The Hidden Risks in the AI IPO Labyrinth

Key Takeaways

• Upcoming mega-IPOs could create significant wealth for investors but also pose risks due to the interconnected relationships between the companies and major tech giants.
• Investors face challenges in determining how much AI revenue reflects genuine demand versus self-reinforcing growth within an interconnected ecosystem of suppliers, customers and investors.
• A new Nasdaq rule allows companies to join its Nasdaq 100 index within 15 trading days if their market cap ranks in the top 40 constituents, potentially increasing exposure to AI IPOs for index investors.

Investors are being asked to value trillions of dollars worth of soon-to-be public AI companies that are simultaneously customers, suppliers, partners and portfolio holdings of the same handful of technology giants. 

SpaceX, Anthropic and OpenAI will be among the defining IPOs of this decade. Given their recent valuations, their public debuts could create enormous wealth for investors - especially early investors - and validate hundreds of billions of dollars in investments made by Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN) and Nvidia (NVDA).

But these blockbuster IPOs are also leading investors into a financial labyrinth that may prove inescapable, and potentially dangerous. In fact, we are already in it. 

Individual investors’ largest holdings—Microsoft, Alphabet, Amazon and Nvidia—are highly exposed on both sides of the AI trade, as investors in these companies and as beneficiaries of the revenue they generate. If the AI IPO boom succeeds, they stand to benefit from appreciating equity stakes and continued demand for cloud services, computing power, and infrastructure. If it falters, they could face pressure on both fronts, and investors could get squeezed in the middle.

Much of the concern surrounding the AI-hype has been focused on valuation multiples and exorbitant capital expenditures. But technology investor Om Malik recently suggested that critics may be fighting on the wrong terrain.

"The question is not whether 25x revenue is too much. The question is whether the revenue is the revenue," Malik wrote recently, referring to the lofty valuation that is being assigned to Anthropic.

Investors Risk Wandering Into Hall of Mirrors

Consider the increasingly intertwined relationships that the Big Tech behemoths have with OpenAI, Anthropic and SpaceX.

Microsoft has tied much of its AI strategy and future growth to OpenAI, while OpenAI has become one of Microsoft Azure's largest customers. Amazon and Alphabet have invested tens of billions in Anthropic while simultaneously providing the cloud infrastructure that powers its business. Alphabet also has a long-standing equity stake in SpaceX and partners with the Elon-Musk led company on a variety of projects, as do Microsoft and Amazon. Meanwhile, Nvidia is the dominant supplier of the chips underpinning the AI boom while also investing in several of its leading participants.

Bottom line: Everyone is in everyone’s business.

None of this is improper. In fact, these partnerships have accelerated innovation at a remarkable pace. But it’s nearly impossible for investors to follow the thousands of threads of revenue and discern which are real, and which are mythical.

It’s even harder given that Open AI and Anthropic submitted confidential S-1 filings with the SEC and the paper trail is thin.

"Whether it is OpenAI or Anthropic, revenue cannot be resolved without an S-1." Malik said. "I would believe it only after it shows up in SEC filings, and there too I am expecting part fact, part fiction."

In Greek mythology, Theseus, the Prince of Athens, entered the Labyrinth to slay the Minotaur, the mythical beast with the head of a man and the body of a bull. He escaped only because Ariadne gave him a thread to follow back to reality.

Investors navigating today's AI ecosystem need some thread. Without it, investors risk wandering into a hall of mirrors where every reflection reinforces the next.

Echoes of the Telecom Boom

During the telecom boom of the late 1990s, investors celebrated explosive growth without always examining how much of that growth depended on capital circulating among the same participants. In Japan's bubble era of the late 1980s, cross-shareholdings among corporations and banks created a similar sense of self-reinforcing strength—until confidence cracked sending the Nikkei into a 60% tailspin.

The challenge for investors now is determining how much of today's growth reflects independent demand and how much is being reinforced by an increasingly interconnected ecosystem of investors, suppliers and customers. If just one of them slows spending, the thread could snap.

Before buying into the next generation of AI IPOs—or adding to positions in the companies funding them—investors should focus on Ariadne's thread: Where does the revenue ultimately come from, and how much of it would remain if the mirrors disappeared?

Ironically, index investors might not have a choice. As of May 1, Nasdaq started allowing companies to join its marquee Nasdaq 100 index within 15 trading days instead of waiting a minimum of three months to a year as long as their market cap puts them within the top 40 constituents.