Prof G Markets
00:08:41 · Ed Elson, Paul Kedrosky
[00:08:41] S3: Credit to them for not giving us a completely bullshit, you know, non GAAP adjustment. Where where... I I remember you and I were speculating, are they going to strip out the training costs? Are they gonna say, oh, don't worry about about what we have to do in terms of training these these things? They didn't do that. [00:08:57] S4: They didn't break it out cleanly, but they didn't try to do something non GAAP in terms of hiding it. That's exactly right. [00:09:03] S3: Yes. They didn't they didn't try to say, don't worry. It doesn't exist. It doesn't matter. [00:09:06] S4: Yep. Totally true.
00:09:06 · Paul Kedrosky, Ed Elson
[00:09:06] S4: Yep. Totally true. [00:09:07] S3: But... So I was I was looking for, okay. Well, the... Maybe this is gonna work. Maybe compute costs are actually, like... They're they're on a path to profitability, which seems, you know, plausible and, to be honest, imminent given what we saw. But then I go through the document. I wanna get your reactions to to what I make of this. And I get to the the liquidity and capital resources section. This is like page 161. It's it's way further down. And they go through some of their future compute agreements, and they they tell... They show us that they have an agreement with Broadcom with a $161,000,000,000 and Google, a $115,000,000,000. And you add it all up, and you realize that they are about to spend on a timeline that they don't tell you, but they're about to spend more than $800,000,000,000 on compute. And none of that is included in the income statement. And so I'm looking at the income statement now, and I'm thinking, does this actually tell me anything? Because it seems as though they've left all of their compute costs at the bottom as a footnote, not because they're trying to pull a fast one, I don't think, but because those costs haven't actually been reflected in their income statement yet because they're about to happen. So what do you make of that of that part?
00:10:26 · Paul Kedrosky
[00:10:26] S4: I think that's exactly right. And this is a deep structural problem that I think Moody's pointed to a few weeks ago in terms of the way that all of these commute... Compute commitments trickle back to and are consolidated in the financial statements because they're... Well, they're non cash obviously now because they're future commitments, but they don't even show up necessarily in the form of orthodox debt because you're... These are future commitments that are aren't actually debt instruments. They're more like a lease that's being discounted back to the... Their present value today. And I... They're all obviously highly consequential, and investors would need to think about it as you consider what the actual cash flow nature of the business looks like going forward. Because in particular, it's not just the size of the commitments, they're all noncancelable. Right? This is really important. This is not something where I say, you know what? It's not working out the way we wanted. We don't... We're not gonna have that commitment. No. These are all non cancelable capital commitments, with the only exception being that there's a growing capital commitment in terms of doing compute at SpaceX, which I think works out to about $3,000,000,000 a year. So much smaller in the great scheme of things than these other non cancelable commute commitments. And that I think is cancelable on a ninety day basis, ninety day notice, which speaks more to what SpaceX is trying to do I think than anything else. That they're desperate to have this cash flow coming back in because they in turn consolidate it as growing AI revenues when it's really not, obviously. This is just compute you're to someone else on a rental basis. So it's it's important, I think, to remember that the preponderance of the commitments are in future, they're massive, and they're all non cancelable.
00:11:56 · Ed Elson, Paul Kedrosky
[00:11:56] S3: Even if you were to get rid of SpaceX, you're close to $700,000,000,000 compute spending. [00:12:03] S4: That's exactly right. It's immaterial in terms of the great scheme of things, and I think that's by far the most important factor here that they're looking at. And in turn, those compute commitments are even more important because in a sense, you're working through distributors. And they say this in the in the s one itself. And so they're distributing their large language models through competitors. Right? Microsoft is one of the prime examples, Google and so Amazon. And this is a really unusual relationship because you're distributing through companies who also sell on your behalf but also take a rake off the top as they do it. So my analogy is this is a little like as if Spotify, which take... Has a rake from the music companies are about 30% of their revenues. But instead of it being 30% of revenues, it was a fixed percentage. It doesn't matter how much you sell. Not only that, all of your competitors also have music streaming services, and they're perfectly happy to kick you out. So this is the this is the deep fragility and the nature of the distribution business, and I used the Spotify example because it shows you how a company that's been penalized for this kind of relationship is actually in a much more favorable position than Anthropic is.
00:13:05 · Ed Elson
[00:13:05] S3: So this brings us to what I think is the most illuminating part of the of the filing, which is that we learned, and a lot of people said, oh my gosh. This is so great, that Anthropic is not spending on CapEx, the the... Which has obviously been a huge expenditure for the hyperscalers, I e, building their own compute, building their own data centers. And everyone said, look. This works because they they don't have this CapEx issue. But they admit to the problem that you're describing, which is that they are leasing compute from their competitors primarily, which is probably gonna be an issue later down the line. And so I'd like to just quote... Read you this quote from the s one. Our increasing efforts to build out our compute and infrastructure require substantial capital expenditures and are changing the cash flow profile of our business. Whereas the compute purchase through our CSP agreements is generally paid as the compute becomes available to us, we expect an increasing portion of our compute and infrastructure investment to take the form of capital expenditures and other commitments, including lease obligations that require significant upfront payments well in advance of the related compute becoming operational. That tells me they're about to build data centers, and they're about to spend a shit ton on them. Is that right?
00:14:26 · Paul Kedrosky, Ed Elson
[00:14:26] S4: Right. That's exactly... A shit ton being the technical term here. So this is also a fancy way of saying, or maybe a relatively opaque way of saying, that what you see in the past in terms of the structure of the business won't be representative of what it looks like in the future. That we can't maintain these leasehold, these lease relationships with our competitors in terms of passing product through, So we're gonna be forced to make duplicate capital investments so that we're not beholden to them, both in terms of strategically, but also in terms of this rake off the top in terms of what we have to give up from what's called marketplace sales, we're actually selling products through the marketplaces on these other services. And so that's what you're saying. You're saying the nature of what we spend in future not only is going to continue, but it's going to accelerate in terms of the CapEx because we're in this strategic quandary of being reliant on our largest competitors. [00:15:11] S3: Which tells me that the income statement is actually irrelevant. Right? I mean, if if that's not even close to a reflection of what this business is about to look like, why does it matter?