Notable Capital's Jeff Richards: As long as end demand is there, tech capex will be fueled

Key Concepts

• Mega Cap Tech Earnings: Earnings reports from the largest technology companies.
• AI Trade: Investment strategies focused on companies involved in Artificial Intelligence.
• Capex (Capital Expenditures): Spending by companies on physical assets like property, plant, and equipment.
• Free Cash Flow: Cash generated by a company after accounting for operating expenses and capital expenditures.
• Private Equity & Venture Capital: Investment firms that provide capital to private companies.
• M&A (Mergers and Acquisitions): The process of combining companies.
• LPs (Limited Partners): Investors in private equity and venture capital funds.
• Quantum Computing: A type of computing that utilizes quantum-mechanical phenomena.
• Forward Revenue: Projected revenue for a company in the upcoming fiscal year.
• Annual Run Rate Revenue: The annualized revenue of a company based on its current revenue.

Mega Cap Tech Earnings and AI Innovation

Next week, the focus will be on the earnings reports of mega-cap technology companies. Jeff Richards, Managing Partner at Notable Capital, highlights that the ongoing AI trade, which has been a dominant theme for the past 12-24 months, is underpinned by significant capital expenditures (capex). This capex is laying the groundwork for innovation in cybersecurity, cloud infrastructure, and the application layer over the next one to two years. Richards expresses excitement about the current innovation landscape in Silicon Valley.

Sustainability of the AI Trade and Funding

The sustainability of the AI trade and the continued rise of related stocks hinge on the maintenance of capex numbers. Any hesitation in spending by these large tech companies could lead to market suspicion. A key differentiator from the dot-com bubble 20 years ago is that current capex spending is being funded by the substantial free cash flow generated by major players like Meta, Amazon, and Google. This contrasts with the previous era, where funding models were different.

Furthermore, there's an increasing trend of these tech giants partnering with private equity and large capital partners. An example cited is Meta's "Blue O" announcement. The demand for the infrastructure being built is robust, evidenced by end-user demand from Fortune 500 companies globally and consumers. The rapid growth of ChatGPT, which has surpassed 800 million users (representing 10% of the world's population), serves as a strong indicator of this end demand, which in turn fuels the spending that supports capex.

Challenges with Private Company Valuations and Visibility

A significant challenge in the current market is the opacity surrounding private AI companies like OpenAI and Anthropic, whose valuations are growing rapidly. Public market investors struggle to grasp the metrics of these private entities. Companies such as Verscell and Replid, operating in the application and cybersecurity layers, lack the visibility that public companies offer. This lack of transparency also affects analysts covering public companies, as traditional software players like SAP, Salesforce, and Adobe are not the primary drivers of current AI innovation. There is a desire for more of these innovative private companies to go public, with expectations for this to occur in 2026 and 2027.

Healthy Capital Markets and M&A Activity

Despite some current market hesitations, the overall capital market is healthy. M&A activity is at a record high, with the current year being the second-largest for M&A in history, trailing only 2021. This robust M&A environment is expected to provide much-needed liquidity to Limited Partners (LPs) in the private equity and venture capital industries, who have been seeking liquidity for several years.

Potential for Bubbles in the AI Trade

While the AI trade is generating significant excitement, there are concerns about potential bubbles. Quantum computing is identified as one area with a high degree of speculation and relatively unproven technology. Government involvement in this sector has also been signaled.

In the software and application layer, Palantir is highlighted as the only public software company currently growing at over 30% annually. It trades at a high valuation of 70 times forward revenue. This contrasts with private companies that may be growing at 50-100% annually and trading at 20-50 times forward revenue. The observation is that some private companies might actually be more highly valued if they were public. The hope is that more of these high-growth private companies will go public, providing public markets and analysts with valuable data and insights into the underlying value of the AI trade.

Venture Capital and the Uncertainty of Innovation

From a venture capital perspective, the current period of intense excitement presents a challenge in distinguishing between great and bad ideas, with the outcomes often only becoming clear over time. This uncertainty is inherent in the venture capital business, which operates on a long-term horizon, with investments made today potentially yielding results in three to ten years.

While billions of dollars are flowing into venture capital, it's acknowledged that a portion will inevitably be invested in companies that do not succeed, a phenomenon observed during the dot-com era with companies like Pets.com. However, the expectation is that this period will also produce highly valuable companies, with OpenAI already valued at over half a trillion dollars and Anthropic at over $100 billion.

The growth rates of companies like Anthropic are particularly noteworthy. Anthropic publicly disclosed starting the year with around $1 billion in annual run rate revenue and reaching $5 billion by the summer, a growth rate unprecedented in enterprise software. The next 12-24 months are anticipated to be exciting, with the understanding that failures are part of the venture capital process. The successful companies are expected to be highly impactful, potentially becoming the next Meta, Google, or Amazon, with many of these future leaders having been funded in the last three to four years.