The 50 Most Influential People in Tech, Fed Raises Rates, AI Adoption Has Stalled

Akash Pasricha (0:13)

Welcome, everyone, to The Information's TITV. My name is Akash Pasricha. It is Thursday, September 17th. Today on the show, we're going to be talking about what the Fed raising rates means for the AI sector. We're then going to hear about Bridgewater Co-CIO Greg Jensen's view on AI regulation. My colleague, Dakin Campbell, spoke with him and we're going to unpack that conversation. We're also bringing on Menlo Ventures to discuss some new data they've collected on consumer AI.

We're going to close out the show with a conversation about the information's newly released of the 50 most influential people in the tech sector. It's going to be a great show, so let's get right on into it.

The Fed raised interest rates yesterday. It has been three years since that has happened. It looks like there will be another hike later on this year that will certainly impact the AI sector as debt has become so crucial to the build out. I want to bring on Paul Meeks, Head of Technology Research at Freedom Capital Markets, for a conversation. Paul, welcome back to the show. It's great to have you here.

Paul Meeks (1:14)

Good to see you, Akash.

Akash Pasricha (1:16)

Okay, so first in three years, more to come. We've got this AI build out going on in the background. How do you think that this is going to affect the AI story?

Paul Meeks (1:27)

It's a clear negative, but dampen somewhat by the fact that everybody sees it coming. Because you can take a look at Fed funds futures contracts and know what percentage probability, which is awfully high when rates hikes are coming or when rates fall on the other end of the cycle. But it's going to really hurt things in two ways. The first way is the obvious problem, which is all these AI infrastructure builders are aggressively borrowing money because they have to fund these huge builds. You know, cumulatively by the end of the day, when we get through all this AI infrastructure building, we're going to cumulatively have spent several trillion dollars. And so most of these companies, the Neo Clouds, the AI co-location companies, they are subprime credit rated. And so this is not good.

But there's going to be other ways around that. Now, the offset is...

Akash Pasricha (2:27)

Well, what are the ways around that?

Paul Meeks (2:30)

Well, the key is this.

The offset is that recently, because demand is so voracious and there's still not enough supply, and actually the gap is getting worse and worse, they are getting a much better pricing on their deals. So, much higher, 2 or 3X what they were getting a year or two ago, revenue per megawatt. So, their P&L should improve, so they can pay off higher interest expense. So, that's the offset, nothing really mechanical. The other way that we get dinged is, all these companies have cash flows that are estimated so far out in the future that just on a valuation basis for an equity analyst like me, rising interest rates equals rising discount rate for these cash flows, really hammers the stock valuations. So, one, through higher borrowing costs, two, just dams the valuations with a higher discount rate.

Akash Pasricha (3:33)

So, how do you think the AI companies change their strategy in an environment like this? I mean, pricing is one thing, I hear you.

Do they temper their ambitions at all? I'm thinking about the CFOs of all. I mean, and by the way, we should say, it's not like they haven't modeled this stuff in. I mean, like you said, this is stuff they've been expecting, but I wonder how you might see the dialogue from these companies change on earnings calls, guidance, talking about the public companies, right? We'll talk about the private companies in a second here. What are you expecting there?

Paul Meeks (4:11)

So one of the things that they've even started to emphasize in this last round of core leak calls is the inflection in the adjusted EBITDA margin or even EBIT margin for some companies, where they're starting to see as you turn on the capacity, usually there's a couple weeks between what they call active power and revenue generation, that the inflection in the margins are so strong, and actually shows you a business that's attractive to finance.

And so they really have to show, hey, it's not just bringing on contracted capacity, and over time, converting that to revenues. Obviously, that's really important, but the fact that as they scale these businesses, they get to adjusted EBITDA margins 60%, 70%, 80% in some cases, which is people turn around and say, wow, I'm cool with financing this business, because it looks like it's going to be a good one.