Funding the AI Revolution

Thoughts on the Market vor 2 Jahren

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4:05

As the infrastructure needs for artificial intelligence soar, so
does the need for financing. Our Chief Fixed Income Strategist
talks about the role credit markets can play in providing capital
to power the sector.

----- Transcript -----

Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan
Stanley’s Chief Fixed Income Strategist. Along with my colleagues
bringing you a variety of perspectives, today I'll be talking
about the role of credit markets in the artificial intelligence
(AI) revolution.

It's Thursday, June 27th at 1 pm in New York.

Technology diffusion driven by artificial intelligence has been a
defining theme for investors over the last few years. Recent
developments in generative AI, or GenAI powered by large language
models, have the potential to bring transformational changes
across the economy. Today, I want to talk about the role of
credit markets in this AI revolution.

The infrastructure requirements of AI – semi fabs, data centers
and the energy resources to power the Gen AI models – are
enormous. Our analysts estimate that GenAI power demand will rise
rapidly, reaching 224 Trillion Watt hours by 2027 in their base
case which is roughly close to Spain's total 2022 power
consumption.

So, it goes without saying that AI infrastructure will need
substantial capex. Early on, much of the AI capex has been funded
by a combination of venture capital and retained earnings from
cash-rich technology companies; in other words funded by equity
capital. As the focus shifts from early innovators and enablers
of AI to adopters of AI, these needs are bound to grow and will
require more efficient forms of capital. We think that credit
markets in various forms – unsecured, secured, securitized and
asset-backed – will have a major role to play in this
transformation.

So far, debt financing has played a relatively small part in
funding technology companies, especially AI beneficiaries. The
sector has significant capacity to add debt without a material
deterioration in their credit metrics. This capacity is also
complemented by an investor base with a significant dry powder to
absorb incremental issuance, thereby avoiding a demand-supply
mismatch.

Of course, the story is not that simple. Cash-rich companies may
not have a compelling need to access credit markets if the equity
market continues to reward redirection of these free cash flows.
But then the path of the interest rate markets will also matter,
as monetary policy eases, the cost of debt becomes incrementally
even more attractive. It’s clearly early innings, but credit
markets holistically should play a bigger role as the cycle
matures.

In addition, as the capex cycle broadens out from enablers to
adopters, we note that most sectors are nearly not as cash-rich
as the technology sectors. For example, the median cash to debt
ratio for the technology sector is over 50 percent, but then for
the remaining sectors, it is just 15 percent. So as capital needs
driven by these infrastructure needs increase, we expect the
reliance on credit markets also to increase.

In some ways, this has already begun to happen. The first data
center asset backed security was issued in 2018. The market has
now grown to over 20 billion outstanding and it is poised for a
rapid growth. The bottom line is simply this: As AI driven
technology diffusion takes center stage, credit markets, broadly
defined, will likely play a growing role. As always, there will
be winners and there will be losers. But AI as a theme for credit
investors is here to stay.

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