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### Unveiling the Echoes of Historical Vicious Circles in AI Investments

Artificial intelligence is spawning some genuinely concerning financial decisions. As technology ti…

NEW YORK, Nov 29 (Reuters Breakingviews) – The realm of artificial intelligence is giving rise to some genuinely worrisome financial decisions. As major tech players compete to support promising new startups, they are securing commitments for revenue in various forms. The recent tumultuous events at OpenAI, the entity behind ChatGPT and backed by Microsoft (MSFT.O), shed light on how these seemingly virtuous cycles can take a dark turn.

The frenzy surrounding AI programs that mimic or even outperform human capabilities is at its peak. Following the swift dismissal and reinstatement of CEO Sam Altman at OpenAI, with some involvement from Microsoft CEO Satya Nadella, the startup is moving forward with plans for a share offering that could value it at over $80 billion. This move indicates that the hype is potent enough to overshadow the significant risks recently exposed, partly due to the support from corporate backers. Prior to the leadership shakeup, OpenAI had to halt subscriptions for its paid ChatGPT Plus service due to overwhelming demand from new users. This level of enthusiasm harkens back to the exuberance of the dot-com era.

Microsoft’s infusion of \(10 billion into OpenAI earlier this year played a pivotal role in igniting the fervor. As part of the agreement, the operator of ChatGPT committed to using only Microsoft’s cloud services. Before this deal, OpenAI had spent less than \)1 million on Microsoft’s services in a year. Now, the expenditure is projected to exceed $400 million annually on Microsoft’s Azure platform alone.

Generative AI, which leverages algorithms to generate new text or images based on training data, has unleashed a wave of excitement in Silicon Valley. Companies like Microsoft, Apple (AAPL.O), and Alphabet (GOOGL.O) are outperforming the Nasdaq Composite Index (.IXIC) this year. While the enthusiasm is understandable, there are notable risks in the structuring of these investments, reminiscent of the challenges faced in the 1990s when expanding global communication networks was in vogue. Both scenarios fuel innovation while creating demand for existing products. However, regulatory hurdles or other obstacles could impede AI adoption, potentially jeopardizing the anticipated revenue growth and inflated valuations of Big Tech firms.

OpenAI’s recent fundraising efforts could potentially double its earlier estimated value of \(30 billion. This growth has been mutually beneficial. Microsoft, including its debt, is now valued at around \)2.8 trillion, over 10 times the projected revenue for the next year. This valuation represents a 25% increase from a year ago, driven in part by the potential upselling of Microsoft 365 subscriptions with AI features and the 30% growth in its Azure web services division, bolstered by collaborations with OpenAI and similar entities.

Other tech giants are also investing heavily in AI ventures, with funding matching the capital inflow. For instance, Amazon (AMZN.O) announced a \(4 billion investment in Anthropic, which reciprocated by committing a similar sum over five years to Amazon’s cloud services. Following Amazon’s move, Google pledged an additional \)2 billion to the same startup, which had previously signed a contract with Google Cloud worth over $3 billion.

The current trend of mutual support and investment echoes the bubble of the past. Decades ago, companies invested heavily in laying telecommunication cables worldwide, leading to substantial growth and valuations for equipment suppliers like Cisco Systems (CSCO.O), Lucent Technologies, and Nortel Technologies. However, the revenue driving this boom was often inflated, with practices like roundtripping coming to light. This involved companies engaging in reciprocal deals to artificially boost their financial performance, ultimately leading to bankruptcies and financial restatements.

Vendor financing, where equipment makers extended credit to startups for purchasing their products, was another problematic practice during that era. While this strategy aimed to leverage the strong financial positions of established firms, it posed risks of defaults and market distortions. The eventual burst of the bubble resulted in significant market capitalization losses for network gear manufacturers.

The current scenario, likened to vendor equity, raises concerns of history repeating itself. While these arrangements inflate valuations on both sides, the risks seem more contained due to the scale of the companies involved. The industry’s high mortality rate may be offset by the overall market growth, offering potential benefits amidst the risks.

Amazon’s interest in bolstering its chipmaking business through collaborations with startups like Anthropic exemplifies strategic motivations behind these investments. By leveraging these partnerships, companies aim to enhance their competitive positions and potentially disrupt dominant players like Nvidia (NVDA.O) in the AI market. Despite the risks, the potential rewards for early adopters could be substantial.

The allure of tech investments often grows exponentially, reminiscent of the telecom bubble that preceded a crash. As this tech frenzy escalates, monitoring the interdependence between tech giants and emerging AI ventures becomes crucial to mitigate risks and sustain growth.

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Last modified: February 9, 2024
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