Technology strategist explains the end of the AI party

Drew Breunig is Vice President of strategy at Precisely, a data integrity software company that was acquired by large private equity firms for $3.5 billion in 2021.

Mr Breunig does not claim to be an expert investor but we think he presents a legitimate framework (in his personal blog) explaining how the current AI hype may grow to a supersized bubble and how it may tumble.

Inflating the current AI bubble is mistaking expenses as revenue.

Cloud infrastructure giants invest billions in AI startups, which are required to build models on their cloud platforms.

The AI startups take the billions of investment dollars and spend them on the cloud platforms.

The giants’ investments, which ought to be recognized as expenses, becomes revenues for them.

More revenue for the giants justifies more purchases of chips from you-know-who.

More chips attracts more AI companies hungry for investments from the cloud giants.

The cycle repeats and creates a supersized bubble.

The more important question is what would pop the bubble.

We agree with Mr Breunig that declining valuations of AI startups would do the honors.

If AI investors realize that monetization is far off or impossible, they would stop assigning ever-higher valuations, halting investment dollars to AI, and effectively putting brakes on the entire cycle.

But if AI investors are mostly the cloud giants, why would they spoil their own party?

We think their hands would only be forced after AI investments become large and unproductive enough to dent their stellar economics which would dial up the pressure from the public markets to reduce AI investments.

How large are we talking about? No one knows for sure, but we guess unproductive investments to the tune of 1-2 years of free cash flow should be sufficient to make the public markets nervous. Corporate investment in AI was ~$90 billion in 2023. If half of corporate investment was unproductive, $45 billion is nowhere close to the $200 billion FCF generated by Google/Microsoft/Amazon/Nvidia combined. The AI bubble may have room to inflate.

We do not deny the game-changing nature of AI but we also recognize that good inventions are not always good investments. Warren Buffett recognized that airlines have caused so much losses for investors that they are better off without planes. Buffett said it best:

Before the AI party slows down, we think Taylor Swift best describes the party: