From the horse’s mouth
Recently, the BBC interviewed Sundar Pichai, the CEO of Alphabet, Google’s parent company. With all the claims that the rise of artificial intelligence (AI) is a bubble – something I noted can only be known after the event – I wonder if the BBC was motivated to go to the source.
Pichai described the rise in AI funding as a remarkable period, yet marked by some unrealistic expectations, and warned BBC News viewers that no company would escape unscathed if the AI boom collapses.
While the BBC interview covered topics ranging from energy demand and delays in environmental targets to investment in Britain, the reliability of AI systems and how the AI shift could reshape employment, it was Pichai’s response to whether Google could protect itself from the fallout of a collapse that attracted some attention.
Despite the recent investment in his company by Warren Buffett’s Berkshire Hathaway, Pichai suggested the company is equipped to handle a bubble burst, but noted: “I don’t think any company will be immune, including us.”
Alphabet’s shares have doubled since April to reach a market cap of $3.6 trillion, thanks in part to the creation of custom AI processors that rival those of Nvidia.
Escalating market valuations and OpenAI’s status as a private company may be masking the industry’s losses, leading some investors to publicly express concerns about OpenAI’s $1.4 trillion in spending commitments, despite profits being a small fraction (1/1000).e) of expected expenditure.
I have several concerns.
One is that OpenAI’s projected losses of $9 billion this year, rising to $74 billion by 2028/2029, effectively make all other listed players look unnecessarily cheap on a price-to-earnings (P/E) basis.
Another concern is that throughout history we have repeated the same cycle as new General Purpose Technology (GPT) emerged. I’m not just talking about the Dotcom bubble of 1999/2000. Returning to shipping, the automobile, electricity, commercial flights, the telephone, television, the computer and then the Internet, and more recently big data, machine learning, the Internet of Things (IoT), and now, Artificial Intelligence (AI), what we see is a pattern of behavior that inevitably leads to the same outcome.
After the technology emerges, excitement about it increases. The hype attracts investors who compete to be involved, lowering the cost of capital for participants. Armed with cheap capital (initial equity), participants use it to build and scale the technology in a rapid land grab. If the hype continues long enough, capital increases will eventually run out and debt will pile up to further finance the expansion. Cheap financing and the resulting land grab create oversupply. At the same time, the investment theme, long considered ‘structural’ because of its impact on the course of human history, inevitably collides with customer demand that is not structural but ‘cyclical’. Oversupply meets a cyclical consumer. Then prices collapse and expected returns evaporate.
Of course, even if the bubble bursts, technology will indeed change the course of human history. To do that, however, it must be widely supported by billions of people. Fortunately, the period of ‘creative destruction’ provides cheap purchase prices for buyers of distressed assets, who are picking up the pieces and can now deliver the technology affordably to the masses.
My next concern is that there isn’t enough money in customers’ pockets today to pay enough for the AI tools to justify spending on the buildout. Some calculations suggest that the world will need to spend six to eight times current software expenditures to achieve sufficient returns on capital expenditures for AI participants. Others have suggested that each of the world’s 1.6 billion iPhone users would have to spend another $35 a month on AI software to earn a 10 percent return — which, if true, isn’t a particularly exciting return.
Finally, I worry that the dream of artificial intelligence (AI) could easily be “interrupted” by many factors, including the inaccuracy of AI tools (don’t blindly trust what AI tells you, says Google’s Pichai), the slowing marginal evolutionary improvements to existing AI models, likely project delays, and the costs and shortages of energy and water (Pichai pointed to the “immense” power needs of AI, which accounted for 1.5 percent of global electricity consumption last year, according to the International Energy Agency).
In comments echoing those of US Federal Reserve Chairman Alan Greenspan in 1996, who warned of “irrational exuberance” in the market about a year before the dot-com crash, Pichai said the sector could “overshoot” in investment cycles like this.
While some compare this boom to the 1999/2000 Internet bubble, the argument that many of the AI players are established dominant monopolies and not profitable startups is valid. Since today’s companies are not profitable, valuations in the aggregate are obviously not considered ridiculous. But the aggregate price-to-earnings (P/E) ratios of today’s top ten companies are higher than the same figure in early 2000, and OpenAI’s loss privatization could mask much worse economic conditions for the others, so who knows.
The historical patterns of invention, hype, cheap capital, overcapacity, creative destruction, and distressed purchases lend some credence to Pichai’s warning: sectors may overload during this investment wave, even if the technology is ultimately transformative.
“We can now look back at the Internet. There was clearly a lot of overinvestment, but none of us would question whether the Internet was deep,” he said.
Both can be true, and history is full of examples that were. Technology is changing the world, but investors who acted too early were often wiped out.
Pichai notes, “I expect AI to be the same. So I think it’s both rational and has elements of irrationality at a time like this.”
Pichai’s views come after a fresh warning from JP Morgan chief Jamie Dimon, who recently told the BBC that while AI funding could deliver returns, some of the capital “could likely be lost”.
As always, time will tell.
He is also the author of the best-selling investing guide to the stock market, Value.able – how to value and buy the best stocks for less than they are worth.
Roger regularly appears on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
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