The Exchanges

Q on balance, basically everybody we've talked about so far, you know, sometimes it's nuanced, but pretty much everybody is incentivized to play up the power bottleneck. Um, and indeed, you know, they are. It is also real, but, but they are playing it up. Who do you think is on the other side of this equation? Like, who is incentivized to say that power is not such a big bottleneck?

A Yeah, and I think this part's a little bit more interesting, too, because to your point, I feel like a lot of people benefit if the power constraint remains. And, you know, that's just like an okay thing to observe. It's just facts are facts. But on the other side, you know, I'd, I'd call it a few buckets. And, and the, the first that I think is independent power producers, and this might seem counterintuitive, but let me lay out my logic. Is if you're an independent power producer, that means that you have a fleet of existing assets today. Those generate money based on selling into electricity markets. And so, you know, the input to their revenue is electricity prices. If we're in scarce conditions and those continue to grow, they generate a really healthy incremental margin on that, right? Because they're not really building out new assets. You have slightly higher O and M perhaps by running your assets harder, but you're just flowing through a high electricity price. That is extremely rewarding. Profitable for them. And that's actually been the thesis for a lot of owning these assets. So these, these are like the constellations, the talents, the energies of the world. One thing I noticed, it's interesting. If you look at the, like the last two earnings calls, right, you have the folks like the CEO of constellation talking about the fact that, you know, energy prices actually…

AI assessment note: “the first that I think is independent power producers, and this might seem counterintuitive”

Q them, um, what we are hearing from these various parties, and then the incentives that they have to say what they are saying, or maybe to say what they're not saying. Um, But let's start by categorizing. Like, walk me through at the high level, like, there are a bunch of, there are a couple groupings of actors that have similar incentives. So how do you think about the groupings?

A Yeah, at a high level, I'll try to keep it simple, but, you know, again, there's various degrees of nuance required. But at a high level, you know, let's start with the hyperscalers who are, you know, the folks that are driving a lot of this capex and investment cycle. You know, these are, think of it as, like, the cloud service providers, the Amazons, the Googles, The, um, you know, um, Microsoft's of the world, as well as including Meta, which is another hyperscaler, even though they don't have a legacy cloud business, um, that drives, you know, investment spend on GPUs, and that's kind of the equipment, like you have the technology hardware, if you will, that includes, you know, GPUs, CPUs, custom silicon offerings. That moves upstream into like the supporting equipment, which includes like electrical and cooling equipment. Uh, and then if you kind of go outside the data center, then you start to get into You know, who supplies that power equipment, as well as the overall actual power of the facility. And moving upstream there is like, you know, who actually builds power, which is like utilities, um, as well as, you know, the, the labor and the EPCs and the engineering that goes into those types of facilities. So if you kind of just go from who's spending the capital and follow that down the, the stream, that's a general way to think about some of these bigger pockets. And s…

AI assessment note: “start with the hyperscalers who are, you know, the folks that are driving a lot”

Q your job is to provide services or hardware into the build of data centers. My first thought would be That everybody there is aligned in their incentive to promote the power scarcity narrative. It's just, it just furthers their, the argument that there is limitless demand for their services, and we're just going to sell out as much as we possibly can. Do you think it's more complex than that?

A I think that one is pretty straightforward to your point, is that, just going back to our prior point about long lead time items, and the most constrained, a lot of this is equipment and As well as the labor, those are the direct beneficiaries. What do they get? They get higher backlogs. They get longer duration backlogs. They get better pricing in typically industries where you don't get, you basically get minimal pricing or as much as the market will bear. Um, whereas now you're pricing power for the first time in, in generations, right? For certain equipment providers or certain labor producers. So this one is pretty straightforward and you see that across the earnings, right? Um, you can look at the earnings transcripts of companies like Quanta, like record backlog, uh, MosTech talking about, you know, record Activity in their pipeline business, as well as really a strong, even clean energy pipeline. Um, you, you can go to the equipment or you send them like somebody, let's see something like a vertive, which has a backlog that was up 30% organically year over year. You have eaten, which is up 20% backlog organically over year on, you know, like billion dollar books of business. And so I think there, that's what you'll see to your point, like a very limited narrative on talking down the potential market opportunity, because if you think about it from their point of view, ri…

AI assessment note: “I think that one is pretty straightforward to your point”

Q How do you think about the, there's an, there's another category, which is like the, I'll group together like real estate owners, landowners, and then the, the like powered land developers, the developers who are going off and trying to find sites and make them powered and then sell them to a colo or a hyperscaler or whoever. What's their incentive?

A Their, their incentive is to talk up the constraints as well, because it increases the value of the asset they're owning, which is the real estate or the powered land bank. If we think about, Just solving again, if there's a constraint, that means that anything that accelerates you through the constraint is, is valuable, right? Or increases in value as a constraint gets worse or it remains. And so if I have a powered land bank, that means that I can move a lot faster than someone that has just a plot of land that has no interconnection access or anything like that, right? So I can charge a more premium price to developers and new clouds, et cetera, anyone else that would want to be further along up the development cycle. And so they're generally universally talking up the opportunity that they have, um, and the ability to move faster. I'd say, you know, a lot of what we're seeing there is, or at least what we hear chatter wise, right? Is that like you have transaction values that are much higher than they've ever been, or at least in recent cycles, um, as folks all are chasing the similar opportunity. So pretty much any land banks, uh, that are powered that are near plentiful energy sources, something like, you know, in the Northeast with narrow gas fields or in West Texas, right? You're seeing construction activity be plentiful because people think that it's a much faster Path…

AI assessment note: “Their incentive is to talk up the constraints as well, because it increases the value”

Q Where is that money going now? Like, you know, for all these funds that want exposure to this category, um, what are they buying into? What are they staying away from? Has it, has it started to create any bifurcation within the sector?

A I think it's a great question. I think a lot of folks are asking themselves that, but I would, I would say I would observe two major, I guess, transitions in terms of how capital is allocated in these spaces to your point. And I think one is generally a flight to safety. And what I mean by that is, you know, the companies that are executing, you are seeing them trade at wider premiums or higher multiples in the companies that are not seeing as much growth or execution. So, you know, if, if to give you examples, as we just talked about, like, for example, trackers, you saw next tracker talk about a lot faster, top line growth and better execution that trades at, you know, a several multiples higher than let's say an array, which is talking about some project delays. You see the same thing in like EPCs, which are engineering procurement. Procurement and construction firms where I talked about Quanta seeing, you know, significant top line growth, um, and trading much more at a premium valuation than, than its competitors, such as like a Moss tech or something like that. And so what you're seeing is the companies that do really well, uh, in the current market starting to get a lot more investors pile into them because they're saying, Hey, at least these companies are performing in an otherwise tough market. The other main angle, which I also, I probably see more of, to be honest, i…

AI assessment note: “I would observe two major, I guess, transitions in terms of how capital is allocated”

Q the public markets however you want to and compare the performance of that basket of companies around Over the past few years against the broader market, because that's been the interesting and pretty wild ride that we've been watching from, from the climate tech ecosystem. So just give me the high level of like, what, what has happened in climate tech and in public equities versus public equities in general?

A Definitely wild rides and accurate, accurate characterization. And so we think about the broader climate tech markets, you know, with the two indices that I'll use to look at them is the S and P global clean energy index, and then the Mac global solar index. And what these are, they're baskets of stocks that are exposed, uh, at a global basis to different climate technologies, as we just talked about solar wind batteries, things of that nature. So when you look at like a multi-year basis, let's call it the last two years, uh, you know, the S and P 500, which is a not climate tech Uh, indices, but a broadly used indices to assess market performance is up 23%. When you look at something like the MAC Global Solar Index, that's down -34%, and you look at the, and the S&P Global Clean Energy Index, that's down 25%. You're talking about a 40 to 50% underperformance over the prior two-year period. So it's been a really tough go for some of these sub-sectors compared to the broader overall market. Um, and so what does that mean for, for the climate tech or clean technology is that, You know, when you look at the prior five-year period, you saw this really run up in performance and largely valuation versus earnings growth from a lot of the climate, climate tech companies and sectors, and this was on the back of a few different things, right? It was a very low interest rate environment. …

AI assessment note: “You're talking about a 40 to 50% underperformance over the prior two-year period.”

Q you know, the whole economy is sensitive to interest rates and interest rates rising and inflation, in fact, did mute Performance in the broader market until it didn't. And then the market has now been back on a boom again. So what is it that distinguishes, uh, these clean, the, the components of these clean energy indices to make them perform so much worse in this high interest rate environment?

A Yeah, there's, there's a few factors. And so I think the, the most obvious one or the most intuitive one is that in a period of higher interest rates, especially for products that, uh, have consumer point of purchase that require external financing. So think of a residential solar system that's financed by debt or, or an EV or any type of car purchase, actually that, you know, you have a car loan that you purchase it. When interest rates are higher, that means that the overall cost for the car, the residential solar system, or whatever the debt finance purchase is, is a lot higher. And as we all know, consumers, when they see a higher sticker price Makes it a lot less likely to go purchase, and it also drives up that payback period where, you know, in a few years ago, it might have been seven years for a payback period. It was all of a sudden 10 years plus, and that does change the calculus for the point of purchase. In terms of the broader companies and their business models, oftentimes with some of these climate tech companies, you do have what we call capital intensity, meaning that you need to spend a lot of dollars at CapEx or R&D or et cetera to develop your product and get it to market, and so they oftentimes raise external debt To finance these, uh, this capital spend. And so in periods where interest rates are higher, that means a higher interest expense for them, as w…

AI assessment note: “consumer point of purchase that require external financing... capital intensity”

Q time for sure for all those companies, but like, I don't know. Nobody's arguing that demand for lithium is not going to continue to drive upward for the next decade, right? The pace of that and exact supply-demand balance on a yearly basis obviously is important, but the macro that led those, the lithium stocks to be kind of darlings for a little while hasn't really disappeared, I don't think.

A It hasn't, but one thing you just mentioned was supply and demand, right? So we talked a lot about demand. We haven't talked about supply. So the last two years, To give you an idea, demand I just mentioned last year was 30%, 30 to 35, let's call it that. Supply that came online in terms of lithium global mines was somewhere on the order of 30 to 40%. If we look at this year, I mentioned the growth outlooks for most reasonable market forecasters is 20%. Supply for lithium again for this year is supposed to be 30 to 40%. So we have supply that's outpacing the demand increases. To your point, I don't, I think if you look at most sell-side banks, and when I mean sell-side bank, I mean it's the large investment banks that have equity research departments, published forecasts. Almost the majority of them have, you know, the market falling back into a deficit by the end of the decade. But for this year, they have a surplus. And so that's what's changing that lithium market. And that's what's driving prices down is that you have enough supply to meet the current demand trajectory. What does that look like in the next two, three, four or five years? I think it ultimately depends on that growth curve, but I think most reasonable forecasts have the demand curve grown at 15 to 20% CAGR through the end of the decade and supply. It really depends what happens now because what a lot of Produ…

AI assessment note: “It hasn't, but one thing you just mentioned was supply and demand, right?”

Q All right. So what got you Started thinking about the incentives of all the different actors involved in data center power nexus. Like what, what sparked the thinking?

A It's a good question. I feel like everyone has been thinking about this for the last two years, or at least hopefully, so I don't feel as lonely. But I think the, the, the premise for this tweet or thought that I had was that, you know, there's general understanding that there's like, you know, a few ground truths and ones like AI found it AI is a foundational technology that's going to persist in society. Two is we need a lot more energy infrastructure. The, you know, magnitude and duration of the cycle is of the debate, but it introduces a duration mismatch where technology is often done on cycles that are, you know, one to two years, whereas energy is typically multi-year, even multi-decadal, depending on the type of asset. And what I was trying to gear in is, you know, psychologically, Humans or organizations have incentives and incentives drive behaviors, as everyone knows. And how could we take that, you know, lens and apply it to the power debate? Because so many times I have folks coming to me, uh, from earnings calls or from events or conferences and saying, I heard this from X party or this from Y party. And that's completely at odds with what they heard from another player, uh, down the stack. And so what we were trying to do is a clean sheet exercise was looking up and down the supply stack for AI, uh, Who has incentives to talk up the power constraints? And who may…

AI assessment note: “so many times I have folks coming to me... and saying, I heard this”

Q power providers. So we ended up mostly just going with, like, technology companies, companies who are selling some form of technology directly in the space. Even there, it's murky. Do you include General Electric, for example? But, um, But that was sort of how we tried to define it, just to keep it relatively narrow. And even there, obviously, ah, one person's definition of climate tech doesn't match another one's.

A Definitely. And then to your point, too, is that narrowness is a really good point because, I mean, if you break down, I focus on US public equities, and if you break down that universe of what you're calling, you know, the pure climate technology or climate service companies, you might end up with a universe of, let's call it, 50 to a hundred names just using rough approximate numbers, and so, uh, that's often challenging if you were to build a portfolio and you only had 50 to a hundred names to work with. That's a typically very concentrated portfolio because you're probably only investing in a subset of those, and so that's why you get portfolios or funds or indices that include Boy, you mentioned some other companies that might have incumbent businesses with, you know, underappreciated climate tech angles, and that's typically what you'll see in some of these portfolios and why you might see like a GE or, you know, other industrial businesses like HVAC or electrical components into a climate portfolio. I'm using air quotes.

AI assessment note: “why you might see like a GE or, you know, other industrial businesses”

Q All right. So let's, let's start with the hyperscalers. They're obviously at the epicenter. Of the data center build out. How do you think about their incentive when they talk about power?

A Definitely. And I think this is the most interesting from a, from a game theory standpoint. So, um, just to back up for the, for the audience, that may not be entirely clear, right? The hyperscalers have really strong incumbent businesses. Um, you know, oftentimes depending on you're talking about cloud or digital advertising, and they think that the spend on AI allows them, you know, a better product opportunity in the future, such as they can accelerate growth. Um, of cloud or advertising offerings, um, or it'll enhance our product offerings, which, you know, leads to better returns over time. And so you have two options to go out and get more capacity, right? One, they build their own capacity, but then two, they also can go out and procure capacity on the external market. And that comes from Neo clouds or, uh, co-locators or things that we can get into. But if you think about it from their perspective, right? Building your own capacity is typically what they prefer because they have Control and vertical integration. Um, when they have the chance to, cause they, you know, they have these, they have teams internally, they have the expertise. Um, but when you go back to that core issue, right, is that I think everyone agrees that we need more energy. I think where the uncertainty comes in is how much energy do we need? And if you think about it from the perspective of them, if…

AI assessment note: “Do I want to be the long-term risk taker of the assets that I'm underwriting?”

Q on, on this podcast is the, the sort of EV, um, Market. We've talked about what's happened to the auto OEMs overall, and like all the guidance changing around how many EVs they're gonna introduce and sell and so on. But there was a raft of, um, new pure EV companies that, that became public in the past few years. So what, what has happened to all of those companies?

A Yeah, it's tough to kind of talk about it at a whole, but, you know, I think it depends on the company's ability to produce vehicles and their different volume expectations. But in general, right, I think the past few years, especially, um, 2020 to 21, you saw like a hundred percent growth. 21, 2021 to 22, you saw a 64% growth. And this is the global growth rate for electric vehicles defined as battery electric vehicles and plug in hybrid vehicles. And then you saw 33% growth in this last year, and if we look at market forecasts, whether you look at like BNAF, RoMotion, uh, S&P Global Mobility, you're looking at closer to 20% growth in the overall market. So what does that tell me at a high level? Is that you saw explosive growth in a really nascent market, and you're starting to get into the, the business of law, large numbers, where that growth rate will slow down. The biggest thing that's happened with a lot of the EV stocks or EV exposed stocks is the realization that growth is coming down from, you know, what I'll Describe, just for lack of a better term, is like that explosive growth in years past, and I think the big argument or disagreement was the debate around the, the, how quickly or how steep the penetration curve would be for EVs, where, you know, maybe 12 to 18 months ago, some folks had, you know, forecast that they were, had high conviction on that you could get…

AI assessment note: “The biggest thing that's happened with a lot of the EV stocks”