other tasks like inference and not training. Um that's great, but that

training. Um that's great, but that should reflect itself in rental rates and and so we will have a check on this in by the free market as to to how

valuable these chips really are, you know, three years out, five years out.

So far we're seeing we're seeing depreciation you know reduction in rents consistent with with sort of four to six year life.

>> Talk about how indebted Coreweave is.

How is it financing this incredibly capital intensive growth?

>> So they they're they're they're doing what the Bitcoin miners are. They're

using lots of converts. And I I kind of laugh because when I see people throwing throwing bricks at me on on X for my comments, I often see the same people

saying, "Oh my god, they just did a 1% convert deal. It's like free capital."

convert deal. It's like free capital."

And and not not understanding that converts for for some companies can be really really expensive when you factor in the option value that they're giving up. Um a convert for your listeners is

up. Um a convert for your listeners is is composed of really two components, right? a a call option based at some

right? a a call option based at some premium price, the conversion price for typically five years, seven years, whatever the term of the the bond is.

And then the remaining part is in effect a very low coupon or zero coupon bond that will mature at par at at maturity date. So you can you can kind of once

date. So you can you can kind of once you get the option value of what you've given away and the convert you can figure out the the yield on these things and you know they're they're they're

quite high. The cost of capital is quite

quite high. The cost of capital is quite high when you factor that in. And but

retail investors seem to think that the opposite that this is just 1% cost of capital because that's the coupon on the bond.

>> And if you knew for a fact that the stock would never hit the strike price, maybe it would be a 1% cost of capital.

But if the strike if it hits that strike price, there's going to be a very large dilution, which is basically just issuing shares.

>> Yeah. Yeah. And we just saw that with IN. I just did a convert at current

IN. I just did a convert at current prices to buy out the converts that it had issued like a year, 18 months ago.

And and they paid I think 3x from from to buy out those bonds that they issued, you know, less than two years ago. And

so in effect those bonds which would have been seen by the same people as cheap capital you know ended them ended up costing them quite a bit in terms of

new shared dilution and and so there's no free lunch on this and and the fact that so many of these companies are trying to issue convert is in effect

it's a backdoor way of issuing equity.

And what do you think stops kind of this this train this circular reflexive loop where the more capital is raised the higher the revenues go and therefore the

higher the revenues go the more capital can be raised what you know you've been on Wall Street a long time you study financial history what stops this circle

>> you you never know I mean you know in in 2000 we we can look at a couple things that that occurred that that changed perceptions

But but the negative fundamentals in in the dot and the telecom boom didn't start showing up till 01 even though the stocks began going down in March of

2000. So the stock market correctly

2000. So the stock market correctly anticipated the the decline in orders and earnings that occurred in 01 and 02. And and if I

had to look back and and one of the things on the my reading list for my course is the wonderful work that Anthony Adzilo at University of

Minnesota did in the late 90s and early 2000s when he basically punctured the prevailing wisdom at the time that internet traffic was doubling every

quarter. And that was something that MCI

quarter. And that was something that MCI and others had WorldCom had had told people and it it kind of got out there is is as is the accepted wisdom that

internet traffic was doubling every 3 months. So people were ordering like

months. So people were ordering like crazy and it wasn't just the fiber optic companies. I want to dispel a myth. Most

companies. I want to dispel a myth. Most

of the ordering during the telecom bubble was by regular corporations building out their networks or very profitable telecom companies like local

local bell companies, the other long-distance companies. Fiber optic

long-distance companies. Fiber optic companies were a very small part of that. And so everybody basically cut

that. And so everybody basically cut back their orders when they realized that well maybe you know we don't need all this qu equipment in 2002 and 2003

if the growth isn't going to be 16x a year because that's what it is if the internet traffic doubles every three months. It's up 16fold a year. What

months. It's up 16fold a year. What

Zilko's work showed was that it was doubling every year. So so up 2x not up 16x. And and that makes a world of

16x. And and that makes a world of difference for your ordering if you suddenly realize that you only need 1/8 of what you thought you were going to

need. And and so order books

need. And and so order books collapsed in late 2000, early 2001. And

you know, with a very mild recession, very mild in 0102, we saw corporate profits drop 40%.

and and and so it's and now if you think about how much of economic growth and corporate profitability in the tech sector is based on data center buildout

and AI you easily could see people you know pausing their spending and in any kind of capex boom that translates immediately to to earnings.

So if demand is only growing at two times a year, it's doubling every year.

That sounds like a lot. But if if the capex is 4x a year, that's too much. And

so ultimately it it slows down. Is that

how you see this playing out is basically dot 2.0?

>> I I I don't know. I mean again that's what happened the last time and it just and and it blindsided everybody and and so you know nobody at the time was

saying yeah we got a big order book and our revenues are growing dramatically but it's based on you know it's based on a really optimistic views on current demand and if that drops you know we

could be in trouble. No one was saying that and nobody's saying it now. I'm

just pointing out that that when anytime you get a capital spending boom in a certain area driving your whole economy or driving your corporate sector

profitability and increasingly we have that now then you run the risk of people overestimating their need for all that capital equipment and capital equipment

unlike you know regular consumer consumption items can be switched on and off you know abruptly.

we don't need eight data centers, we just need three. And and so as opposed to I'm going to buy less hamburgers this month, you know, and so I think that

that's the the amount of earnings risk that is coming from this is increasing rapidly and does look a lot like 99 in

2000. And I want to ask you about that

2000. And I want to ask you about that cyclical nature in just a bit, but you because you mentioned that that paper that I'll have to check out showing, oh, it's only doubling uh uh twice a year,

not 16x. What do you think about the

not 16x. What do you think about the claims right now about how you know chatbt and the large language models are growing faster than the internet?

They're going faster than everything else. What do you make of those claims

else. What do you make of those claims and and that data?

>> Yeah. Well, I mean, again, we'll have to see. I mean, some of them are coming off

see. I mean, some of them are coming off a pretty low base, >> you know. So, so it's not surprising that maybe from 2022 or 2023 it it gets

a lot harder to keep doing that when you know when your revenues are 50 or 100 billion. And so what well that's why I

billion. And so what well that's why I keep pointing out to you know this 2027 2028 period is going to be so crucial because all of these companies are going to be monstrously big in terms of their

balance sheets and at that point the growth at better continue because if it doesn't they're not going to be able to to uh either keep ordering or service their debt. Are you a sophisticated

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for listening. Let's get back to today's interview. That nature of double

interview. That nature of double ordering and just, you know, pounding the table to buy as much as you can in a boom and then totally pausing and canceling orders during the bust. You

know, we could criticize that, but in some sense it could be rational because if you're an order manager, like you you need it and to or to make sure that you just need that you just get what you

need, maybe you have to order three times what you actually need. It can be rational. What what do you make of the

rational. What what do you make of the argument Jim that that you know particularly the semiconductor supply chain that was characterized by this boom and bust dynamics that it's right now in AI it is different because that

the growth is secular and you know you're not seeing the the iPhone cycle or the cycle that you know that is kind of like this it's it kind of has been it has been a super cycle maybe but may

maybe doesn't continue. What do you think? the real the real boom bust in

think? the real the real boom bust in dot wasn't semiconductor is it was telecom equipment and and that's where the that's where the bust occurred and

so I again I I I think that where we're seeing it now is in the massive massive capex going into AI and data centers and

and um that's clearly where it is. I

mean you can't can't miss the numbers.

So we're just going to have to see. And

by the way, as I would say, most of the most of the companies ordering that telecom equipment were corporate America, right? Building out their

America, right? Building out their networks and for the internet and and and they were profitable. Customers were

profitable. They just cut back on their their their spend. What's scary about this one is that the underlying customers that are spending a lot of the money are unprofitable.

and and and so it raises it raises the risk level I think in a way that's worse than 1999 2000 again the the only core

unprofitable entities back then were the fiber optic companies and the selex the so-called competitive local exchanges which were local local phone you know virtual phone companies that were

popping up in every city but the combined capex of fiber optic companies and selex the two unprofitable business models in the telecom bubble was a

hundred billion dollars from 97 to to 01. So it was it was about

01. So it was it was about whatever $20 billion a year in capex from those two unprofitable business

models. And think about think about the

models. And think about think about the unprofitable AI companies and what they're spending today. It's a lot more than 20 billion. And so it's a it's you

have you have a much riskier construction of the demand than you did in the telecom and.com era.

>> Okay. I'm glad you brought this up, Jim, because I have said and it has been said many times on other financial media. The

argument that oh right now the people who are buying the video chips are profitable companies. Microsoft, Amazon,

profitable companies. Microsoft, Amazon, Meta. And I stand by that statement in

Meta. And I stand by that statement in what it is actually who actually is buying the chips. You're saying the underlying customer, the people who are buying the compute from Amazon and Microsoft and the reason why Amazon and

Microsoft are buying the chips in the first place are OpenAI anthropic and other unprofitable >> a big a big chunk of them are and not all of them but but yeah but a very a very large amount of that that

underlying demand and that's why I keep getting back to you on this 2728 you know time frame um are are inherently quite unprofitable and so

we'll have to see the the unprofitable companies as a percent of the spend is higher in this cycle than it was in the telecom cycle. I guess that's my

telecom cycle. I guess that's my message.

>> That is really important, Jim, because I think a lot of the market believes that now, oh, it's what I said, it's Microsoft, it's Amazon, it's the most profitable companies that have ever existed to to to spend. and they view

view the.com uh uh bust, you know, like I did. Maybe they were maybe they

I did. Maybe they were maybe they weren't around then, but of as oh, it was the pets.com that are spending the money. You're saying you're saying it

money. You're saying you're saying it actually was those companies were tiny. I mean, the the companies everybody sort of laughs about in in in the IPO boom of the

dotcom era were tiny. The real spend was coming from the General Electrics, the Coca-Cas, the AT&Ts, the the the local, you know, the telecom US West and

Packbell and and Verizon. Those

companies were immensely profitable and and they were the ones buying from Cisco, Lucent, Nortell, and and then cut their orders. again the the inherently

their orders. again the the inherently unprofitable companies that everyone points to the fiber optic companies and and in our experience the selexs which all went bankrupt they were they were

relatively small part of that spend and and you know we lived it we we we were short these companies so I remember it vividly but most of the telecom spend

that got cancelled was and and network spend was from very profitable Fortune 500 companies >> wow that's uh that is very that is very interesting. Um I'm glad you you tell me

interesting. Um I'm glad you you tell me that. Jim, uh you said you spoke

that. Jim, uh you said you spoke somewhat favorably of open AI. Um

because in the the com the companies that benefited from all the the spend was the the Amazons and the Microsoft that actually did reap the the benefits of all this technology. I wonder, Jim,

if OpenAI was publicly traded, you're telling me you wouldn't take a look at it on the short side given that HSBC forecasts half a trillion dollars in operating losses?

>> If they go if they go public, we'll certainly take a look at them. Right

now, right now, it's all forecasts and, you know, and whatever Sam Alman says it is, but we'll have to see. Yeah, I mean everything you you said about iron coreweave I I think in terms of scale it

is you know open AI is the king right now of losing money and of of uh spending a lot of oper uh of uh uh capital expenditures

>> but if if AI is truly truly uh the the technology that its proponents believe it is then it's most likely that that those companies will become inherently profitable or

monopolistic.

much like Microsoft was during, you know, the the CPU era and and so, you know, they'll they'll turn out to be good investments. We'll we'll have to

good investments. We'll we'll have to see. We don't know. Um they're claiming

see. We don't know. Um they're claiming they will be able to monetize all this stuff. There are skeptics about that.

stuff. There are skeptics about that.

There are believers about that. What I

can point to now is that the the guys building the infrastructure around that are the ones building bad businesses.

But OpenAI is kind of at the at the heart of it of of their spending the money. I mean, how over the next five

money. I mean, how over the next five years, you know, I mean, HSBC forecasts that their revenue could get to over 200 billion, which sounds great to me. Um

but again they have 500 billion in operating losses which in includes uh depreciation on the what what the mo ro most rosy open AI bulls and Sam Alman

say to the HSBC forecast as well as even more bearish forecast of they don't even get that revenue that high you know the total AI bears where are you on that spectrum would you say or how are you thinking about it >> again I don't have to be anywhere on

that spectrum I I can look at it and and and look at the hyperscalers on one side and the and the the data center companies neoclouds on the other. I

don't have to have an opinion yet on on that. We'll have to see. I you know

that. We'll have to see. I you know there there needs to be concrete steps to monetization for these companies sooner rather than later I think. But

you know I I my prediction about what happens in 2028 is no better than anybody else's.

>> Okay. But something maybe you do have a view on is how is this being funded? So

in the publicly traded, it's funding in the debt markets and as well as convertible bonds. OpenAI is raising a

convertible bonds. OpenAI is raising a lot of venture capital. Do you have a sense on, you know, just how capital intensive it is? Like how much money it needs to raise next year? I think

literally this morning we got the headline that Disney is going to invest $1 billion in OpenAI. You know, uh I remember back in the day when a billion dollars was a lot of money, but that is not going to fill fill this bucket. And

you know, I mean, what are they going to every week they fly over to Saudi Arabia to get another billion dollars? Like,

how how is this going to play out?

>> Well, I I I you know, you'll have to talk to the venture capitalist. I mean,

these are enormous numbers and everybody says the dry powder is there and eager to invest and it is until it isn't. And

I I just, you know, again, it was there to build out the telecom stuff until it wasn't. and venture capital dried up

wasn't. and venture capital dried up almost instantaneously, you know, in the third quarter of 2000.

It's it's it's very it's very interesting and and to use George Soros's term, it's maybe reflexive if the stock prices of these entities start going down. You know, you could also see

going down. You know, you could also see the the capital drying up as opposed to people wanting to invest more at lower prices. This is the kind of situation

prices. This is the kind of situation where they were investing more at higher prices and the the purse strings could literally close up if stock prices in

this area begin to decline. So there's a lot of it is a confidence game.

>> Jim, it's so important. Earlier you said that the spending in the dot telecom boom ended at the end of 2000. You know

we know that the peak in stock prices was the beginning in 2000. So a lot of people, myself included, have this mental model of the price follows the fundamentals and the fundamentals change

stops first and then the price goes down. But actually you're saying the

down. But actually you're saying the price the market decides first.

>> The mar NASDAQ I believe was down 30% from from early March to midappril in 2000 on no in effect no news. It was

before even March quarter earnings came out. the market just started going down

out. the market just started going down and what the market correctly at least in that that selloff was predicting was

that order books were were about to you know collapse. Now that didn't happen

know collapse. Now that didn't happen for another six months but but the market kind of figured it out before even the purchasing managers did. And so

if you're waiting for some of that that kind of evidence to show up, I I'm just saying be mindful that that there could be a big impairment of your capital

happening before that even happens. And

and then you'll see the verification of why it dropped later. And and that's that's something I think novice investors don't understand. And there

are plenty new novice investors in the market that weren't around in 2000 that I think, you know, might be surprised if that happens. That's another really

that happens. That's another really important point. What do you think about

important point. What do you think about Nvidia Jim?

>> They have a good business. I, you know, I I the amount of vendor financing that they're doing is is so far not material.

I I don't know why they're doing it, i.e. investing in their customers and

i.e. investing in their customers and and doing some of the same stuff that Lucent and Nortell were doing back in back in 99 and 2000. Um, they don't need to do it if demand is as good as as they

say it is. you know, they could sell all these chips twice over. So, I I'm I'm a little perplexed at at some of the things that they're doing, but it's a cash machine currently. They're the

they're the the biggest player in town until Google, you know, and Amazon maybe and AMD uh begin uh to uh to put out

their uh their chips to compete. But,

you know, right now it's it's there are much better places for for skeptics and short sellers like me to be looking than Nvidia.

>> Mhm. What about Palunteer?

>> No opinion.

>> Jim, tell us about the alternative investment industry, private equity, real estate, and increasingly private debt that is now getting involved in

this game. you you know blue alowl as

this game. you you know blue alowl as you mentioned earlier did an uh offbalance sheet special purpose vehicle to finance meta's data centers what do you think of that that business and as

well as private credit in general which has just exploded in growth >> so I've been kind of skeptical about private equity for a number of years now you know I pointed out in the investment committees I sit on and and to clients

that you know private equity was was basically leveraged leveraged equity and that returns to private equity, while good, were were not commensurate with

the risks you were taking. And that the whole idea of marking your portfolio sort of arbitrarily was was um hiding the risks that in effect you were, you

know, buying leverage, you know, small and midcaps and it levered 2:1 or 3:1.

Well, then your return should be, you know, a hell of a lot better than than 10 to 15%.

And that's what private equity was returning when the public markets were returning 10%. And and you know I said

returning 10%. And and you know I said sooner or later the the public markets may end up doing better than private equity. And I think now that's the case

equity. And I think now that's the case for the last five years um because the fees structure is so huge and and in effect uh a lot of the kinds of companies they were buying at the time

you know have not done as well as areas like technology.

But today my concern would be the sales job being done on private credit because again being a bit of a gray beard dinosaur I've seen this before. The

concept of private credit is that you are going to earn equity rates of return for for basically incurring senior level debt.

That is amazing, right? To to to be a debt holder and earn equity rates of return should not exist in a in a perfectly efficient market and and you

know but through through uh great underwriting and good analysis all these private credit companies are telling you that that they can give you 10 to 15%

returns for owning in effect senior or senior secured paper. Now, everyone kind of forgets because a lot of ar people aren't as old as me is we heard this

before and and when did we hear it? We

heard it from a guy named Mike Milin in the late 80s who told us that junk bonds had an excess rate of return, an equity rate of return because they were they

were lower rated and people shunned them and investment shunned them. And if you took the risk to buy these bonds, you could earn equity rates of return. And

even if there were defaults, the recoveries would be so great that they would offset any any default risk. And so therefore,

you were protected. And it rested on two two false assumptions that people didn't realize till Ed Alman and others in 1989

pointed it out. number one that most of the excess returns that Milk and pointed to from the 50s and 60s and 70s in lower rated debt were from so-called fallen

angels companies that had been investment grade but cyclically became junk and then the cycle turn they became investment grade and thus bonds went up

and that was your that was your return number one they were not from new issuance of junk and number two that as time went on in the 70s and 80s

Milin and Drexel was pointing out the default in any given year based on the total amount of bonds outstanding at during that year.

Which of course is not the analysis you should do because if the market is growing rapidly, lots of new companies are issuing debt. The denominator of course is going to grow faster because

those bonds haven't seasoned. And then

what you really needed to do was look at the bonds that you issued in 1979 relative to all the bonds that were there in 1979 and follow it on a cohort

basis. And when you did that, you saw

basis. And when you did that, you saw that the default rates were not lower and the recovery rates were not higher than

people expected and that adjusted for that you were getting a corporate debt rate of return, not an equity rate of return. And that whole thing kind of

return. And that whole thing kind of came undone in the real estate and SNL bust in the late 80s and early 90s.

There's one other thing though that Milin did that was was genius at the time and we noticed it and now we're seeing it again in private credit.

Increasingly he had his his network of companies buying high yield bonds own regulated entities like SNLs, insurance companies or trust companies.

And because regulators would prevent the owners of those companies dividending up too much money to keep the regulated entities safe and sound, what he did was

he had those entities buy the junk bonds of other companies in the network. And

then when your parent company needed to raise money, you'd issue junk debt and everybody else's regulated SNLs and insurance companies would buy the debt.

Well, we're seeing an echo of that with more and more of the big giant private equity credit companies increasingly own regulated entities like insurance

companies to buy this debt.

uh Apollo has a theme for example and that's something that I think is worth keeping an eye on because you have increasingly retirees who are the

beneficiaries of annuities from these companies increasingly being buying a lot of this debt and taking maybe risks that they don't realize they're taking

>> and Jim what Apollo might say and has said is okay Jim sure but over 90% of the assets that we own through Athen are investment grade.

>> Well, that that that's certainly fine, but but that was also the case of a lot of the regulated entities back in 1989 that went bust doing this because they were leveraged 10 to1 or 20 to1 like

executive first executive, Columbia savings alone and a number of companies that were stuffed with drexal junk. It

just depends how levered your lever levered your your equity is, your statutory capital to your assets. You

could have 90% investment grade, but it might still be 100% of your equity is in that stuff.

>> Yeah. And particularly the the thought of a pro of a private credit loan being investment grade, does that give you pause?

>> Well, I it depends. I mean, again, there's I'm of the view that capital markets are pretty efficient and to say that this giant amount of credit out there is just inefficiently priced so

that the investors in it can earn 10 to 15% when often the coupons aren't even 10 to 15%, right? They're they're seven to

15%, right? They're they're seven to eight to nine to 10. And so there's some inherent leverage in the funds going on to get you to that higher rate of return. Um,

return. Um, and then of course we get into the whole thing about shopping for ratings and and you know, how how valid are are some of these uh some of these third party work

that's being done on the credit, but that's a separate issue. and they make the 15% by buying a 9% yielding bond, levering it up slightly. They may also

generate that 15% historically by the 9% loan narrows because there's this huge credit boom at 7% so there's a marktomarket gain on that.

>> Yeah, it could be. I mean, there's there's always, you know, nice innovative ways for for people to goose returns, but at the end of the day, it just usually entails taking more risk.

>> Yes. And Jim, I want to ask you about so historical LP limited partner returns for private equity and private credit have been quite good on paper. It's also

true that investing in the the publicly traded GP uh general partner like Apollo or Aries, you have done very well in that business. I've tried to look

that business. I've tried to look through their accounting. What do you make of the Aries, you know, and Apollo Blackstone just their accounting?

I'm not saying that there's anything wrong with it at all, but it's extremely complicated. You know, even even to

complicated. You know, even even to someone like you, you it must, you know, you must be scratching your head at least once, right?

>> Yeah. We we haven't looked at them recently, but the answer is yes. They

they're they're complicated, but typically they they turned out to be much better investments than than the the LPs gotten their deals. And and I think that's that's an interesting

observation that that you should have invested in in the GP, not the LP. But

no, you're right. They're incredibly

complicated. Take a look at something like Brookfield, you know, which is is just a a maze of interconnectedness. But

we haven't looked at these companies recently.

>> Jim, how would you say this bull market right now compares to the bull market of maybe late 2021?

I mean, we we said after 2021 that was the most speculative market I've seen in my career, just that that sort of six-month period post GameStop

because you had the meme stocks, you had uh you had NFTTS, you had a big rally in crypto. Um, you know, lots of things

crypto. Um, you know, lots of things going on there. um you know spaxs at one point spaxs were raising two to three billion a night in February of of 01

which was equal to the entire US savings rate so you knew that wasn't going to last. Um I don't there were there were

last. Um I don't there were there were there were periods in 2025 it gave 2021 a run for its money. Let's just put it that way. Um, you know, I certainly this

that way. Um, you know, I certainly this late spring and summer with the run of AI and nuclear stocks and and uh quantum computing stocks,

you see saw a lot of the same kind of behavior you saw in the first six months of 2021. You didn't get the issuance

of 2021. You didn't get the issuance that we saw in 2021. So that's a difference. But things are starting from

difference. But things are starting from a higher level. So you know that's the offset to that. And then you had a big move in crypto and you had the crypto

treasury companies which was absurd. So

there were there were some parallels.

>> Yeah. A very good short by you shorting Micro Strategy and going long Bitcoin against it to harvest that that premium.

Jim, why do you think we haven't had the issuance this this time around unlike 2021?

>> I think because a lot of it's happening in the private markets. So the the the private markets are so much bigger than they were in 99 and 2000 that that uh I

mean they're they're willing to finance lots of things and and keep them on their books longer than than go public.

Uh in fact, ironically, if you go public, you may find a valuation lower than what you've been marking at and your in your private fund. So there's a little bit of a catch 22 at work, I think, too. But I think it's just

think, too. But I think it's just because the advent of the private markets is so much greater than it was 25 years ago. The private markets can handle a lot of the capital needs of these companies.

>> You know, Jim, I uh been following you for for a long time like a lot of people. And I I really liked your

people. And I I really liked your explanation of why for for a time I probably not true. I don't know anymore, but you you were short Uber expressing very skepticism about Uber. It's just

crazy to me like for how long you your thesis was right of the fundamental economics of the business. But it just does appear that maybe Uber Uber has kind of reached escape velocity and now is you know somewhat profitable. But um

>> yeah you were right for a really long time. We we are no longer haven't been

time. We we are no longer haven't been negative on Uber for a few years now because they it did they got they they reached escape velocity but of course the valuations in the early years was

just way too high and and people paid too much in in the IPO and post IPO.

>> What else is drawing your skepticism in the in the public markets right now?

>> There's a lot of things that are that are uh the basically uh you know we're looking at in terms of of areas. We've

covered a lot of them today. Um, but but we have a lot of sort of one-offs. You

mentioned Live Nation that that that we like that we don't talk a lot about publicly that are just really interesting. I mean, often accounting

interesting. I mean, often accounting stories. Um, we we published something

stories. Um, we we published something on on uh and I I went online to talk a little bit about one of them uh earlier in the year, ERA insurance, which was

playing big accounting games with its insurance subsidiaries where it basically fobbed off its insurance company to the policy holders so it could take that off the books and then

just charged that in those insurance companies a flat fee of 25% of their premiums and held themselves out to be a service company. Well, the underlying

service company. Well, the underlying insurance companies had no employees, no no directors. Erie, the publicly traded

no directors. Erie, the publicly traded company was doing all that for them. So

really, it in terms of our view was not arms length. Um, and Eerie's only

arms length. Um, and Eerie's only customer was the Eerie insurance companies and vice versa. The Eerie

insurance companies relied totally on the parents employees to do their business. So this was simply, you know,

business. So this was simply, you know, an accounting dodge to get the rel relatively mundane and recently unprofitable property casualty business

off their books and and just show a service income off the top line. Um, and

that stock's come down now quite a bit this year as people have come around to our point of view on that. Um, so those are the kinds of things that's kind of our bread and butter that we still look

at for our clients and um, you know, the data center stuff is fun and interesting and timely, but you know, we we sort of

uh thrive on the ideas that are that are more uh, idiosyncratic and oneoff like Live Nation or Eerie or what have you.

>> We'll leave it there. Jim, thanks so much for coming on. People can find you on Twitter, realjimchainos.

Thank you everyone for watching. Please

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