With AI Finance, It’s All in the Timing
This may be the moment of maximum AI uncertainty. That means some things will get clearer in the coming months—not necessarily better, just clearer.
There are three specific points of uncertainty right now:
- AI developers have raised a ton of money recently, led by OpenAI’s $110 billion haul, which we broke news on and explained. Coming soon is the expected SpaceX, xAI and X combined initial public offering. The uncertainty is: Will this cash be enough to put them on a sustainable financial trajectory? Also, will the tech giants writing the checks wind up as winners or losers?
- The fear of a train wreck among software makers due to AI has spilled into private credit and private equity markets, which have heavy exposure to that industry.
- The first real signs are emerging that companies are using AI—and justifying big job cuts as a result. Fintech company Block might be leading the way.
What makes these three developments so unnerving is that they are each in a different stage. Spending on the AI build-out has been soaring for the last couple of years, and some believe we are near a peak. Software makers are doing just fine, but investors think their long-term outlook is grim. AI use by businesses is just ramping up, so it is impossible to know whether a wave of layoffs will result in the coming years.
The common theme is uncertainty about the impact of the huge transformation AI will bring to industries and the economy. The good news is that some of this uncertainty should start to ease soon.
Here’s why: Wall Street analysts agree that the growth in AI spending by developers and the big tech companies will peak this quarter. They could be wrong. But if they’re right, the pressure on AI firms OpenAI and Anthropic to raise funds might ease. Upcoming IPOs could give them a broader range of funding options if they still need cash.
A decrease in the growth of AI spending will also take pressure off the big tech companies, which have been pouring most of their bountiful cash flows into capital expenditures.
Here’s the evidence: Capital spending by those companies on AI has gobbled up nearly all of their cash and sent some of them to the bond market in a quest for more. When they announced earnings for the fourth quarter, they collectively projected that spending this year would hit $667 billion, far more than investors had expected. That created anxiety and knocked down some stocks.
The growth rate in capex spending by big tech firms is expected to hit 86% this quarter, according to the consensus of stock analysts calculated by Goldman Sachs. The good news is that analysts expect spending growth to fall by half by the fourth quarter and to drop to 12% by the end of next year.
That decline could mean capital spending as a percentage of cash flow will start to fall, since cash flow will keep rising. More importantly, investors would no longer see AI spending as an endless money pit for the big tech companies.
At the same time that spending growth starts to fall, revenue from AI should continue to grow. That’s good news for AI companies but potentially bad news for software makers, whose businesses could be disrupted. That’s our second moment of uncertainty.
There’s an unsustainable split right now in software. The public companies and the analysts who follow them expect earnings growth to continue unabated over the next two years. Investors, on the other hand, are treating software stocks as if their outlook is grim. Shares in the industry are down 20% this year.
Public market conflicts like these tend to work themselves out as evidence emerges about which side is right. The real pressure is in private markets, which tend to freeze up in times of uncertainty. Both private equity and private credit funds are stuffed with software companies. Investors in these funds often try to get out, if they can, before the funds mark down the value of their holdings. All of this drama means one source of funding for AI could be sidelined for some time.
Lastly, there’s the issue of jobs. AI’s impact on jobs had been mostly talk until last week, when fintech company Block announced it would cut 40% of its workforce. Co-founder Jack Dorsey said AI is allowing the company to do more with fewer people.
Amrita Ahuja, who oversees the finance, legal and people functions at Block, said at the Morgan Stanley Technology, Media and Telecom conference on Tuesday that the company had built a new risk model for one of its products in two days recently versus 90 days for a prior version, according to a transcript from S&P Global Market Intelligence. She said recent improvements in AI models had given Block the confidence to make the job cuts.
More companies are talking about this. According to transcripts of company earnings calls and other statements compiled by AlphaSense, the words “AI” and “layoffs” appeared close together in nearly 137 transcripts in the past two quarters, compared to 56 a year earlier.
The market’s reaction to Block’s news, sending the shares up 18%, is more important than the news itself. If investors cheer job cuts like these, clarity will come quickly. It just won’t be good news for workers.
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