The Exchanges

Q on your, on your investment. You might not, might only need to get a hundred and twenty billion back. You know, if you're going to compare this to a, uh, to a real estate investment. And now that I'm thinking about it, I'm like, well, Meta makes what, like 30, forty billion a quarter. Um, that might be eminently possible with, you know, the outlay. So where's the concern here?

A Well, the concern is that the nature of the investment is profoundly different from real estate. So what you're really entering into is a project that not only has current capital requirements, but it has ongoing capital requirements. This isn't just now and then I'm going to have to replace a tenant's drywall. This is a project that would require wholesale replacement of most of the hardware and probably changes in the cooling system and probably changes in other aspects of these data centers continuously and probably, you know, depending on the math, anywhere from a four to seven year period. So it's nothing like an apartment building In the sense that most of the capex occurs up front, and then it generates recurring annuity cash flow from which I would, I would that I bask in and generates compelling returns back to my investors. This is much more like a utility with a non-regulated utility who has continuing capital requirements, which continually dilute, uh, the returns because you're having to raise more capital all the way down the path. And this will continue for the lifespan of the projects, which you end up From the standpoint of an investor, you end up with a duration mismatch problem, right? So I've got what looks like a long duration project, like an apartment building. That's actually a short duration project in the sense that most of the underlying assets need t…

AI assessment note: “Well, the concern is that the nature of the investment is profoundly different from real estate.”

Q And, ah, their demand for the tokens is higher, and the old hardware is working well beyond that chip, that typical three to five year estimate that people expected. So, what is your thought when people say that?

A So there's a whole bunch of nested arguments in there. Um, so let's take them on kind of one at a time. Um, the lifespan of a GPU in terms of just looking at it from an MTBF standpoint, I mean time between failure standpoint, depends very much on what it was used for in the, in its, in its, in its adolescent years inside the data center. The analogy I often make is if you could buy a used car, both two, you have two used cars, one of them both has, they both have like 5000 miles on them. One was driven in a, you know, a 72 hour nonstop race across the country. The other one was driven. That was the only, that's where all the 5000 miles came from. And the other one was driven to church on Sunday per year. Which car would you buy? Well, I think we would all buy the car that was driven to church on Sundays. I want nothing to do with the one that was raced in some kind of, you know, bubblegum rally across the country. So the, in the context of GPUs, what we have is a generation of GPUs that were largely used for very intensive training purposes. And so the, the failure rates of Of GPUs used so intensively for training purposes are much higher than inference specific usage. So yes, there's no question that if a chip is used exclusively for inference, which is to say token completion in response to prompts, um, then the lifespan will all else being equal likely be longer. And if I ha…

AI assessment note: “the lifespan of a GPU... depends very much on what it was used for”

Q this type of build out, what is the return that's going to be necessary to justify these investments? So let's just take like, seven hundred billion. What is, what for, for even investors to like, I don't know, not go under, or I guess a lot of this is big tech, but like, what are the numbers that we need to be looking for, for those numbers to be rational?

A So you have to turn it around and look at it from the standpoint of the providers of capital. So alternative uses of capital and what return I could get on the same capital in another context. So the way that I try to analogize this loosely, and this is very loose, is that data centers from the context of many capital providers are real estate. They're really just multi-tenant apartment buildings. It just so happens there's no humans in the apartment building. There's just GPUs. And so from the standpoint of providers of capital who look at these, As project finance in the, and then by that measure, try to compare the returns they're getting on this to the returns they're getting from doing project finance. So think about it in the context of commercial real estate, uh, a strip mall, uh, a multi-tenant apartment building or whatever else. So increasingly the providers of capital for these things look at it in that context and say, well, what's the yield in terms of I'm contributing on, you know, a hundred billion dollars to some massive meta project. What's my reasonable cashflow expectation very much analogous To what I might expect from the cap rate on a, on a multi-tenant apartment building, and is this competitive on that basis? So that's, that's the, the, the short answer to your question is it's very much a market-based return that's required. The scale of the money is, i…

AI assessment note: “we're looking at cap rates around 6.8%, six percent, is that reasonable?”

Q A million X. Okay. Let's just say that. Um, a million X. Why are they still writing the checks?

A Because, yeah, no, it's, it's a bit crazy, but yeah. So why are they still writing checks? But you might say the same thing. It's back to the Harold Prince line. Back at the, during the financial crisis, as long as the music is playing, I keep dancing. This is that, right? This, as long as the music is playing, they're all going to keep dancing because there is absolutely no incentive as any of the largest capital providers on earth from sovereigns down to private equity and private credit to walk away because you get pressure from ELPs saying, why aren't you participating in this? And then even worse as a sovereign, as a sovereign wealth fund. And I've been inside these folks is that Once you're managing hundreds of billions of dollars, you start looking at opportunities, not in terms of their economic value, but in terms of check size. And you say, I need to write a check for fill in the blank, a hundred billion dollars, because I do not want to write a hundred one billion dollar checks. So this weird filter starts happening where you now, these projects are like, look at my friend, sorry, Qatar. I have this project. That's perfect for you. You want to write 50, a hundred billion dollar checks. Nowhere else on earth can you write it other than these giant data center campuses like the, the, the meta project in Louisiana or take your pick. And so once you become, uh, develop a…

AI assessment note: “there is absolutely no incentive as any of the largest capital providers on earth”

Q for his great newsletter at paulkodroski.com. All right, Paul, uh, you know, we talked a little bit on the other, on the, on the first side of this, this break or before the break about, um, the money will keep coming until the music stops. Um, I mean, I imagine it would take something dramatic for the music to stop playing. What do you think could be the compelling event?

A So the argument I make is, you know, people fall into this trap of saying it's going to be this or it's going to be that. I think it's actually overdetermined in a statistical sense, meaning that there are so many different ways it can stop that. The only thing you can say is that it's going to stop because it could stop because of a macro event that changes the hurdle rate that external capital providers are looking for. If I'm suddenly looking for, you know, high single digits and not six and a half anymore. Well, then all of a sudden data center projects with their deflating underlying token comprising, uh, looks much less competitive. So that changes things dramatically given that more than half Half of data center projects now or half of the capital for data center projects now are external financing. So that changes things dramatically. Um, the, the, so, so the, the, the providers of capital pulling back is a, is a, an obvious source. And then obviously the, the, the post IPO phenomenon of having these, these companies having to generate competitive returns on the back of a deflating commodity and then moving up market and discovering the returns aren't there as they move up market and they continue to spend aggressively on CapEx. Investors become dis, uh, you know, unhappy about it very, very quickly as we know from hanging around this stuff for a long time. So it wouldn…

AI assessment note: “it could stop because of a macro event that changes the hurdle rate”

Q That is scary. So how are you playing it? I mean, you are an investor. Are you like shorting certain things or what is your plan here?

A So I very much, so my day job in large part is in venture capital. And so for the most part, we just don't invest in it. We just, it's, it's not obvious. It's not obvious how to invest around AI because one of the worst things you can do as a venture capitalist is get into a marathon where there's a thousand participants. They're all at the start line. They're all well-funded and well-trained. And it's like, oh my God, I'm going to have to outlast all these people to get to the finish. And so you, you really have to pick your spots and try to stay away from these sectors where people are concentrating capital and doing it in a way that leads to much poorer returns. So for the most part, you know, we've been, we were very active in a host of different areas, but not, not AI, which is perverse because it's not because we don't believe in AI. It's because we believe it's structurally a terrible place to be as an investor. And then on a, on a more personal level in terms of, you know, assets, I just. I'm very loathe to invent, to commit any, haven't committed new capital to any sort of broad index class passive categories in over two years for that reason. Because you just, you, whether I like it or not, prior commitments now amount to a much larger commitment to this asset than I would like already. So I'm already over invested in this stuff just by the fact of having a pulse and …

AI assessment note: “in venture capital. And so for the most part, we just don't invest in it.”