Prof G Markets
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?
00:15:11 · Ed Elson, Paul Kedrosky
[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? [00:15:25] S4: Yeah. And I think that's the thing that people are missing is that, in a sense, we all know that income statements and financial statements in general are backwards looking documents, but this is backwards looking at a particularly sharp inflection. And the sharp inflection is from a business that was largely relying on distributors to a business that's increasingly going to be trying to go direct. This is the transition that's underway. And in going direct, it has two consequences. One is massive current CapEx for doing that. And second, and this is the thing people miss all the time, and kudos to Michael Burry and others for pointing this out, is that it creates maintenance capex. You don't have to spend it just once. You have to maintain these things. And so you have a future capital obligation that's not just the amount you spend to build, but also the amount you have to spend to maintain these very expensive facilities, but they're in this Hobbesian choice. They have no choice but to do that because otherwise is to be reliant on their largest competitors who could, you know, like Microsoft did back in its heyday, you know, cut off their air supply at any moment.
00:16:20 · Ed Elson, Paul Kedrosky
[00:16:20] S3: So here's a little conspiracy theory that I'd like to see if you think is perhaps correct. Is it possible that this is why they wanted to go public now? Is it possible that they wanted to take this one moment in time where the operational... The the operating profitability looks pretty good right before it's about to look quite bad? Because that seems like that is what is about to happen. They're at this inflection No. [00:16:51] S4: No. No. No. Listen. I've... I I was arguing that earlier today multiple times with people. So I think that's exactly what's going on. This is as good as it looks from the standpoint of the business as currently structured, and now you go through this inflection that makes it much more CapEx intensive. So you're essentially changing jockeys and changing the underlying structure of what's happening. And so I think this was probably their... And they they know this. This is the best time to do it because the future business is going to be very different. They're essentially reduplicating AWS, Amazon Web Services in both directions, building up and building down in terms of both the client customer facing as well as the the cloud facing stuff. It doesn't mean it's impossible. It could work, but it does mean that the bill... The way the business is characterized in this current statement is not representative of the future. [00:17:34] S3: So what would what would it working look like in your view?
00:17:34 · Ed Elson, Paul Kedrosky
[00:17:34] S3: So what would what would it working look like in your view? [00:17:38] S4: Well, think it would have to look like you'd see, for example, one of the statistics they wanna they wanna tout in the document is the declining compute intensity of token production that it's been coming down something like... It's fallen like 50% or something like that. And so you want to... They want... The business would have to look like collapsing cost in terms of compute intensity of the underlying business. And that's the only way that the margins are supported and could work because otherwise you just simply are gonna eat the business on the basis of the the compute costs associated with it. That has to continue to decline. The more troubling piece is is that there there is a there's a revenue deceleration underway if you looked at the leaked q three numbers in the context of everything else. They're now looking at something like 50% revenue growth, but arguing that in Q4, they'll see a spike. It's implied, but back to about 64% or so. So you... That has to... You have to see that reversal in the fortunes of the business. So one is declining compute intensity. One is a reacceleration of growth. And that I'm saying a company coming like this to market needs already to reaccelerate growth just blows the top of my head off. [00:18:39] S3: Final question. This is set to go public. The reported valuation is going to be $2,000,000,000,000. There has been some debate as to whether that will actually materialize. [00:18:49] S4: Yeah. $1.05 or so. I keep hearing him.