THE ECONOMIST: Who will pay for the trillion-dollar tech boom triggered by rise of Artificial Intelligence?

America’s biggest technology companies are combining Silicon Valley returns with Ruhr Valley balance sheets. Investors who bought shares in Alphabet, Meta and Microsoft a decade ago are sitting on eight times their money, excluding dividends.

Spending on data centres means the firms possess property and equipment — accounting-speak for hard assets — worth more than 60 per cent of their equity book value, up from 20 per cent over the same period. Add the capital expenditure of these firms during the past year to that of Amazon and Oracle, two more tech giants, and the sum is greater than the outlay of all America’s listed industrial companies combined.

Jason Thomas of Carlyle, an investment firm, estimates that the spending boom was responsible for a third of America’s economic growth during the most recent quarter.

This year companies will spend $US400 billion ($600 billion) on the infrastructure needed to run artificial intelligence models. Predictions of the eventual bill are uniformly enormous. Analysts at Morgan Stanley reckon $US2.9 trillion ($4.4 trillion) will be spent on data centres and related infrastructure by the end of 2028; consultants at McKinsey put it at $US6.7 trillion ($10.2 trillion) by 2030. Like a bad party at a good restaurant, nobody is quite sure who will pick up the tab.

Much of the burden will fall on big tech’s bottom line. Since 2023 Alphabet, Meta and Microsoft have divided $US800 billion ($1.2 trillion) of operating cash flows roughly evenly between capital spending and shareholder returns. This goldilocks capital allocation, which combines a building boom with a trip to the bank, is unprecedented even among their own ranks.

Amazon’s shareholders are paying for huge capital outlays but have been starved of returns; Apple investors have benefited from vast share buybacks but are worried that the company’s lack of investment means it is falling behind on artificial intelligence.

But capital spending is growing faster than cash flows. Morgan Stanley’s calculations indicate a $US1.5 trillion ($2.3 trillion) “financing gap” between the two over the next three years. It could be bigger if advances in the technology escalate spending further and kill existing cash cows. Conversely, if companies are slower to adopt artificial intelligence than consumers, big tech will struggle to earn a quick return on its investment — shareholders might then demand a greater portion of their earnings to compensate for this sluggish growth.

More certain than the size of the financing gap is the type of investors looking to fill it. The hot centre of the artificial intelligence boom is moving from sharemarkets to debt markets. That is surprising since the attitude of the biggest tech firms to debt has been essentially conservative.

They are much less beholden to their bankers than telecom outfits were at the turn of the century, during the dotcom mania. Fortress balance sheets are prized. Large bond issuances have been outweighed by even larger piles of cash. (If the “magnificent seven” tech firms pooled their liquid financial assets and formed a bank, it would be America’s tenth biggest.)

Slowly, this is changing. During the first half of the year, investment-grade borrowing by tech firms was 70 per cent higher than in the first six months of 2024. In April Alphabet issued bonds for the first time since 2020. Microsoft has reduced its cash pile but its finance leases — a type of debt mostly related to data centres — nearly tripled since 2023, to $US46 billion (a further $US93 billion) of such liabilities are not yet on its balance sheet).

Meta is in talks to borrow around $US30 billion from private-credit lenders including Apollo, Brookfield and Carlyle. The market for debt securities backed by borrowing related to data centres — where liabilities are pooled and sliced up in a way similar to mortgage bonds — has grown from almost nothing in 2018 to around $US50 billion today.

The rush to borrow is more furious among big tech’s challengers. CoreWeave, an artificial intelligence cloud firm, has borrowed liberally from private-credit funds and bond investors to buy chips from Nvidia. Fluidstack, another cloud-computing startup, is also borrowing heavily, using its chips as collateral. SoftBank, a Japanese firm, is financing its share of a giant partnership with OpenAI, the maker of ChatGPT, with debt.

“They don’t actually have the money,” wrote Elon Musk when the partnership was announced in January. After raising $US5 billion ($7.5 billion) of debt earlier this year, xAI, Mr Musk’s own startup, is reportedly borrowing $US12 billion ($18 billion) to buy chips.

This means the technology revolution is increasingly coming into contact with a financial one. Those at the apex of Silicon Valley are not the only elites in the West who — after spending decades perched in the realm of ideas — have decided that the physical world is where it’s at. Private-equity firms are refashioning themselves as lenders to the real economy. The resulting balance sheet transformation has been, if anything, more dramatic than the one in Silicon Valley.

Data centres produce large amounts of debt. This sits easily on the huge balance sheets managed by these outfits, which are often funded by life insurance policies. Like big tech, private markets are increasingly concentrated. Tech firms are raising capital because they think the gains from artificial intelligence will be concentrated among a few players. Investors are lending to them because they know the same thing is true on Wall Street.

Railroaded

This symbiotic escalation is, in some ways, an advert for American innovation. The country has both the world’s best artificial intelligence engineers and its most enthusiastic financial engineers. For some it is also a warning sign. Lenders may find themselves taking technology risk, as well as the default and borrowing cost risks to which they are accustomed. The history of previous capital cycles should also make them nervous.

Capital spending booms frequently lead to overbuilding, which leads to bankruptcies when returns fall. Sharemarket investors can weather such a crash. The sorts of leveraged investors — such as banks and life insurers — who hold highly rated debt they believe to be safe, cannot.