The Market is a game of information warfare. Companies, the media and the government lie about economic reality, daily.
Fraud is defined as the intentional perversion of truth to deceive or cheat someone of something of value or a legal right. It can also refer to a person who is not what they claim to be or a thing that is not what it seems to be.
The law makes all kinds of distinctions about fraud. You have credit card fraud and mortgage fraud and securities fraud and wire fraud, accounting fraud, tax fraud, and so on. But at the end of the day it is all just lying to people to get money.
We could argue about the morality of it or how to prevent/encourage it and a range of other aspects, but what I want to focus on here is that all of the above flavors of fraud are illegal in the United States. People go to jail for years after being prosecuted. So like, culturally we have decided that doing fraud is bad. And yet...
Imagine you have corporate boxes A and B.
Box A is an S&P500 company with $1 million in revenue and $500k in net earnings (obviously no company in particular). Box A also has $10m in "assets" on its balance sheet (stocks and bonds of other companies and governments) that can be used to borrow cash at 75bp above the risk free rate.
Box B is a "business" with no customers and no money.
The board of directors for box A decide to use borrowed cash against their securities portfolio to purchase $5 million worth of shares of Box B at a valuation of $1 billion, because that's just how it's done.
However, the real deal is that Box B will purchase "non-tangible products" from Box A exactly equal to the $5 million investment, turning Box A's $5 million SOFR+75bp borrow into an additional $1 million in revenue per year for 5 years.
Box B does NOTHING. It will return nothing to its shareholders because it never sells anything to anyone. It is a pure accounting fiction that is used to tell a story about how Box A is "growing" quickly with rapidly expanding earnings per share. EPS is growing rapidly because the product that Box A is selling to Box B has a near zero marginal cost. They bought "coding services" or "advertising" or "data center compute" or ... better still "subscription memberships" that are used to inflate subscriber numbers.
Box B is usually PRIVATE. They have minimal disclosure requirements and Generally Accepted Accounting Principle (GAAP) allows Box A to add the $5m investment in Box B to the "assets" pool for future borrowing (at SOFR+75bp). So like, you never really notice that the money isn't there anymore by looking exclusively at the financial documents.
In effect the above is a carousel, spinning money in circles to give the illusion of revenue and profit that doesn't actually exist. The whole game is to tell a story about the stock. To have a convincing story to tell the sucker on the other end of the phone, or whatever, to part with their money. Compare the above fraud with the recent announcement by Nvidia that it will invest $100 billion in OpenAI (a private company), so that OpenAI can purchase "data center compute" over the next several quarters. And note that Nvidia's margin on that compute product is ~80%.
With one breath Jensen Huang is telling investors that there is more demand for his product then he can meet, and with the next he is investing $100 billion into a company so that it can afford to buy his product? How much demand is there for his product in the real world?
Looking at Nvidia's accounting there appears to be far less demand for their products than is commonly assumed.
As of the most recent quarterly financial report to the SEC, Nvidia had total assets of roughly $140 billion. Total Liabilities were about $40 billion, leaving total book value of $100 billion, which they just committed to spend on private OpenAI stock.
And yet, somehow, Nvidia closed at $183.61 yesterday, up 3.93% from the day before. That closing price represents a market value for Nvidia's stock of >$4 trillion.Something doesn't make sense right?
Here is the interesting bit: A few weeks prior to this Nvidia/OpenAI investment, OpenAI announced it would purchase $300 billion of data center compute from Oracle. And where does Oracle get its compute? Nvidia.
In the span of 15ish days Nvidia bought $100 billion of stock in OpenAI, OpenAI bought $100 billion of hosting from Oracle, and Oracle bought $100 billion in processors from Nvidia. It is the same money being passed from one insider to the next for the purpose of maintaining the illusion of the "Magnificent" tech companies explosive growth and "American Exceptionalism." But in the real world it's all basically just fraud. I buy your stock, you buy my product, I brag about my revenue, you brag about your valuation, and our executives sell stock to the stupid public at obscene valuations.
Tangible Profits don't matter because nobody ever pays a meaningful dividend. The insiders are paid in stock. The whole purpose of the treasury is to lift the share price. And I suppose that's all fine and good... everybody loves a guaranteed winner. Unfortunately, things that are too good to be true usually are.
To be clear, I do not believe any of these companies are complete frauds. Nvidia, for example, is a seemingly well run company that produces some fantastic technology. People ARE buying their stuff, and Nvidia probably earns a profit on it when they do. The dispute here is the credibility of the numbers in their totality.
It should also be noted that the above named parties are not the only participants running this scheme. Over the weekend Meta announced a $20 billion investment deal with Oracle for data center compute. Nvidia has several deals with Meta. In recent memory Google made investments in OpenAI, which OpenAI is no-doubt spending on ads. And then there is the Tesla/Space X/Twitter revenue/investment circle, and the Apple/google circles involving maps, search, and ads. On and on it goes. The sad truth is that these practices are a systemic feature of the modern Silicon Valley financial ecosystem.
It is all very strange how and why a handful of very high profile companies are able to get away with this. The biggest problem seems to be that nobody is complaining about it. The modern SEC is toothless, but these transactions have been going on for years with no enforcement action taken. Investors don't seem to care because the stock keeps going up and more than half of stock purchases are by passive indexers buying whatever stock shows up on the list.
It all seems so brilliant to so many, and yet... math. Ten companies, all of them heavily invested in AI and data center trading, all originally financed by the same handful of venture capital investors, all reporting multi-billion dollar deals almost exclusively with each other, account for >30% of S&P market value. Sometime soon there isn't going to be enough economic activity in the general economy to rationalize the validity of these firm's claimed "profits."
As I mentioned earlier, Nvidia closed at $183.61 yesterday. With $100 billion in shareholder equity and 24.5 billion shares outstanding as of the most recent 10-Q, that sucker who hit the closing offer paid $183.61 for a share of stock worth $4.07 on a liquidated basis (at best).
When a critical mass of average Joe investors realize that this AI miracle is all smoke and mirrors, they will ask for their money back, and a great many people are going to realize that their money is already gone.
As a matter of law what they are doing may not be an illegal fraud because it complies with disclosure requirements, but I'm not a cop or a regulator looking to prosecute someone. I'm an analyst doing math and what I see is a collection of companies that claim enormous profits, but for some reason have almost no cash to show for it.
In short, if it isn't a fraud, where is all the money these companies are supposedly generating? Cuz it ain't on their balance sheets.
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Thanks for pointing out the buybacks. The subject of buybacks is worth a whole thread of its own, but at the moment I would just like to point out that Nvidia is buying back stock at >40 times book value. The average price to book for S&P500 companies is currently ~6.5, which is about double the long term average. And every time Nvidia buys another share the price multiple to book increases because they no longer have the cash asset on their balance sheet.
In other words, the buybacks are actually shrinking the tangible value of the company because the firm is overpaying for the shares. When the hype dies and the multiple premium for AI connected stocks evaporates, all those billions will simply disappear. Which is my whole point. The money is already gone, but nobody notices because the stock price keeps going up. Unfortunately, it is only going up because the company is systematically inflating its perceived market value.
Now, I will acknowledge that they must have earned at least $24 billion somewhere to pay for the buybacks.
Like I said in the OP, I do not believe Nvidia is a total fraud. They do sell real products to real companies for real dollars. We're debating the totality of their financial statements, and you have to admit that investing $100 billion in a customer when you have total shareholder equity of $100 billion just doesn't make sense. The fact that the customer is then making their own $100 billion investment in a third party who will then buy $100 billion of your product gives off a certain smell, and it isn't pleasant.
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What you want, when you invest in a startup, is a founder who combines (1) an insanely ambitious vision with (2) a clear-eyed plan to make it come true and (3) the ability to make people believe in the vision now. “We’ll tinker with hydrogen for a while and maybe in a decade or so a fuel-cell-powered truck will come out of it”: True, yes, but a bad pitch. The pitch is, like, you put your arm around the shoulder of an investor, you gesture sweepingly into the distance, you close your eyes, she closes her eyes, and you say in mellifluous tones: “Can’t you see the trucks rolling off the assembly line right now? Aren’t they beautiful? So clean and efficient, look at how nicely they drive, look at all those components, all built in-house, aren’t they amazing? Here, hold out your hand, you can touch the truck right now. Let’s go for a drive.” That’s not true, but it’s a nice metaphor; the goal is to get the investor to see the future, so she’ll give you money today, so that you can build the future tomorrow. |
Yeah, look... I started following financial news in 1993. By 2003 I was trading treasury futures. In 2007, capital markets became my full-time job. I learned how to code while waiting for trades to play out.
I've experienced more cycles of hype and implosion than you can imagine. My world view is dark because I know how everything ends.
I am outside of the market consensus on this topic, and I appreciate that. Unfortunately, it doesn't matter what the investment bankers these firms keep on their payroll say. If the market collectively decided to remove $1 trillion of their investment from Nvidia today, the embedded buyback earnings value that grandma is relying on for retirement is gone. You do not have the liquidity you assume.
None of it matters today because the hype is running strong. So I'll look stupid until I don't. All I can say at this point is that I understand why there is $7+ trillion in money market funds. My bet is that many are going to be surprised how far valuations need to drop before the stock market hits the strike on that put.
More to the point, all the future expectations are built on the idea that AI is going to experience a social media like demand curve that expands into infinity. Social media is free. AI is an expensive technology to operate. It is also not very good at anything that doesn't exhibit recurring patterns.
There is no AGI and we are still a long way from a world where it can solve the problems for which there are currently no solutions. If these companies don't find answers to the very real problems in the next 5 quarters, there is a strong probability that we see a material revaluation of the industry's prospects. And should that come to pass, we all better hope the numbers make more sense than they do today. |
