Gavin Baker - AI Market Jitters - [Invest Like the Best, EP.485]

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1:11 And welcome everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. If you enjoy these conversations and want to go deeper. Check out Colossus, our quarterly publication with in-depth profiles of the people shaping business and investing. You can find Colossus along with all of our podcasts at Colossus.com. Patrick O'Shaughnessy is the CEO of Pastum.

1:38 All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum may maintain positions in the securities discussed in this podcast. To learn more, Visit PSUM dot VC Mm. Gavin, it's only been two months. Like the model release cycles, the gap between our podcast episodes are shortening. We're we're basically uh you and I are basically on a model release cadence at this point. Well, I was I was sensitive to criticism that I think somebody pointed out that our podcasts were coincident with like

2:21 Local market peaks. And nobody could say that after this. What's on your mind? It's been a crazy Yeah, I would describe July as two thousand twenty two. In a month. Yeah. There are some fundamental negatives which which we should talk. But on the whole, the ballots of fundamentals

2:40 I think is Improving significantly. Loads of AI days are down. Fifty, sixty percent from their highs.

2:49 Well forty to sixty percent. In a month. And a straight line. And I asked you before we started. You've been out here for the summer.

2:58 Have you heard a single Negative. Quantitative metric about AI. A single instance of deceleration. Nothing. Nothing.

3:08 In fact, every metric Is accelerating. And to your point, not just blind optimism from people excited about AI. Like here's some data that they can show you and from their different vantage points. Absolutely. I mean, however you cut it, whether you cut GPU availability, whether you cut GPU rental pricing. I mean whether you cut like the spot price of D Rayum

3:30 This month. Token growth. Everything is Actually accelerated. And I do think a big part of the problem.

3:39 Is One. The market. Does that have visibility to anthropic open AI. And then I would say these open source inference clouds that monetize

3:49 Inference here in America, fireworks based to modal together. And the picture looks very different when you see that. Because open source has accelerated massively because GLM five point two, KBK three. And then Nevatrod continues to kind of chug along. We had a great Very small American open source model release.

4:09 Open AI has accelerated. And anthropic continues to grow. Really strongly. And it's almost certainly pumping out. Significant.

4:18 amounts of free cash flow. And I just think if you know there's this chart that everybody looks at. Of semi-conductor cash flow going like this. And hyper scale free cash flow going like that. And

4:31 You're missing these private companies. But I also think that that chart misses something very important. Which is just that you have everyone in twenty four and twenty five. Even if you were really bullish.

4:44 You thought that GPU prices, if you're really bullish, you thought they would Declines slowly. If you bearish, you thought it would decline precipitously. I don't think anyone in 24 or 25. thought that the prices of old GPUs

5:00 Would be going vertical. Everybody thought, hey, we're gonna be smart. Or to sign these long term contracts. And to some degree, like a lot of the Neal Clouds had to do that because they needed an off take agreement to finance the GPUs. And so essentially you have the contract base of installed compute.

5:19 trading at a massive discount. To the current spot market. And As those Contracts roll off.

5:29 Compute gets repriced higher. It spot can decline and compute. We'll still get repriced higher. I think you're gonna see a lot of acceleration that's gonna answer these ROI questions. You've started to see that this quarter if we look at operating cash flow, not free cash flow.

5:45 Operating cash flow. from Microsoft, Meta, and Amazon has reported accelerated from twenty eight to thirty two. There are some actually pretty big unusual items now, like these hyper scalers, they always seem to have billions of dollars of legal expenses that are unusual. Mostly fides to the EU.

6:02 But there was an unusual amount of one timers. This quarter, and if you judge from that, we went from twenty eight to thirty five. That's That's a material acceleration at the scale. And that's really before They start to light up the rupids.

6:16 Oh true. covered a meaningful premium before these contract's reprice. It's been a challenging butt. Is it helpful to kind of like walk through the month how we got here? Yeah. So first

6:28 That is gonna rent out compute. This is seen as like very bearish. They have excess capacity. They're gonna cut CapEx. This is a disaster. This is not at all what it was.

6:39 It's not. They didn't cut Capac. What it was is they saw. SpaceX have a big installed base of compute. Ed sell

6:49 Some big Trading optimized clusters. Into the market. At a truly massive premium to these contracted rates. Yeah.

6:58 At least the analysts like that. They saw an opportunity. There's a lot of speculation they're gonna raise capital, so Maybe what they're thinking is like hey, we will show on a small chunk of capacity. That we can

7:09 generate really strong IRRs. Then we're gonna raise equity capital and We'll be off to the races and probably raise capex. It doesn't look like that's what they're doing. But nonetheless, the market sold off because it interpreted this very negatively.

7:24 And I was really sure it wasn't negative. A lot of telemetry into Betis Capex planes. None of that telemetry had shifted at all. If anything they're continued to get more aggressive.

7:37 And then shortly after that they released their best model at a long time, use one point one, which is Actually. A very good model. I mean it's overshadowed by Crock Four point five. But it was a good bottle. Way better th than anything in two years.

7:50 No chance there. Taking their foot off the gas. Then Kimmy comes out. Huge freak out about open source.

7:58 And at the same time this silica data Token index. Kind of dips and flattens. And the two are connected, what the silica data token index captures. Is mix.

8:09 And they don't see all the tokens. But because of GLM five point two and the Keep although it took a while to layer it. There's kind of a Make shift to this data.

8:18 From more expensive frontier tokens. Mm. Probably have it in Fritz Margin. We can debate whether it's eighty, ninety, or ninety five. But super high.

8:28 Towards open source tokens. And for whatever reason the market Thought this was negative, but the reality is a token is a token. And you need the exact same amount of compute. To make a token, all else equal.

8:40 Takes the same amount of flops. The same about a memory. The same amount of watts. Tokens are not equal, but broadly speaking. All open source taking share does is

8:51 Take margin dollars. Out of The Frontier model layer. There is elasticity.

8:59 Thereby driving token demand. You need more demand for compute. And the margins. You know, atropic. And

9:07 Open source, they all run on the same underlying cloud providers. У Charge the same amount of compute. So you're literally just taking margin from frontier bottles. and essentially driving more margin dollars into the AI infrastructure layer. That was a catalyst.

9:23 Well, this combination of things. Well, yeah, Jitson is the world's largest supporter of open source. He is like a super idealistic guy. He's a patriotic American. I think he always does what's right. But

9:35 Does it really stand to reason? Yeah. Jitson. would be the world's biggest supporter of open source if it was bad for his business. You'd still support if it was the right thing for the world. Yeah.

9:47 And by the way, I think open source is really important to world where there's just one or two dominant frontier bottles that charge like Nine percent. It's not good for humans, it might not be good for society, and I think we want a lot of models, as we've discussed before. So then it's like, okay, the market digests that and comes strong with it. Then China has a DUV machine. You know, everybody's at these baskets has causes a huge sell off in CB cap equipment.

10:12 And then we get to what I think is In a lot of ways. The real concern, which is Real yields have gone up, which makes sense. You know, we're investing a lot. to fund this investment to for sure credit is

10:24 an increasing part of it, even if the majority is still funded out of operating cash flows. So real yields go up. And spreads wider, better priced. A bod last week and it did not price where you would think a meta bod. Price.

10:42 Nvidia C D S was was blowing out. All of these CD uh CDS for everybody is is blowing out. And you know, very smart. private capital people just like that, hey, this is just exactly What you'd expect, these are just bakes. But nonetheless, it doesn't look good. These are undeniable facts. CDS is up, spreads are widened, real yields are up.

11:02 That would be really, really scary. If we Needed. Debt. to fight it's this build out.

11:09 And that's where I think it's this differential between spot and contract. Pricing for the installed base of compute is so important. It's so important to understand what the financing will be like for the next six months or something. The degree to which This build out.

11:26 is going to require credit. Right. Which would be the classic capital cycle absolutely. Overextend ourselves with debt and that's where things get debt fueled build outs they demand immediate repayment. So if supply and demand get a little bit out of whack, things can unwack very, very quickly. That's what happened to the internet. If one believes'cause I do, rightly or wrongly, after this month, I'm super open. You know, I'm I'm looking like I've been pressure testing. All of these and like I really went deep on credit because hey, this is real, it's undeniable. And if we need credit to

12:01 F this build out, this is a significant negative. And If you bottle it out. If you look at the amount of gigawatts that are supposed to come out It could census estimates.

12:12 For hyperscalers. They're effectively bottled. These are gigawatts of Blackwell and Ruben. Ruben being NVIDIA's next chip, Blackwell being the current chip. They are essentially bottled. to monetize roughly at the rate of a appear. Which is two generations behind, not at Hopper.

12:30 But I appear. So there's one point three to one point four trillion in hyperscale operating cash flow. If you just assume I think it's very unlikely they monetize at the rate of A peer, we could go into why. Some of it comes from just seeing what is happening on the ground with demand here from real quantitative metrics. But like let's just say they monetize at a discount to Curt Blackwells. Then it's more like

12:53 Two trillion. Of operating cash flow. Takes seven hundred billion Of credit demand. Out.

13:01 Ironically. As that Improves all the credit ratios. as these installed bases of compute. Reprice

13:10 we're gonna continue accelerating because since this is modeling at a deceleration, which I think is unlikely. Then the credit metrics look better than all of a sudden It gets easier to finance with credit. Now Whether they choose to do that or not, we'll see. This is all a little bit

13:25 І think we spoke. Two months ago. No, but the tie before that about kind of the risks of a Blackwell air pocket. Hundreds of billions of dollars on black wells. They're mostly being used for trading initially. Trading does not generate a return.

13:42 This could be a risk. He actually really saw that in the first quarter. I think one reason to the podcast two months ago. I got comfortable with that risk was just that you were seeing such incredible things out of anthropic. And then it's like, Okay, well the market's kind of gonna

13:58 Look past this. And it did look past it in April, in May, in June. And then in July, because of this kind of confluence of things. Stopped looking past it. Just has the operating cash flow.

14:12 started to really accelerate and This is just a fact. It is accelerating. At big scale. You know, like Microsoft, they brought out a huge suck of capacity in the month of June that didn't even show up.

14:24 In the second quarter. So essentially what this All comes down to is do you believe That uh Quantitative demand signals

14:34 See all the ground here at Silicon Valley for private companies. Are going to continue. Such that The install base of compute. Reprice as higher as contract roll off.

14:45 Operating cash flows go up and you could fudge. Most of this out of operating cash flows, maybe all of it. Like if it reprices it. Current rates? You could probably FUD.

14:54 All of it for the next several years. It has been a very unusual episode in the market. We should talk about what the fundamentals are that are getting better that I'm talking about. Technicians would say it's actually in twenty two. Okay, the market is worried about a recession.

15:11 Rates going up. Inflation. That's what the market was worried about in twenty two. You knew exactly what it was. Okay, deep seek, you know what it's worried about. Liberation Day. You know what it's worried about.

15:21 There's something very clear. In a in a weird way, that's comforting. Sure. And here, you know, we talked about a lot of specific things. But it just feels all those specific things with the exception of credit. Are just kind of ridiculous. It so the fact that it is still going down.

15:39 A technician would say, Hey, that's That's a little scary. Definition the bullet you don't see. That gets you. You know, I think we've talked before about how like I think the three most important words in investing are margin of safety, but I don't know. But just

15:54 You've been out here for two months, I've been out here I literally spoke to a company this morning. Of several and this is what of The

16:04 Sexiest startups that people want to be in business with. And they had ridden a cluster of several thousand black wells. And we'll just call it somewhere the mid two dollars. for GPU hour. They're renting the exact same size cluster.

16:18 Essentially identical in every way, B two hundreds, no differences. And they're hoping Seven months later. To pay just under four dollars. Today.

16:29 Like that's pretty crazy because again you would expect a really Gentle decline in prices would be bullish. It's dead, we're up Depending on the starting point.

16:39 Fifty to sixty percent. It's six or seven months. There been so many anecdotes like that. Like I think one of the inference clouds. I think it was based shit, I'm not sure. They went on a podcast and they essentially said We are planning to pay one hundred percent more.

16:55 For Blackwells with our And that just means that essentially All the hyperscalers are are dered. My be

17:04 Kind of bishop out here? This week. Yeah. Yeah. Tell me something negative. Like you know, the question I asked you is there one negative quantitative metric you've heard? That's

17:17 Everyone. The main thing people are saying is the third party data suggests that the entropic curve started to go off of its trajectory a little bit. That's like the only thing that I think that may very well be true. But then you have open AI and open source. Massively accelerating if you look at the sub

17:36 It is debt accelerating. Like I think open source is a little bit of a Yeah, they talk about dark matter in the universe, like open source is kind of dark matter to the public markets. It's hard for public markets to measure it. But like if you just track what these inference clouds are saying

17:53 People saying things on podcasts or people saying things in meetings. They're not. Audited financials. Demand is clearly accelerating, which makes sense, because you have this huge capability leap with GLM five point two and KBK three. Which I think we're gonna see continue. I think you're gonna see Nvidia Brig

18:09 Debo trod. Steadily closer to the frontier. But yeah, it has been A Hubble. Challenging month. But just

18:18 It's also like wow, I've kind of pressure tested every assumption. The underlying fundamentals Are improving. Nvidia is actually As we record this.

18:28 At its lowest forward PE of the last two years. Crazy. The only time the CBs have been cheaper where Liberation Day Deep Seek and those were kind of V bottoms. And that means to you just that the market thinks

18:42 Significantly over earning. Yeah, the market A hundred percent thinks they're significantly overhearding. It Do we need to be humble? Love there.

18:51 Maybe they are. But like my kind of mission out here this week. Was to look. For negative data points. As hard as I could. Normally come to Silicon Valley.

19:03 And you know, there's a mixture of Here's something negative, here's something positive, da da da. On ballots it's positive, you know, tech. It creates value over time. But I haven't been able to find one that is like a quantitative metric. that anthropic third party data.

19:18 I would say that seems to be hotly contested by the by the anthropic shareholders who are who are chopping at the bit to tell you what they know. We're also very scared they're not gonna get an IPO allocation if it gets back to the company that they're the ones who said. Actually things are great. You know, you can just see anthropic shareholders. Like they want to be like, it's not true. It's hard for me to believe that open source and open AI have accelerated to the extent they did.

19:47 But yeah, Ethropic is clearly in the position. And oh, by the way, Rock Also, you can see from third party data. Like July was a pretty transformational month with

19:57 Groc four point five, grok builds coming out. So it has been a Tricky month and I have a friend. I'm afraid of fidelity.

20:07 Who just says the way to have navigated. The last Three years. It's just to the Dubbest?

20:14 most superficial thing as quickly as possible. And just cycle between them. What is that now? Yeah. Well that's just that has been to cut risk. All month in response to these There it is. That factually Except for credit.

20:30 We've done makes me think that credit just isn't gonna matter, has this reprice is Let's just say you do need Credit. To like build the flops we eat.

20:41 Well if credit's not there, it just means the flops that are there. are going to be even more valuable. Eventually. That will improve the metrics. And then it's like credit is there. So as long as we're in a compute shortage. Which I'm just like desperately trying to find a single side that were not in one.

20:59 And that it's not actually getting worse. Almost by the day. It's almost like the Problem becomes the solution. Yeah.

21:07 This company Black Forest Labs. I think that's her name, I hope I got it right.'Cause there is an interesting essay that got said to me. Yeah, I think we've talked about it. before about Mike Bovison's theory that breakdown of diversity is kind of what leads Bubbles and crashes.

21:21 And essentially everyone I know in the public equity investment business. Whether retail Or institutional. Every piece of news gets fed to Claude. And clawed clawed code. Sometimes

21:33 A quad agent. And it's probabilistic. There's probably not that much variation in the way it's interpreting. This views. It's it's almost like we're back to uh

21:46 It's stock market terms. There's never really been this way in the stock market before, but people talk about the fragmentation of media and how it used to be like Walter Crogkite. oldie voice of truth, and now we don't have that anymore. It's like Claude

21:59 It's kind of Walter Crock kite for the stock market, and everybody just believes whatever it says. It by the way, it's really smart. But it's not always right. It's interpretation isn't Always correct.

22:15 And with the stock market, you were fundamentally dealing about, you know, a probabilistic Bayesian interpretation of the future. It feels like In the market. Here's this piece of news. It gets fed through Claude. Claude interpreted this way.

22:29 A huge chunk of people. Trade on Cloud's view. And so you've seen stuff, there's this guy T B U, he's like uh part of the A Anotomus semi conductor. Mafia odd X. Yeah.

22:40 Actually very smart guy, I know but in real life. But he posted this amazing chart of Japanese capacitor stocks. And he said, We've had an entire capacitor cycle in six weeks. And it's true, you know, the stock's like Whether they double, triple, or quadruple, I don't know, but like Vertical.

22:55 And then whoosh. Like the actual Fundamentals haven't even hit. And yet you've already had what probably would have normally been a three year cycle.

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24:37 What's your sense of being out here especially makes me especially curious about this. The innovation that is going on here. to improve the efficiency and every aspect of serving inference of training models, et cetera. And how that will affect like public markets over time. Like have you learned anything interesting about

24:55 the long lead time innovation type stuff that has you especially excited or Or curious. Yeah, I am very curious. A lot of people seem to feel like they are very close. to solving continual learning and sample efficient learning, which we've talked about before.

25:12 And it is possible that if those are solved that Could that be like a Tipperary. Discontinuity. A demand if instead of

25:23 I was trade dot. effectively twenty billion tokens, and that it's like these models are traded on three hundred trillion tokens. And if you know you could Trade something got ten trillion tokens and then let it out into the world and learn sample efficiently. That doesn't sound good for trading demand, but like

25:40 Trading has a percentage of semiconductor demand to compute. Is gonna asymptote to something Not approaching zero, but very small. But I would say that is the most interesting and you know, who knows if it's long horizon or short horizon.

25:54 You know, SSI says that they're gonna come out with their model in August. There's this whole generation of new labs that are focused on this. And this would be good for the world. This would be a basic world, yeah. This would be awesome for the world. We all want we want this for the world. Yeah, we want this. It would be amazing for the world and it's just It's hard for me to believe that that would

26:13 actually be negative for AI infrastructure demand. But he had tried to be really, really open minded. I would say that was probably Like the biggest scientific or technical takeaway.

26:27 You know, it's also well yeah, and also like NVIDIA is heavily involved with All of these startups. If you were just forced to come up with the set of circumstances that would really switch you around and get you really scared. Would it just be

26:43 This operating cash flow thing doesn't play out and therefore we just need to definance this stuff. Does not continue to accelerate, that would be negative. And that to some degree is gonna be a function of how A dropic, open AI. Rock cursor.

26:58 An open source. If there was a pretty dramatic contraction in GPU. prices that was kind of sustained, the market would react to that instantly. That would be worrisome if it started to get to be really easy to get GPUs.

27:13 I mean Have you heard anyone say they have too many GPUs? No. Like not not a single person. In fact, it's the opposite. It sounds like a drug market or something. Yeah, it really does. It's just wild. But yeah, I mean I think there's a long list of pretty obvious things. If the sub of these labs

27:32 plateau's or starts to decline. That's really negative. Unless it's just because open source tokens are not growing the pie and taking share. And I do really think the future is Multi bottle.

27:46 Particularly for the AI dates. They're going to want to take an open source model. It's got all these inference clouds have gotten really good at Supervised fightuing and reinforcement learning. So you could take your data. Customized open source model.

28:01 And they'd get something that you could And the router routes it to often first your bottle and then Quad Frontier bottle, whatever, Claude Groc.

28:11 Checks it. And you can in a lot of cases get Slightly better outcomes. At half the cost? But again, that half the cost, I think a lot of people hear that. They're like, that's bad for AI demand. It's actually not at all.

28:27 Because the cost the user pays is just a function of the margin of the tokens. And you're literally just shifting. Tokens from really expensive tokens with like ninety percent gross margins. to tokens with maybe let's call it a thirty percent gross margin.

28:43 That's where the savings are coming from, but the tokens cost the same amount of compute. To produce. And then also all these things are kind of happening. A different cycle types. All these

28:55 Big public companies are like Oh my God, my AI spit is twenty X. I've burned my budget in three months. So they set up a router. And That actually Cuts their AI spin. But it doesn't really impact it, may actually increase.

29:09 The amount of tokens. that they are generating just by shifting them to these cheaper open source tokens. That's just more compute. So a company getting smarter about which model to use for which task. That may lead to a stabilization of their spent or even a decline.

29:25 But it actually has nothing to do with the amount of GPU compute hours. They are effectively consuming. Behide These model layers of this router.

29:36 The GPU computer hours. Probably you're going up. As you shift to these cheaper tokens you can use more of. That's happening to like

29:44 A cutting edge of public companies. And then you have this whole wave of AI datives. They're leading into this so hard and they're not hiring Humans. They're just putting it mostly into tokens.

29:58 They're not slowing down. And then you have companies on the east coast of America. Who have like barely adopted AI companies Broadly speaking, you know, not at the coast to Maybe our

30:09 Just tried to figure out how to regulate AI, you know. Yeah, so just like there's kind of these differential Waves of adoption all happen at the same time. But the thought I can't get out of my mind is like I think I said it maybe last time, but just y'all sessed it out like Five hundred thousand people in the world, two hundred and fifty thousand

30:31 Maybe you're using a gentic AI. Yeah. We're at a cute compute shortage. There's seven or eight billion people on the planet. What happens when we go from five hundred thousand to one percent to a hundred million.

30:44 You know, to five hundred million. It is interesting. You know, a lot of people I do think it's like helpful to post on X to see the pushback. We accept your

30:55 Argument. That hyperscalers are are dirty. It is Compute reprices. their operating cash flows could accelerate and maybe we could flood this, but like Where's that operating cash flow gonna come from? Where is the customer?

31:07 It kind of definitionally it has to either come from Faster economic growth through productivity. Got Satchia's cabinets like Either we're gonna start growing 10% or we're not. Or labor substitution.

31:20 And For sure, I think at a lot of these AI datos. You're seeing labor substitution, but not because they're firing people, they're just not hiring nearly as many humans. The gross profit dollars per FTE and

31:34 A sixty Z, Iconic, a bunch of companies that have done this work. They're vertical. particularly relative to Past generations of startups. And then it is interesting.

31:44 Are you Doing any surveys of Your companies are their token spid relative to labor spid? Oh yeah. I mean it's Tokens as a percent of Total comp spend or something like that. What what are the ranges you've seen? I mean, like in the really pilled companies, like it gets really high. Twenty percent, twenty five percent.

32:00 our Fred Dillard Patel at Hills at his at his company. So he's an ASI maxi, but he's at thirty percent. That's probably the highest one I've heard. I've actually heard of fifty. And there's twenty five trillion dollars in knowledge work. Let's take your twenty percent number. That's five trillion.

32:16 And not either. Cubs. out of labor substitution or faster economic growth. And we really, really, really want his He would say to come from faster economic growth.

32:28 One interesting thing I heard this morning from one of the great leading technology CEOs has founded several companies. If you look at the founder led and controlled companies and adjust for some of the like Covid era over hiring. Nobody's really laying people off. These are the people that would probably be most quick to adopt

32:45 AI to become more efficient or whatever, like they're not really doing Jack aside like huge scale layoffs. Which probably tells you something about where they think there will be lots of opportunity to still have people plus A hundred percent. Well the bull case You've seen church from cognition rape at stripe.

33:01 That the companies that are spending the most on AI are growing meaningfully faster. Yeah, I love that cognition index. Yeah, the cognition index is wild. All the skeptics will point out rightfully, it's not really controlling for industry, but then if like you dig down into it. I think one of them gave an example of I forget if it was a plumber or an HVAC contractor. But like Everybody who's a blue collar worker's do it great'cause of AI.

33:22 By the way, something that I think we should touch on and we could do it now or later. Is just Everybody is citing these LTAs. So everything is at a shortage. If there's weakness, it's just because we can't energize the gigawatts fast enough. The gigawatt are gonna get energized, like

33:37 regulatory policies moving in a good way. The turbine manufacturers, the diesel jib manufacturers. You know, you're ripping Turbines off old airplanes and you know, reconditioning them and then repurposing them. There's crazy things happening. Capitalism's very, very good at this. But I do think one of the most important questions of the market

33:56 And like a Transition of the market that I got wrong. Is We are shifting.

34:03 particularly for memory more than anything else. From Crushing. Numbers. In the short term.

34:11 To they are trading short term upside for these Whether they call supply chain agreements, long term agreements, LTAs. There's many flavors, but customer prepays. There's a floor at a ceiling. This comes back to the

34:23 Point about labor because you know, a lot of people after Fire. During COVID, we're really reluctant to lay people off. They talked about labor hoarding, if you remember a few years ago. You remember this? Yes. Let's just think about the game theory of breaking an LTA.

34:40 So For companies that matter at scale. There's a episode with their tradiums. Google with their TPUs. There's A of D.

34:48 And then there's NVIDIA, who's like much bigger than everybody else combined. Let's just say it's two thousand and twenty seven. And It's very important to realize memory is The more bibbery you put.

35:01 With flop. For a given unit of compute. the more tokens you get out. It's the single Most important thing you could do.

35:09 to increase token output per unit of compute. And then that obviously definitely. Actually lowers costs. Which is why the demand hasn't responded at all negatively. There's been no elasticity.

35:21 Just because it's the axis that is dominating all others. And this is At some level like a giant game of thrones or Ippers. Between these companies. Okay, it's two thousand and twenty seven.

35:33 Or twenty eight, you're vaguely tempted to break one of these LTAs. It Try to get a lower price. But to a large degree market shares I think for the next several years

35:44 are going to be determined by supply chain allocations. And kind of what you have Pre purchased. So if you break the LTA. This is assuming we're not in a severe oversupply situation.

35:56 The game theory even holds in a severe oversupply situation. If you break your LTA. It did it the next. Two or three years. For any reason. Leverage shifts back to the Bibri guys.

36:09 You're out of business. It's over. Let's just say Google. Breaks at LTA. There's an oversupply I'd make you the stop, but

36:16 Twenty eight, twenty nine. They break their LTAs. Well, if they're breaking their LTAs, it probably means, you know, your oversupply prices are coming down. It did, you know, capacity naturally contract. Well, what do you think's gonna happen to Google's allocations and then you know, this is a cyclical industry and oversupply is followed by undersupply. What do you think they think is gonna happen to their allocations next time?

36:38 So I just think given Th this is the Axis around which kind of everything is revolving. You might blow up your entire бізнес. In your franchise.

36:49 By breaking an LTA. And that was never the case before. Apple Who cares? They don't have a competitor. They're overwhelmingly the largest purchaser.

36:58 This is, you know, going back three, four, five years. They know they can do whatever they want with no consequences because their volume is so big. that even if they like super screw hidex, Bicrod will of course take them. This is just different, you know. You have at least four players. Did you have all the startups you're investor etched? If you break an LTA

37:18 They just say okay. Fine. Great. You broke the price agreement? We're gonna break the volume agreement. And screw you, we're gonna give the volume to your competitor.

37:28 You just lost share, you know? NVIDIA's David's the current environment, the extent to which it favors NVIDIA. It is a little hard for me to understand why trading at such a low multiple. In other words, if you need to be able to finance the chips and you do.

37:42 Nothing's more financeable than an NVIDIA GPU. Nothing. If you need to get land in power. Well, they're doing a very good job of playing that chess game and matchmaking. And then they've rolled out this really clever

37:56 New business model, which I would describe as kind of like a credit wrapper. With A revenue share If GPU prices are above it. Yeah, yeah. Yeah. This could lead to them having a really giant cloud business effectively through royalties.

38:11 Really quickly. And it is another way of kind of alleviating this. Cash flow mismatch. Like, hey, we're making all the cash. This isn't really vinter financing, because they're not loading the the body. Somebody else's

38:25 Loading. The GPU buyer of the body. They're still making equity investments, but it's not like you're just putting money into someone. Did some of that money. was used to buy your chips, even though Nvidia said that they write into Alter.

38:38 Equity investments that The buddy can't be used to buy NVIDIA chips, but obviously Buddy is fungible. And uh funny thing makes no sense. Yeah. But you know, I think at some level it probably makes everybody feel better. What would you do if you were the member like if you were the CEO of Heinz? I do the exact same thing in videos, doing you. Right now.

38:56 Which is I would be going to the buyers of GPUs, tradeums, and whoever. It's saying. I'll participate. The NVIDIA credit wrapper.

39:06 Now their business is just inherently less stable and predictable. But in sub way And maybe they just put up some cash up front, so it's like they're not on the hook. I'm just making this up. But like

39:19 Do something like you can because you have money now. And credit markets are revolting. I'm sure Blackstow did.

39:28 Apollo Um Suggesting some variant of this to the memory companies but hey, we will Put up some amount of money. From our cash flow today.

39:38 It it's God, it's surety. That makes the the person who's extending the debt feel better. But we want Some sort of a cut. of the ongoing revenues as well.

39:49 That is one hundred percent what I would do. And it's almost like a logical extinction of The LTAs where they're trading upside for durability. Here you can effectively get a royalty on recurring revenue. So that is what NVIDIA is doing. And I do think that is very misunderstood.

40:08 And I think it would serve well to really Explain this. One. They're really bullish on AI. Essentially every time they haven't taken an equity stake in something, it's a bit of a stake.

40:20 They've taken equity stake. In everything essentially. Except the memory companies that for a long while Athropic, that they took an equity state get Athropic. But like why not if you have cash flow and you're bullshot AI at Jidsen because he sees every lab. He knows all the advances, you know, like all these continual learning labs, you know, safe superintelligence is now working with them.

40:41 He sees everything and like what he sees makes him bullish. So what have some equity upside? And then two have a revenue share. And you're generating hundreds of billions of dollars. Of free cash flow.

40:53 And helping To kind of bridge What is Clearly kind of a gap, at least given everybody's got free cash flow negative. Until the operating cash flow accelerates enough that you can internally fund this.

41:05 Very opportunistic in a good way. And it significantly increases their revenue per gigawatt. And then it also strengthens their competitive position. You and I, we both have startups, but okay. That's great.

41:18 Use that startup's chip. What prices are they play Pega Tawatsu? higher the Nvidia to all these guys. What prices are they paying for HP of D R higher. Can you finance those chips easily at the same rate as NVIDIA?

41:30 No? It's so it's always like there's a real burden. Particularly. If you use HB of D Rail, you're the crosshairs of this. Unless like actually.

41:40 They made really different Architectural choices. Architectural choices. Everything that's happening is actually pretty good for him. By the way, going back to Gabe Theory.

41:53 Anthropic. If they had been as aggressive on compute as open AI had been, they would have run away with it. Now open AI is back in the game. I think Grock is at the game. Those are the companies on the Pareto frontier. And they have the computer. Do you think

42:06 After watching that. Anyone is going to let off the gas? Right. It was I think four months ago that Dario was talking about how It was a really thoughtful commentary, but it's like it's really, really hard.

42:20 Because if you buy too much compute You could go bankrupt at the scale of these things. But if you don't buy it off, you could lose. Well, Oh, but I just got back into the game and now

42:30 SpaceX is in the game in a big way with Crock Four Five and Cursor. After watching that. From a game theory perspective, is anybody going to back off any time soon? Especially if it can be funded out of operating cash flow. Have you met anyone in your travels out here that you would say is like way more bullish than you? And if so, what do they believe that you don't?

42:51 I mean, essentially everyone out here is more bullish than me, man. You know, I read this thing that Dwarke wrote and I was like the three X compute price thing or whatever. Yeah, well he is I forget what it was. No, it was like fifteen X or something. Yeah, but no, but just basically that renting at H one hundred for a year would cost two hundred fifty thousand dollars. And that's fifteen X the current spot or something. Exactly. Like wow. You know that was just like that wasn't in my book. That wasn't in my Forget my like Bayesian probability space of expected outcomes. That wasn't even in my considered, but dismissed his totally unlikely outcomes.

43:29 He's very smart guy, he's very plugged in. Then he pointed out that. Margins on compute are going up. The amount of compute is going up. And Inference margins going up. And if you multiply those three, that's how you're getting this crazy acceleration.

43:42 In the sub of the labs plus Open source or though the margins on open source are not. Really going up. I look at what's happening in the stock market and I feel like a Foolish optimist.

43:53 And then when I talk to people Whether it's people at the labs Anyone in this ecosystem I'm like Bearish relative to essentially everyone.

44:05 Just a strange state of affairs. What do you make of the D U V news out of China where I've seen reactions really along a spectrum of like this is the equivalent of like what ASML had in two thousand and one or something. Or like no, this is actually the first bit of news in a New story for how we should think about the global supply of

44:24 Cutting edge compute. I think both could be true. Make an analogy. Like let's just say A D U V machine was a jet turbine, and now an EUV machine is like a warp drive. D V machides like a propeller plate.

44:38 A UV is like a jet turbide. They didn't have it before. And Now they allegedly do. And that is like a phase transition.

44:47 You've gone from like liquid to solid. No, that's solid. That J Prop played, whatever. It's twenty five years behind.

44:56 But still it's important and I don't think should be dismissed, but I also Yeah, it's kinda funny. You just see this in the stock market. The stock market massively overreacts. And then if this ever hits ASML's orders. Maybe it hits it in five years and like the market has forgotten about it, got worried about it, forgotten about it, gotten worried about it.

45:16 Forgotten about it multiple times along the way. So I do think that was probably an overreaction. But we should Dismiss that either. And if you're China, like this is really important.

45:28 To you. You know, there are some reports that like an EV machine had been smuggled into China. I mean, what a feat of espionage, because those things are like shy. Yeah, they're huge. Well, I don't know if that's true. You know, there's some noise about it, but you know, China, they're really, really good. They're really, really smart. They work brutally hard. And they see this as super important for them as a country.

45:52 But are they gonna go from the year two thousand and one? to two thousand and twenty six or even two thousand and Thirty? It's alerting by doing. And

46:03 You can't accelerate the doing. You can't teleport into the future. You actually have to go through those learning cycles. Is it significant? Yes. Did the market overreact? Probably. It's very hard as an American. to really understand what is happening in China and like have

46:20 Total conviction and clarity, you know, like for better or worse, we are decoupling. That is a process that has been set in motion. And At this point it almost feels like it's self reinforcing on each side. That's unfortunate.

46:36 We are where we are. They're not gonna stop, neither are we. Any commentary on like every other company in America? Like I feel like right now it is ten companies, couple private not last month. Everything but AI was vertical. And I do think Open source getting closer to the frontier.

46:54 And companies like Fireworks making it really easy to customize a bottle. Such that you could get in some cases better than frontier performance for uh meaningfully lower cost. That is a godsint for the software industry. And it's also a godsend for all these AI datives, you know, it's like our Fred Visher, I think he said two years ago.

47:14 I've never seen more companies go from being founded. to like fifty billion dollars a year in revenue. generating cash flow with like whatever it is, nine months. And it's hard to know if any of them were durable. Because

47:26 A lot of people would dismiss them as chat GPT rappers. Well now it's open source. You've generated some data. That's unique to your use case, whatever your vertical you're going after as a wrapper is. Fireworks did come out with a really cool product called Dexus.

47:42 And if you're using cloud code. Open AI codec, Crock Build. It is literally three lines of code, like twenty words. And fireworks adjusts your Data.

47:54 They can R L a model and then there's a router. That Sids the query And they've had Amazing results. I this is kind of the solution.

48:04 for every AI data, that's why you saw Harvey Before it was acquired. Cursor. lead so heavily into this Harvey, Lagora, all of them.

48:15 Because if you could go from just using one, two or three frontier bottles. To use a Those frontier bottles.

48:24 For whatever it is, thirty to sixty percent. of your token consumption and then use your owed RL bottle, all of a sudden you're not a rapper. You're way more defensible. I was so interested by that cursor thing that came out. I think it was cursor. Where it's sort of like AI is speed running like what we've learned amongst humans, which is you could use the frontier model to plan and then far out tasks to the dumber models.

48:46 And it's fifteen times more efficient, or whatever the metric was. And it may be this is like super ironic. Lower margin open source tokens that are just A little bit behind the frontier. We have Frids who believe that What's a frontier model hits RSI.

49:04 It will actually have a dramatically lower cost. To serve at every level of intelligence by kind of distilling this. And then there's no place for open source. I would say that's like a Atropic. Open a eye.

49:18 Rock. Maximalist view. Shouldn't just miss anything. Anything is possible. We wanna be very humble. I particularly wanna be humble after the month I've had.

49:29 But that doesn't seem that likely to Big. One, because there are so many of these AI datives. They have

49:38 Actually. generated a decent amount of domain specific proprietary data. And before Open source had this moment to these inference clouds and these routers. really developed, you kind of didn't have a choice. Like whatever the terms of service were, you accepted them.

49:56 But if you can now get off that treadbill. That gives you a degree of independent Maybe durability Safety But going back to your point.

50:06 It may bi that these cheper tokens. Massively inflate the value of the most cutting edge frontier tokens. Because if today if you have uh you're able to make this up. One twenty IQ open source models. They're really cheap to rod.

50:22 Doesn't that make a one sixty IQ model that could orchestrate them? More valuable? We talked last time about how I've been really surprised that So much of the economic returns have accrued to the frontier.

50:35 That is changing with what we're seeing with these Infruits clouds. Together modal. Based channel. They're all working. In a very cash efficient way. What's shocking about those business models

50:47 Is there growing almost as fast as the Frontier Labs in the early days? But burning very little cash. Right. It's pretty extraordinary. silly Sas metrics like the you know the rule of forty perspective like

51:02 These are crazy dumpers. Do you think there's a lot of instruction in just like the distribution of pay inside of an organization? Like the CEO makes X times more than the median person at a company and maybe that's frontier tokens versus, you know, open source tokens. Yeah. Something simple like Yeah, it may be that what we discussed last time where you know frontier tokens Like the pie's growing really, really fast. They may continue to capture

51:25 The overwhelming majority of economic value, but not. All of it the way they have been. And open source tokens might be the majority of tokens processed. Again, going back. That's great for infrastructure demand.

51:36 Because a token is a token and it takes the same amount of flops, watts. Space. Coolig. To bake. What's the worst thing that could happen

51:46 N AI is a regulatory I think regulatory has to be the biggest risk. The most obvious risk. And so that was kind of one reason I was excited to be here this week. I wanna be scared, you know? I like I don't want to feel like a lunatic.

52:01 Вачи вій стакс Yeah. Cheaper. thinking the expected foreign returns are going up. While it feels like the odd the crowd fundamentals have pretty materially improved.

52:12 In July relative to Eva Jude. But I still come away thinking like regulation, it just has to be the biggest risk like you just can't ignore New York. Making a data center moratorium.

52:26 We're living in this weird Пост фактул, пост логікал, політикал вород. It I mean I think the AI industry it has done a Terrible job. Of P R

52:37 And I do think it at least realizes that now. Maybe if not fixed it, it realizes it. The political narrative. I think amongst a lot of ordinary Americans is like data centers. They're gonna raise your electricity prices. They're gonna take all your water. And then they're gonna take your job.

52:53 The reality is given the deals that are being cut now. When a data center goes in, electricity prices Actually generally go down for everyone around there. 'Bide the meter deals.

53:03 This is that like data center pledge that Trump asked people Decide. generally the data center developer used to be they just had to to get the police department or the fire departments like New trucks and new cars and New body armor or whatever.

53:17 Yeah, it's like We're gonna build you a hospital, a school, a new police station, and a fire station, and we're gonna lower your power bills. How does that sound? And by the way. The jobs are ongoing because it turns out that you kind of need these plumbers, electricians H VAT contractors.

53:34 Data centers are in a lot of ways the best thing to happen. For blu collar wages. In my lifetime. And yet you have the Democrats who ostensibly Represent the blue collar workers.

53:46 Taking those jobs away. It's just kind of wild how What is the phrase like a lie could go around the world Faster than truth gets out of bed. Yeah. Yeah, faster than truth gets out of bed. But an author made a mistake in a book. It overestimated the amount of water usage in data centers by ten thousand decks.

54:04 Not a little bit. Like not one order of magnitude. Not two orders of magnitude. Not three. She's admitted that mistake. Many times. I was completely wrong. It's like been super debugging.

54:17 Did you ever hear that example? No. You know, Papa Spinach. The reason was same deal in an academic book, they place the decimal two things wrong. So spinach does not have more iron than everything else. It was just this one source, and then that propagated. I literally had I thought it had more iron. I mean that's eight years ago. That's wild. I literally thought spinach had more iron. That's amazing. Yeah, you learn something new every day. Same thing, though. Yeah, it's the same thing. And it's just So somebody just needs to tell the truth.

54:47 I feel like the industry Geez, maybe if nobody else is gonna do it, like I'll do it. There needs to be some sort of foundation. Maybe it's a pack. that runs ads during the final four, during an FL games, during college football games. Here's the virtues. World series.

55:02 Here's what a data center does your power a data center that signed this pledge in your community. Your power prices are gonna go down. they're almost certainly going to contribute to the community in a material way. You're gonna see a massive influx of super high plague. Blue collar jobs.

55:19 that are going to persist. And I think a lot of people thought that they were one time and they're just not. Like There's for sure a spike. Then that moves to the next data center, but there is an ongoing need for RMA and then upgrades at these data centers and technology is changing. So you're gonna have more jobs, you're gonna have cheaper power.

55:36 You're gonna have a wealthier community. There's gonna be no impact on water. No impact. Uh the environment. But it's easy to build the data center ten miles out of town, you know?

55:47 That story needs to be told along with We heard a story, I think we talked about it last time. But how AI is increasingly really saving lives, curing rare diseases. I think it was at Askow this year. The vibe was like

55:59 This is the most scientific breakthroughs we've ever seed. at a single conference. And for sure some of that is due to AI. It's so we need to tell those stories, like you know, if you have a sick child. Sick parent.

56:13 A sick loved one, like AI meeting fly increases the odds. Of them recovering. Everybody needs to tell this, and I think people out here All of this is so blindingly obvious to them.

56:29 They hit process. That this is a true But wildly divergent view. for most Americans. The industry really needs to tell its story better.

56:40 New York, it just feels like is the first to Middle, and it even in some of these deep red states, they're super pro growth. They're just like hey, you guys are not Doing a good job telling your story. We can't tell your story. If you tell your story though, we could retell it, but like

56:56 You're the experts. If you do not speak your own truth, no one else will. What have we missed? I do think something that is missing from all of this conversation about compute. Is what is going to happen when you put these S ray based accelerators

57:12 There are not constrained by HBD Rab that are often made on older nodes that are not competing with like the latest and greatest GPUs. When you disaggregate fruits, people talk about prefill a decode. But decode is two parts a tige and feed forward network and like the ultimate holy grail. Is if you could do prefill

57:32 On one chip. It probably doesn't have HBrab. Do the attention. on a super high powered Chip with HB of D Rab.

57:41 And they do the feed forward network. on one of these S ram chips. But like The ROI on adding these S rab accelerators.

57:51 to the existing installed base of compute and new compute. But like what we're seeing is You do better. You just can't beat. Sray in particular for that feed forward network. It No matter how much you try to get the ratio of compute to HB of D Ray of

58:07 To S Ray on the chip, correct? The workloads are always changing and there's different workloads. being able to disaggregate it to these three parts. This is gonna be really, really positive for the ROI at AI. For some reason I just thought of a funny question, which I love their framing of Game of Thrones versus all these people.

58:25 Can you imagine a player that is not currently on everyone's mind becoming relevant at like the major Game of Thrones scale? Like that could be like Micron all of a sudden. Someone that becomes As important as Anthropic OpenAI, Microsoft, Amazon. So like a dark horse. Like Li Bu is probably a dark horse. Lid at fireworks.

58:44 She is a Absolute. Killer. I think Arfred Scott Woe.

58:51 Cognition is kind of that one. Yes. I think those Are The most obvious names. What about SpaceX? What's it been like watching that?

59:02 be digested by public markets, at least initially. Do you think the market understands it as a company, the most important new company to be public? It doesn't really feel like it Does. The fundamentals have gotten better since at IPO, like Rock four point five, the cursor acquisition.

59:19 Cursor. has clearly accelerated Beating Flea. They've shown over the last three years they could bring on more compute faster than anyone. at lower prices and now we know that they could even adjusting for the spot first contract gap.

59:32 Their big advantage was They came into the market. Hit those spot highs. And in a strange way, like one of the more bullish things for compute. Is they put a vast amount of compute into the market overnight.

59:45 It wasn't even really a blip. It was like the market just Utterly absorbed it. The free trade did it. So doubt at all.

59:54 A substack writer, well FUDA AI. They think that SpaceX is gonna try and bring out eight gigawatts of compute. over the next eighteen months. So Eight gigawatts over the next eighteen bucks. I will never bet against Elon.

1:00:09 But I mean That would be a truly incredible feat. Rates have gone up since they signed those last contracts. Not down. And they're monetizing At something like fifty billion a gig.

1:00:21 And consensus estimates for next year are seventy three billion. So forget Star League V three, forget Star League to sell. Grock four point five cursor. I think that The sum of that probably hits a ten billion dollar ARR pretty quickly.

1:00:36 Forget all of that. You know, forget the core base. Starlink business. If they bring out anywhere near that. The consensus estimate is seventy three billion.

1:00:46 That's eight gigs at fifty billion to gig, and obviously that would not all be lit up. At the beginning of twenty seven. And it seems very implausible to be Like I was

1:00:56 Don't believe the funder report. But To this day, the only companies that have brought out more than five hundred mega watts Of power. It a year.

1:01:06 Are the hyper scalers? Core weave, Crusoe, it's Base X. SpaceX has kind of brought out the most the fastest at the lowest cost. It they People do actually really like their clusters.

1:01:18 But again, it's kind of like the market is gonna need to See that. That would not be the market's interpretation of SpaceX today. No, no. And it does feel like, you know, there's this big New York hedge fund shortcase audit. And I think they think The spot price for computes gonna go down ninety percent. It you're gonna bring on all this

1:01:36 compute, it's not gonna generate, you know, nearly as much revenue as you think. Maybe, but also want to be really clear, like I've seen Elon's companies. Do really impressive things. The funder AI report of eight gigawatts and eighteen months.

1:01:49 I mean I'm just quoting that'cause it's public. It's available to everyone. I think one of Elod's phrases is we specialize in making the impossible late. I never heard that. That's great. Yeah. Uh but you know, there's Like kind of a lot of truth to that. Yeah. But I just think Very little is built in

1:02:09 from my perspective to that stock. For the amount of compute. Yeah. they might be able to bring on. And again, I don't think it's anywhere near eight.

1:02:18 And it's gonna be really hard and energizing these GPUs is really hard. But they've been good at it. It it doesn't feel like that's in estimates or really in people's thinking. I'm thinking about that funny meme that says SpaceX, the data center company. Absolutely. I did spend a lot of time at star base and Orbital compute feels more real every Day.

1:02:42 Pretty cool to see that starship landing the other day. And then it's you know, it is funny. Our friends at Bitchmark, they funded Star Cloud and I don't know, last time StarCloud is an orbital compute company that like SpaceX is kind of partnering with. They're gonna I think let them use the Starlink laser technology, which is really important for orbital compute. But I do think that's like kind of a good sanity check. Last time I checked. The benchmark guys were pretty smart and they're not

1:03:08 Coming from the Elon ecosystem. At all. They chose to fund an orbital compute company. A decent valuation without the internal launch costs that SpaceX gets.

1:03:21 To me that's a good like, hey, am I crazy? Am I crazy? And it's like, Well Maybe I'm crazy and Maybe Elad's crazy. And maybe bitch mark is Also crazy. And maybe the SpaceX engineers are

1:03:35 Also crazy. That man, that just doesn't seem that probable to me. Should we say whose offices we're in? Yeah, we're sitting in the middle of the city. We're sitting in the bitch bark office. Yes, this is their famous table for their famous dinners. So thank you, bitch mark. Thank you, bitch mark, for this episode. Yes. Thanks, Eric. Um think of all. Eric coordinated for me, so he gets a special shout out. Thank you, Eric. Thank you all the partners. Thank you, Eric. But I mean We will see where all of these stocks are.

1:04:01 In a year. The great thing is Table tell. People are gonna be right or wrong. The future's probabilistic, but it's an exciting moment.

1:04:10 Well, if we keep doing this on the model release cycle, I'll see you in a couple of weeks. Yeah, it's crazy. That's always a blast to do with you. If you enjoyed this episode, visit Colossus.com. You'll find every episode of this podcast complete with hand edited transcripts. You can also subscribe to Colossus, our quarterly print, digital, and private audio publication featuring in-depth profiles of the founders, investors, and companies that we admire most. Learn at Colossus.com/slash subscribe. You know how small advantages compound over time? That's true in investing and just as true in how you run your company. Your spending system is your capital allocation strategy.

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