CoreWeave’s debt is becoming the whole AI industry’s problem

CoreWeave faced significant challenges last week as its bonds fell into distressed status, a term used when investors require an additional 1,000 basis points in yield compared to government bonds. On Tuesday, Chamath Palihapitiya, known for his involvement with special purpose acquisition companies (SPACs), highlighted the troubled debt and raised questions about whether the current AI expansion is indicative of a private credit bubble. Since Tuesday’s market close, CoreWeave's stock has plummeted by over 20 percent, indicating a severe drop in investor confidence. This decline appears to have had a ripple effect, negatively impacting other companies in the AI sector as well.

The situation raises concerns about the viability of the AI industry as a whole. While many analysts have speculated about a potential bubble in the sector, Palihapitiya’s remarks resonate more deeply when considered alongside those of other industry figures, particularly when they echo worries about the financial sustainability of AI ventures. Elon Musk’s insights on this topic, for example, carry significant weight and suggest a more serious underlying issue.

CoreWeave's predicament worsened when Brannin McBee, a co-founder of the company, disclosed to the Financial Times that the firm aims to elevate its debt rating to investment-grade status to access funding from insurers, who, according to him, have "unlimited" capital. This strategy, while understandable given that CoreWeave recently secured its first investment-grade chip loan, raises alarms among investors about the company's already substantial debt load and the potential for further borrowing.

John Yovanovic, co-head of leveraged finance at MetLife Investment Management, noted that the issue isn't merely the shifting credit profiles but rather the looming influx of supply over the next year and a half. His comments reflect the apprehension surrounding CoreWeave's financial situation, which some analysts interpret as evidence of a bursting AI bubble. However, it is important to recognize that a declining stock price does not automatically equate to financial ruin. Stock performance often reflects investor sentiment about future prospects rather than immediate business operations. Nevertheless, CoreWeave's heavy debt burden means that if borrowing costs rise, it could further complicate the company's path to profitability.

As of its second-quarter earnings report, CoreWeave has accumulated over $35 billion in debt, primarily due to its innovative approach of using GPUs as collateral for loans. The company lacks a substantial revenue-generating business model beyond providing computing services, which has resulted in significant losses, exceeding $1 billion in the first half of the year alone.

Despite these challenges, there are factors that prevent a complete dismissal of CoreWeave's potential. The company holds $103.7 billion in remaining performance obligations from its customers, with approximately 40 percent due by 2028. Major clients include Microsoft and OpenAI, with a likely third significant customer being Nvidia, although CoreWeave has not officially confirmed this. Together, these three clients accounted for nearly 75 percent of the company’s revenue in the second quarter.

Microsoft and Nvidia are generally considered reliable partners, as both companies recognize the potential fallout in the market if CoreWeave were to fail. OpenAI's financial stability is less certain, yet unless it faces severe financial difficulties, CoreWeave may remain stable for the foreseeable future. If the company can continue servicing its debt, it may be able to sustain its operations. The true test of CoreWeave's business model will come if the current AI market momentum begins to wane.

However, the unease surrounding CoreWeave has cast a shadow over other AI-related companies that have also taken on considerable debt. For example, Oracle has seen its stock price drop nearly 10 percent during this period, coupled with a decline in its bond values. The concerns that investors harbor regarding CoreWeave are indicative of broader anxieties within the AI industry, raising questions about the sustainability of the bare-metal computing business model.