As the AI investment frenzy continues to escalate, seasoned investors are drawing parallels to past financial bubbles, warning that the current trajectory may end in economic turmoil. Harris Kupperman, a veteran investor and founder of Praetorian Capital Management, offers a critical analysis of the AI boom, suggesting that the industry is on a path reminiscent of previous speculative cycles.
The AI sector, which has rapidly evolved from a niche technology to a cornerstone of modern business operations, is experiencing unprecedented levels of investment. According to industry insiders, datacenter spending is projected to reach $400 billion by 2025. However, Kupperman argues that this massive capital allocation is unsustainable, as the depreciation costs of these datacenters far exceed their revenue potential.
Understanding the Financial Dynamics
Datacenters, the backbone of AI infrastructure, are composed of three primary components: the physical building and land, power systems and cooling, and the GPUs that drive AI computations. Kupperman estimates that these components contribute to a staggering $40 billion in annual depreciation, while current revenues hover between $15 and $20 billion.
“The AI datacenters to be built in 2025 will suffer $40 billion of annual depreciation, while generating somewhere between $15 and $20 billion of revenue,” Kupperman notes, highlighting the financial imbalance.
The lack of gross margin in the AI sector further complicates the financial outlook. Companies are essentially giving away technology at a loss to drive adoption, a strategy that has historically relied on eventual positive returns on invested capital. Yet, achieving a sustainable 25% gross margin remains speculative at best.
Historical Parallels: Lessons from the Past
Kupperman draws comparisons to the late 1990s dot-com bubble and the early 2000s fiber optic boom, where companies like Global Crossing invested heavily in infrastructure without realizing adequate returns. Despite the transformative potential of these technologies, the financial models proved untenable, leading to widespread bankruptcies.
“Fiber was the datacenter of that cycle, and Corning was the NVIDIA of its day,” Kupperman reflects, noting the drastic decline in Corning’s share price following the bubble burst.
Similarly, the shale oil boom of the 2010s serves as another cautionary tale. Companies continuously reinvested cash flow into production, only to face diminishing returns and financial distress. Kupperman warns that the current AI investment strategy mirrors these past cycles, with tech giants potentially facing a similar fate.
The Future of AI Investment
Despite the challenges, the demand for AI technology is undeniable. Corporations and governments are keen to harness AI’s productivity benefits, potentially driving revenues. However, Kupperman argues that the required revenue growth to justify current investments is astronomical, with estimates suggesting a need for $480 billion in AI revenue to achieve a 20% return on invested capital.
“$480 billion is just an astronomical number,” Kupperman states, emphasizing the improbability of reaching such revenue levels.
The potential for an AI investment bubble bursting poses significant risks to the broader market. As Kupperman suggests, if the current trajectory continues, tech companies may face severe financial repercussions, with shareholders ultimately bearing the brunt of the fallout.
Conclusion: A Cautionary Tale
While AI undoubtedly holds transformative potential, Kupperman’s analysis serves as a stark reminder of the financial realities underpinning the current investment landscape. As history has shown, unchecked exuberance in emerging technologies can lead to devastating economic consequences.
Investors and industry leaders must tread carefully, balancing innovation with financial prudence to avoid repeating the mistakes of past cycles. As Kupperman concludes, the AI boom may not end with the anticipated technological revolution but rather with a sobering realization of unsustainable financial practices.
Caveat Emptor…
Harris Kupperman is the Founder & Chief Investment Officer of Praetorian Capital Management and author of Praetorian Capital’s public blog, Kuppy’s Korner, from which this article has been reproduced with permission. The opinions expressed are those of the author and do not constitute investment advice.
