AI Has A Hidden Debt Problem

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**Ed Elson** (1:46)
Welcome to Prof G Markets. I'm Ed Elson. It is July 23rd. Let's check in on yesterday's market vitals.
The S&P 500 and the NASDAQ declined. The Dow was flat. Brent crude climbed above $95 per barrel. For the first time in nearly six weeks, as both the US and Iran escalated their attacks, the yield on 10-year treasuries increased. And finally, Google and Tesla shares fell. After both companies reported earnings, we will get into those reports later.
Okay, what else is happening? The big AI spenders are increasingly turning to debt, and a lot of it turns out to be hidden. A Nikkei Asia investigation found that five tech giants Alphabet, Microsoft, Amazon, Meta and Oracle are carrying roughly $1.65 trillion in debt that doesn't show up on their balance sheets. That's more than the $1.35 trillion they actually report, meaning the debt we can't see is now bigger than the debt we can. Meta's off balance sheet debt is roughly three times its reported debt, and Oracle's has ballooned about 30-fold in four years. It's all legal, but it raises one big question. What happens if AI demand isn't as strong as investors are betting? Joining us to discuss this question, we're speaking with Ed Zitron, author of the Where's Your Ed At newsletter and host of the Better Offline podcast. Ed, thank you for joining us. I just want to give you some context. Yesterday I was talking about Oracle on this show, and I was talking about how they're increasingly relying on debt to finance their data centers, and how it's becoming borderline unmanageable, and that's why their credit rating is getting downgraded, and their borrowing costs are exploding.
They're being sent into this downward spiral. Up until this point though, it has been my understanding that the debt in the AI ecosystem has been relatively contained to a handful of companies like Oracle, but that it hadn't infected the bigger names, which is why I was so alarmed to see this reporting from Nikkei, which says there's $1.7 trillion of hidden debt that we haven't been seeing, that we haven't been looking at. You've just written a huge piece on this. You investigated these numbers. You did a sweeping analysis of all of this. What do we know about debt in AI? And how is it that so much of it appears to be hidden?

**Ed Zitron** (4:20)
So there are several factors here. With the hyperscalers, the reason they're able to do that is because they've found this interesting accounting treatment that Ernst & Young claim is a red flag in Meta's case, where when you build a data center, it's not like you as the company say, I'm going to buy all the stuff, I'm going to get the debt for this, and here we go. They make a special purpose vehicle or a variable interest entity, which is basically an SPV where you don't own as much. So for example, with Hyperion, I think investors like Pimco and Blue Owl own 80% of it, and Meta only owns 20% of it. Despite Meta being the only client, the person that's going to fill it full of GPUs as well, I think, I think they're moving some across their assets. Despite them being the obvious, despite Meta announcing it and saying, this is our data center, because they don't have full ownership of it, it's not counted as something they put on their balance sheet. They will have it, I think, within operating leases when it starts paying. But the thing is, this is the entire AI data center industry. Every one of them are these SPVs that people pull money into. The SPV owns the debt, the SPV often owns a lot of the risk, though through non-recourse loans, which means that technically you have to go after the assets of the SPV before you go after the company. But nevertheless, these things own the risk, they own the GPUs, they pay investors not out of anything other than the revenues from the data centers, which leads to the important point of what happens if the revenue for the data center isn't there? How do investors get made whole? And the answer is they do not.