Invest Like the Best with Patrick O'Shaughnessy
00:33:12 · Gavin Baker
[00:33:12] S2: A hundred percent. Well, the bull case, you've- I've seen charts from Cognition, Rayop, and Stripe that the companies that are spending the most on AI are growing meaningfully faster. Yeah, I love that Cognition index. Yeah, the Cognition index is wild. All the skeptics will point out rightfully, it's not really controlling for industry, but then if like you dig down into it, I think one of them gave an example of, I forget if it was a plumber or an HVAC contractor, but like everybody who's a blue collar worker is doing great 'cause of AI. By the way, something that I think we should touch on These LTAs. So everything's in a shortage. If there's weakness, it's just 'cause we can't energize the gigawatts fast enough. The gigawatts are gonna get energized like regulatory policies moving in a good way, the turbine manufacturers, the diesel genset manufacturers, you know, you're ripping turbines off old airplanes and, you know, reconditioning them and then repurposing them. There's crazy things happening. Capitalism's very, very good at this. But I do think one of the most important questions in the market, and like a transition in the market that I got wrong, is we are shifting, particularly for memory more than anything else, from crushing numbers in the short term to they are trading short term upside for these, what they call supply chain agreements, long term agreements, LTAs. There's many flavors, but customer pre-pays, there's a floor and a ceiling. And this comes back to the point about labor, because, you know, a lot of people after firing too many people during COVID were really reluctant to lay people off. They talked about labor hoarding, if you remember a few years ago. You remember this? Yes. Let's just think about the game theory of breaking an LTA. So there's four companies that matter at scale. There's Amazon with their Trademms, there's Google with their TPUs, there's AMD, and then there's Nvidia, who's like much bigger than everybody else combined. Let's just say it's two thousand and twenty-seven, and it's very important to realize memory is, the more memory you put with Flop for a given unit of compute, the more tokens you get out.
00:35:22 · Gavin Baker
It's the single most important thing you could do to increase token output per unit of compute, and then that obviously definitionally actually lowers costs, which is why the demand hasn't responded at all negatively. There's been no elasticity just because it's the access that is dominating all others. And this is at some level like a giant Game of Thrones or Ippar's between these companies. Okay, it's two thousand and twenty-seven or twenty-eight. You're vaguely tempted to break one of these LTAs and try and get a lower price. But to a large degree, market shares, I think for the next several years, are going to be determined by supply chain allocations and kind of what you have pre-purchased. So if you break the LTA, this is assuming we're not in a severe oversupply situation, the game theory even holds in a severe oversupply situation, if you break your LTA, and then in the next Two or three years, for any reason, leverage shifts back to the Bibury guys, you're out of business. It's over. Let's just say Google breaks an LTA, there's an oversupply, I'm making this up at twenty-eight, twenty-nine, they break their LTAs. Well, if they're breaking their LTAs, it probably means, you know, your oversupply, prices are coming down, and then, you know, capacity naturally contracts. Well, what do you think's gonna happen to Google's allocations? And then, you know, this is a cyclical industry, and oversupply is followed by undersupply. What do you think they think is gonna happen to their allocations next time? So I just think given that this is the axis around which kind of everything is revolving, you might blow up your entire business and your franchise by breaking an LTA, and that was never the case before. Apple, who cares? They don't have a competitor, they're overwhelmingly the largest purchaser. This is, you know, going back three, four, five years, they know they can do whatever they want with no consequences, 'cause their volume is so big that even if they like super screw Heineken, Micron will of course- Take them. This is just different, you know? You have at least four players, didn't you have all the startups, your investor and Etched. If you break an LTA, they just say, "Okay, fine, great, you broke the price agreement, we're gonna break the volume agreement, and screw you, we're gonna give the volume to your competitor.
00:37:43 · Gavin Baker, Patrick O'Shaughnessy
You just lost share, you know? Nvidia's dominance, the current environment to which it favors Nvidia, it is a little hard for me to understand why it's trading at such a low- Low multiple. In other words, if you need to be able to finance the chips, and you do, nothing's more financelable than an Nvidia GPU, nothing. If you need to get land and power, well, they're doing a very good job of playing that chess game in matchmaking, and then they've rolled out this really clever new business model, which I would describe as kind of like a credit wrapper with a revenue share if GPU prices are backstop it, yeah, yeah. Yeah. And this could lead to them having a really Really giant cloud business effectively through royalties really quickly, and it is another way of kind of alleviating this cash flow mismatch, like, hey, we're making all the cash This isn't really vendor financing, 'cause they're not loading them the money. Somebody else is loading the GPU buyer the money. They're still making equity investments, but it's not like you're just putting money into someone, then some of that money was used to buy your chips, even though Nvidia said that they write into all their equity investments that the money can't be used to buy Nvidia chips, but obviously money is fungible. Funny thing, makes no [00:39:02] S0: sense. [00:39:03] S2: Yeah, but, you know, I think at some level it probably makes everybody feel better. [00:39:06] S0: What would you do if you were the mem- like if you were the CEO
00:39:09 · Gavin Baker
[00:39:09] S2: of Hynix? I'd do the exact same thing in videos doing right now, which is I would be going to the buyers of GPUs, Trademips and whoever and saying, "I'll participate in the Nvidia credit wrapper. Now, their business is just inherently less stable and predictable, but in some way, and maybe they just put up some cash up front so it's like they're not on the hook. I'm just making this up, but like, do something, like you- You can, because you have money now, and credit markets are revolting. I'm sure our friends at Blackstone and Apollo are suggesting some variant of this to the memory companies. But hey, we will put up some amount of money from our cash flow today, and then it's God, it's surety that makes the person who's extending the debt feel better, but we want some sort of a cut of the ongoing revenues as well. That is One hundred percent what I would do, and it's almost like a logical extension of the LTAs, where they're trading upside for durability. Here, you can effectively get a royalty on recurring revenues, and that is what Nvidia is doing. And I do think that is very misunderstood, and I think it would serve Nvidia well to really explain this. One, they're really bullish on AI. Essentially, every time they haven't taken an equity stake in something, it's been a mistake. They've taken equity stake in everything essentially, except the memory company, is that for a long while, Anthropic, then they took an equity stake in Anthropic. But like, why not if you have cash flow and you're bullish on AI and Jensen, because he sees every lab, he knows all the advances, you know, like all these continual learning labs, you know, Safe Superintelligence is now working with them, he sees everything, and like what he sees makes him bullish So one have some equity upside, and then two, have a revenue share, and you're generating hundreds of billions of dollars of free cash flow and helping to kind of bridge what is clearly kind of a gap, at least given everybody's got free cash flow negative, until the operating cash flow accelerates enough that you can internally fund this. It's very opportunistic in a good way, and it significantly increases their revenue per gigawatt, and then it also strengthens their competitive position. You and I, we both have startups, but okay, that's great, use that startup's chip.
00:41:35 · Gavin Baker, Patrick O'Shaughnessy
What prices are they playing at Taiwan Semi? Higher than Nvidia and all these guys. What prices are they paying for HBM DRRAM? Higher. Can you finance those chips easily at the same rate as Nvidia? No. And so it's always like, there's a real burden. Particularly if you use HBM D RAM, you're in the crosshairs of this, unless like H they made really different architectural choices Everything that's happening is actually pretty good for him. By the way, going back to game theory, in Dropic, if they had been as aggressive on compute as OpenAI had been, they would have run away with it. Now OpenAI is back in the game, I think Grok is in the game, those are the companies on the Pareto frontier. And they have the compute. Do you think after watching that, anyone is going to let off the gas? Right. It was, I think, four months ago that Dario was talking about how- Wow, it was a really thoughtful commentary, but he's like, it's really, really hard because if you buy too much compute, you could go bankrupt at the scale of these things. But if you don't buy enough, you could lose. Well, OpenAI just got back into the game, and now SpaceX is in the game in a big way with Grok four, five, and Cursor. After watching that, from a game theory perspective, is anybody going to back off anytime soon, especially if it can be funded out of operating cash flow? [00:43:01] S0: Have you met anyone in your travels out here that you would say is like way more bullish than you, and if so, what do they believe that you don't?
00:43:01 · Patrick O'Shaughnessy, Gavin Baker
[00:43:01] S0: Have you met anyone in your travels out here that you would say is like way more bullish than you, and if so, what do they believe that you don't? [00:43:07] S2: I mean, essentially everyone out here is more bullish than me, man. I mean, you know, I read this thing that Dorkesh wrote, and I was like, [00:43:15] S0: "The three X compute [00:43:15] S2: price thing or whatever." Yeah, well, he was-- I forget what it was. No Basically that renting an H one hundred for a year would cost two hundred and fifty thousand dollars, and that's fifteen x the current spot rate. Exactly. Like, wow, you know, that was just like, that wasn't my book. That wasn't in my, forget my like Bayesian probability space of expected outcomes. That wasn't even in my considered but dismissed as totally unlikely outcomes. Four cash, he's a very smart guy, he's very plugged in, then he pointed out that margins on compute They're going up, the amount of compute is going up, and inference margins going up, and if you multiply those three, that's how you're getting this crazy acceleration into some of the labs plus open source, or though the margins on open source aren't really going up. I look at what's happening in the stock market and I feel like a foolish optimist. And then when I talk to people, whether it's people at the labs, anyone in this ecosystem, I'm like bearish relative to essentially everyone. It's just a strange state of affairs.