Invest Like the Best with Patrick O'Shaughnessy
00:06:02 · Gavin Baker
There are some actually pretty big unusual items now, like these hyperscalers that always seem to have billions of dollars of legal expenses that are unusual, mostly fines. To the EU, but there was an unusual amount of one-timers this quarter, and if you adjust for that, we went from twenty-eight to thirty-five, and that's, that's a material acceleration at this scale, and that's really before they start to light up the rubids Which will come at a meaningful premium before these contracts reprice. It's been a challenging month. Is it helpful to kind of like walk through the month, how we got here? Yeah. So first, Meta is gonna rent out compute, and this is seen as like very bearish. They have excess capacity, they're gonna cut CapEx, this is a disaster. This isn't at all what it was. They just reported they didn't cut CapEx. What it was is they saw SpaceX have a big installed base of compute and sell some big trading optimized clusters into the market at a truly massive premium to these contracted rates, and at least the analysts liked that, they saw an opportunity. There's a lot of speculation they're gonna raise capital, so maybe what they're thinking is like, "Hey, we will show on a small chunk of- Of capacity that we can generate really strong IRRs, then we'll go raise equity capital and we'll be off to the races and probably raise CapEx. That doesn't look like that's what they're doing, but nonetheless, the market sold off because it interpreted this very negatively. And I was really sure it wasn't negative. A lot of telemetry and TIBETAS CapEx plans, none of that telemetry had shifted at all. If anything, they're continued to get more aggressive. And then shortly after that, they released their best model in a long time, Muse one point one, which was actually a very good model. I mean, it was overshadowed by Croc four point five, but it was a good model, way better than anything in two years. So just no chance they're taking their foot off the gas. Then Kimmy comes out, and then there's this Huge freak out about open source, and at the same time this Silicon Data token index kind of dips and flattens, and the two are connected.
00:08:23 · Gavin Baker, Patrick O'Shaughnessy
What the Silicon Data token index captures is mix, and they don't see all the tokens, but because of GLM five point two and then Kimmy, all that took a while to layer in, there's kind of a mix shift in this data from more expensive frontier tokens, which probably have an inference margin We can debate whether it's eighty, ninety, or ninety-five, but super high towards open-source tokens. And for whatever reason, the market thought this was negative, but the reality is, a token is a token, and you need the exact same amount of compute to make a token all else equal. It takes the same amount of flops, the same amount of memory, the same amount of watts. Tokens aren't equal, but broadly speaking, all open source take-- share does is take margin dollars out of the frontier model layer. There is elasticity, thereby driving token demand. You need more demand for compute, and the margins, you know, Anthropic and open source, they all run on the same underlying cloud providers who charge the same amount of compute. So you're literally just taking margin from frontier models and essentially driving more margin dollars into the AI infrastructure layer [00:09:39] S0: that was the catalyst with this combination of things.
00:09:39 · Patrick O'Shaughnessy, Gavin Baker
[00:09:39] S0: that was the catalyst with this combination of things. [00:09:41] S2: Well, yeah, Jitsin is the world's largest supporter of open source. He's like a super idealistic guy, he's a patriotic American, I think he always does what's right. But does it really stand to reason that Jitsin would be the world's biggest supporter of open source if it was bad for his business? You know? They'd still support if it was the right thing for the world. Yeah. And by the way, I think open source is really important to worlds where there's just one or two dominant frontier models that charge like ninety percent margins. Nine percent margin. It's not good for humans, it might not be good for society, and I think we want a lot of models, as we've discussed before. So then it's like, okay, the market digests that and comes through with it. Then China has a DUV machine, you know, everybody's in these baskets, this causes a huge sell-off in In a lot of ways, the real concern, which is real yields have gone up, which makes sense, you know, we're investing a lot to fund this investment, and for sure, credit is an increasing part of it, even if the majority is still funded out of operating cash flows, so real yields go up and spreads widen. Meta priced a bond last week, and it didn't price where you would think a Meta bond would price, and this just shows that the credit market, NBD's EDS was, [00:11:00] S0: was blowing
00:11:00 · Patrick O'Shaughnessy, Gavin Baker
[00:11:00] S0: was blowing [00:11:00] S2: out All of these CD-- uh, it's CDS for everybody is, is blowing out, and, you know, very smart private capital people just like, "Hey, this is just exactly what you'd expect, these are just banks hedging their commitments, but nonetheless, it doesn't look good," and these are undeniable facts. CDS is up, spreads widened, real yields are up. That would be really, really scary if we needed debt to finance this build out. And that's where I think it's this differential between spot and contract Pricing for the installed base of compute is so important. [00:11:34] S0: It's so important to understand what the financing will be like for the next six months or something. [00:11:39] S2: The degree to which this build out [00:11:43] S0: is going to require credit. Right. Which would be the classic capital cycle. Absolutely. Overextend ourselves with debt, and that's where things get stuck.
00:11:50 · Gavin Baker
[00:11:50] S2: A hundred percent. And then debt-fueled build outs, they demand immediate repayment. So if supply and demand get a little bit out of whack, things can unwind very, very quickly. That's what happened in the internet. If one believes, as I do, rightly or wrongly, after this month, I'm super open, you know, I'm, I'm looking like I've been pressure testing all of these and like I really went deep on credit because, hey, this is real, it's undeniable, and if we need credit to fund this build out, this is a significant negative. And if you model it out, if you look at the amount of gigawatts that are supposed to come on in consensus estimates for hyperscalers, they're a Effectively modeled, and these are gigawatts of Blackwell and Reuben, Reuben being Nvidia's next chip, Blackwell being the current chip, they are essentially modeled to monetize roughly at the rate of Ampere, which is two generations behind, not at Hopper, but Ampere. So there's one point three to one point four trillion in hyperscale operating cash flow If you just assume, I think it's very unlikely they monetize at the rate of a MPR, we could go into why. Some of it comes from just seeing what is happening on the ground with demand here for real quantitative metrics. But like, let's just say they monetize at a discount to current Blackwell's, then it's more like two trillion of operating cash flow, and that kind of takes seven hundred billion of credit demand out Ironically, as that improves all the credit ratios, as these installed bases of compute reprice, we're gonna continue accelerating, because since this is modeling a deceleration, which I think is unlikely, then the credit metrics look better, and then all of a sudden, it gets easier to finance with credit. Now, whether they choose to do that or not, we'll see. This is all a little bit, you know, I think we spoke- Two months
00:13:44 · Patrick O'Shaughnessy
[00:13:44] S0: ago.