A company that has revenues and is extremely well-capitalized gets debt finance. That is not news. That is totally commonplace. "Shouldn't all their capital come from investors?" No. Companies at all stages typically use a mixture of debt and equity finance.
His EV calculation is completely flawed also. Debt finance is typically senior to equity in recovery at bankruptcy, so when JPMC do this analysis (and believe me they did this analysis) they are not assuming 0% recovery. They are thinking it is most likely in a bankruptcy that they get some x>0% recovery.
Finally, banks don't think about their relationship with a multi-billion-dollar company in terms of the ROI on a single revolving credit. (even though this will in all likelihood be very profitable for JPMC). They think about how giving this revolving credit makes it more likely they get advisory on any future bond issuance and I-banking work when OpenAI want to do takeovers, and a foot in the door at IPO time etc.
Yeah, I thought it was weird right away too, but brush it off as a tech blog... but then I realized it's actually a finance website. Ruins the credibility of the website instantly.
The $4B revolver will likely sit undrawn. When it gets drawn, there usually a specific plan to reduce it back to zero. It's not for building data centres, a revolver typically used just for timing differences like a credit card is used (and the lenders will be paying attention). Also, when things get bad, there are covenant triggers which would allow lenders to renegotiate.
The other part is that it's a revolver, not a bond.You only pay what you use. It's not uncommon in VC. If you need to buy stuff now but your next round is in 2 months the revolver saves your ass. And once you raise you pay it back.
Agreed. Crucially, it doesn’t ask _why_ they want this line of credit and assumes it’s to serve as an equal source of financing as capital investment. Yet, I think the reason for this credit line is rather straight-forward risk management: it is not at all inconceivable that any one of the numerous legal proceedings the firm is already entangled in (to say nothing of ones surely to come) conclude in settlements that would be existential without it. If I were an OpenAI investor, I would certainly want a story for how they would handle such an expected emergency. A few other high-growth startups are publicly known to have obtained such a line of credit at a similar stage.
Convertible debt is very different: if you do the same (simplistic) analysis as in the article, it behaves almost like the equity example, not the debt one.
I'm going to paraphrase Matt Levine here -- the central trick of bankers is to divide debt into tranches of claims of different seniority, with different rates of return. Debt is a way to borrow money from investors where they actually have a generally low rate of return specified and have a senior claim on being paid back in the case of insolvency. Stocks are a way to borrow money for investors where they get basically _nothing_ in the case of insolvency, but they expect a higher return from either dividends or stock buy backs, or just from company growth. Different investors have different goals in terms of risk/reward for what they want out of a company they invest in, and providing investors more options unlocks more opportunities to raise money.
1) If OpenAI goes bankrupt, JPMC will get more than 0 on their loan. For some reason I have yet to comprehend, when I was sitting on a credit desk pricing CDS, they always used 40% as the recovery rate. I ran into a credit guy who taught finance at two very famous universities, and he also immediately said 40%, with no explanation.
2) It's a revolver, it's not all being used
3) If things go great and OpenAI ends up buying smaller guys or getting bought out (probably MSFT?) then JPMC will be right in there with those young bankers who don't sleep. They will pull in many many millions in fees with very little expense.
4) If things don't go great, OpenAI will be looking for more financing. Guess who will help them?
5) It's really only in case there's an Enron things are terrible for JPMC. Like if it turns out the whole thing was a bunch of guys in India answering every ChatGPT query, something like that. If there's actually an AI business, and despite JPMC's history of due diligence misses (Javice case) that's probably the case, then there's deals to be done.
The 40% historical recovery rate comes from a long line of companies that actually built things and produced products, often in factories with equipment in them... and a warehouse full of product that didn't sell at full price.
If OpenAI folds, there are two basic scenarios:
- one: the LLM crash has come, and OpenAI barely has any material assets. Microsoft isn't putting more money into it, and they won't take it over -- people with seven figure salaries will be looking for six-figure jobs.
- two: somehow, only OpenAI crashes, and the rest of the LLM boom continues. This likely involves OpenAI being extraordinarily outcompeted, so it's a long slow decline as contracts run out and are not renewed. 40% is probably high, but if JPM can retract the revolving debt before it all goes out the door, not ridiculously high.
> the LLM crash has come, and OpenAI barely has any material assets
They have claims on the use of assets via their leases.
More directly, if AI crashes in the next 2 years, they get bailed out. Between OBBA, tariffs and immigration enforcement, the American economy less AI is probably already in a recession. Trump and the GOP would get desperate if the political leash the AI boom has granted them is shortened. Borrowing another few trillion dollars to fix it would be worth the gamble.
If Softbank buys OpenAI, they don't just sign a contract and send a cheque. They need powerpoint slides from JPMC to make the deal happen, and that costs money.
> Cost: $1,000
Case 1 (90%): OpenAI goes bankrupt. Return: $0
Case 2 (9%): OpenAI becomes a big successful company and goes 10x. Return: $1,000 + 5% interest = $1,050
Case 3 (1%): OpenAI becomes the big new thing and goes 100x. Return: $1,000 + 5% interest = $1,050
The actual math is that if OpenAI succeeds, then there's a nod and a wink that JPM will land the lead role in the IPO or any mergers/acquisitions, which translates into huge fees.
a company with 800 million weekly active users, and only losing $10B-$15B before implementing ads - which IMO is coming fast and soon to the LLM world - i would never calculate a 90% chance their shares end up at $0 before an exit option
This is the easiest money and best relationship JPM could imagine
Also, if OpenAI goes bankrupt, you _much_ prefer to have loaned them money to having bought shares in the company. People who own shares in a bankruptcy only recover anything after all the people that loaned them money are paid back in full.
Or the banks own the most valuable, exclusive, world-changing IP in decades. Nobody else really has a shot at that IP besides a few other extremely-capitalized AI companies.
I'd loan them the money for that opportunity. It's possible that the IP will somehow turn out to be worthless; I don't know what will happen, but I am confident ruling out worthless. Could the lender could refuse Microsoft's payment - from a minority shareholder? OpenAI could accept Microsoft's money and pay the bank; with that offer, OpenAI would have leverage to play Microsoft and the lender against each other.
OpenAI could go bankrupt for many reasons having nothing to do with the value of their IP. For example, they could overinvest in developing it - a positive outcome for the lender.
This author obviously has no experience with investment banks.
OpenAI is massive, fairly risky, associated with Microsoft, etc. all true. What matters to JPM is potential future business. There’s potentially an enormous IPO in the future. The credit line is just good business. They are fostering the relationship.
I’m pretty sure the banks view the intellectual property value as the security for their loan not the potential profits of the company.
I’ve worked for enough startups that even if your company folds and goes bankrupt with no business plan the ip generally can easily cover the outstanding loans.
I think that's got to be highly variable. I've worked for a couple of startups that went under and the IP had basically zero value. Who is going to pay for a failed implementation of a failed idea?
Well, the question isn't what OpenAI's intellectual property is worth right now, or what you expect it to be worth, but what it is likely to be worth after OpenAI has become insolvent (and few/none of the current employees are working on it). The most likely causes for it becoming insolvent are probably that another company out-innovates them, or that the revenues never come in (despite OpenAI being a market leader). In either case, OpenAI's IP is unlikely to be sufficiently superior to the competition's to warrant a large premium.
I am not sure how differentiated OpenAI's IP is, so I don't have a strong opinion, but it seems to me that OpenAI is worth a lot more as a package than it would be as a collection of pieces.
Their web-application is worth $200,000. The software of the training infrastructure is worth perhaps $2M; the inference infrastructure is worth perhaps $500,000. Their hardware is worth nothing in 3 years. Their B2B relations are worth perhaps $5M. The "data" they have is worth nothing in 5 years, because a sufficiently smart model will be able to learn without human feedback.
They have no moat. So, how do you get to $4B?
I think the models are wrong way too often for relatively simple queries, so unless they give a secret prompt like "be wrong a lot in the free version" to users, it's basically worthless.
> I’m pretty sure the banks view the intellectual property value as the security for their loan not the potential profits
Naa that takes too long to get any value from. If openAI goes pop, their IP isn't going to be worth much, because it'll die from competition, or the economy going to shit.
Like he said Microsoft is the most likely person to want to acquire the IP and employees. Amazon could be a potential second. Google paid 2.4b to license Windsurfs technology, OpenAI would go for far more.
Microsoft already has rights to the IP. If OpenAI goes bankrupt, they can hire the employees without buying the company (similar to their offer in 2023 when the board tried to fire Sam Altman). Although if OpenAI goes completely bust, that probably means interest in AI across the industry has tanked, so an acquihire makes little sense over just hiring available talent on the market.
That was one of the key parts of Silicon Valley Bank's business model. And that part worked pretty well: their collapse was caused by mismanaging interest rate risk and they never took many losses on loan defaults.
At this point I would rather consider this kind of large loans to be "political" than "technical", that is say, they may or may not make sense in terms of $$$, but may make a lot of sense in other areas.
Big banks will give sweetheart loans to startups and officers of startup for the opportunity to take a company public. They’ll make billions on the IPO.
> This Reuters article claims OpenAI is going to generate $3.6 billion in revenue this year, but the costs will lead to a loss of more than $5 billion. It expects a major revenue jump next year to $11.6 billion
The article linked[0] is from last year.
A recent article[1] from this year says "OpenAI looks to meet its full-year revenue target of $13 billion and a cash-burn target of $8.5 billion, the report added."
Yeah, this is a pretty major error. They already have a higher revenue than the article's quoted "jump next year" (which was this year and was an underestimate).
Don't worry, people in the thread are now going to pivot to "Uhh, those numbers don't matter! Here's an opinion from some tech blog about the financials of a private company!"
I'm no expert in corporate finance, but whether or not OpenAI goes bankrupt feels like the wrong question to me (in thinking about this loan). Wouldn't a bank be more concerned with (1) the likelihood that OpenAI can raise another round of financing from which to repay the bank, and (2) the likelihood that OpenAI will have assets worth >10B when/if they do eventually declare bankruptcy?
The bank's risk seems quite a bit lower than the VC's risk.
Also 5% would be a ridiculously low rate for this sort of corporate finance. You would expect more like 8-12% I think?
Plus the post seems to only include 1 year of interest.
Unless we know the terms, I don't think we can necessarily calculate EV from JP Morgan's perspective. I would say that they aren't usually carelessly giving away money though... They probably have terms where they can get out early if OpenAI's position weakens etc.
I agree but had different questions. TFA mentions the consideration of whether failure cases are correlated, but of course if OpenAI wins big, there's a good chance this directly or indirectly creates much instability and uncertainty in many other loans/partners. What's the EV on whether that is net-positive considering this is a loan at 5% and not an investment?
On the other side, if OpenAI crashes hard, is it really such a sure thing that Microsoft will be the on the hook to pay off their debts? Setting aside whatever the lawyers could argue about in a post-mortem, are they even obligated to keep their current stake / can they not just divest / sell / otherwise cut their losses if the writing is on the wall?
JPMorgan Chase might not mind ending up owning much of OpenAI's IP if they default on the loan. Banks have largely been locked out of making equity investments in OpenAI so far so perhaps they see this as the next best alternative?
Yes. Then I got to the point where it suggested, rather blithely, that the primary function of banks is to understand and absorb risk. I thought that deserved a reply. Did it bother you?
The government(and taxpayers I assume) actually made out pretty well on the bailout loans. Considering the government still owns 99% of Fannie Mae and Freddie Mac, after retaining billions in profits over the last decade and a half.
Yes, US Treasury has gotten profit from Fannie/Freddie. However, there is concern from OMB that risk is not properly being calculated and thus in event of small housing crisis, US Government would have to back stop them again and possibly wipe out any profits gained.
The primary bailout during the 2008 housing crisis went to homeowners, not to banks through TARP. The secondary bailout was to banks, the Fed bought up trillions of dollars worth of garbage housing assets. That homeowner bailout was never paid back: it damaged the economy in the form of dollar debasement (ie lower purchasing power for everybody holding dollars). The Fed increased its balance sheet 400% in six years, and never looked back. The housing bailout was trillions of dollars, meant to keep that gigantic housing asset pool inflated artificially. We did it again during Covid, with another gigantic consumer bailout.
See: gold at $400 vs gold at $4,000. Aka the destruction of the USD.
Banks are pretty chill about these things. I've been controller on something with a billion+ revolving facility myself.
You can basically throw the entire analysis out on a single point:
>Case 1 (90%): OpenAI goes bankrupt. Return: $0
It won't be $0. Creditors have liquidation priority and banks make very sure they're confident in the quality of the collateral before handing out billion dollar facilities.
Who are you?
Hi, I'm the author. I've been dabbling in investing since 2015 and I decided to get more serious about it in 2023.
Is this financial advice?
No. In fact, everything you read here is be half-baked by design. If it were fully-baked, then I wouldn't have felt the need to write about it in order to distill my thoughts.
> However, there's no speculation about what their earnings will be because they're currently selling their services below cost and there isn't really any story as to how they'll turn this profitable.
Do we know they're selling their services below cost? I'm pretty confident they're making money on inference and burning through large piles of cash on capex and research.
I used to work in IB and I'm not that surprised:
* Revolving credit facilities tend to have the highest priority of corporate debt when it comes to going after assets in the event of default
* RCFs are often about relationship management rather than making money as others have pointed out
* Credit agreements (that set out the terms of RCFs) often include a lot of triggers/rules about how much can be drawn and at what rate to protect lenders. e.g. If revenues are below Y you can only borrow Z
I've determined that it's a bad idea for me to write an article like this because every time I've seen one of these they're absolutely riddled with errors and incomplete information. I have no doubt I'd do worse!
People have to stop saying this with NO evidence to back it up. And by evidence I do not mean random investors opinions, anonymous "insider" infomation, etc. Give numbers. Saying the same thing 1000x doesn't make it true.
What do you mean "no evidence"? The Information had just published a concrete analysis showing the OpenAI is spending the threefold of what they collect in revenues. And many other bloggers, Ed Zitron being one of the better known ones, have been writing about it forever.
>A recent article[1] from this year says "OpenAI looks to meet its full-year revenue target of $13 billion and a cash-burn target of $8.5 billion, the report added."
Well, OpenAI "looks to" a lot of things (AGI by the end of 2025 was also one stated goal), but unfortunately, facts are something else. Your artical sums up the costs for running ChatGPT to 2.5B + another 6.7B for "research and development", a.k.a. bunch of PhDs tweaking the model weights - so that is a total of what, roughly 9B USD? Congrats, their burn for the first half was not 3x times the revenue, it was "only" slightly over 2x times that. I am not sure where did they pull the projection for ~13B revenue for the whole year, if they generated only a third of that in the while first half of it? Maybe from that latest pivot, erotica-ChatGPT, but otherwise...no.
No nothing to do with that. Read up on the report by The Information about how much OpenAI spent in the first half-year vs. how much they collected in revenues, maybe that will clear things up ?
This kind of comment isn’t helpful. Of course, people around here also want AI to succeed for various reasons. Everyone has an agenda. Judge based on the merit of the argument.
The issue is that motivated arguments aren’t honest. It becomes like arguing about politics or religion.
If it turns out that OpenAI becomes wildly profitable, they’ll just shift to some other argument about the environment or the specialness of human thought or whatever.
But they aren’t profitable, and there’s no clear path for them to become profitable. The people you’re railing against aren’t exactly wrong to be skeptical.
Surely the burden of proof lies on the more unbelievable side?
Show me how a company setting never before seen piles of money on fire is profitable. Until someone can i'll happily keep claiming they're unprofitable.
The claim is that they are profitable -- all businesses are unprofitable until proven otherwise. That's the null hypothesis for business profitability. The null hypothesis is what must be disproven with evidence.
Right, I am saying there is no evidence they are profitable, so we fall back to the default, that they are unprofitable.
Indeed, the other poster seems right: "The burden of evidence is on the side of the person making the claim" is simplistic and reductionist. "The burden of proof lies on the more unbelievable side" is more appropriate.
Taking an example: If I said the earth was not flat, and someone else told me to prove it, that proof would be unnecessary, because the earth being flat is more unbelievable than the alternative.
>Taking an example: If I said 1+1=2 and someone else told me to prove it, that proof would be unnecessary, because 1+1=2 is more believable than any alternative sum.
It's not just strange, but completely regarded, _assuming_ no more information, but since it's JPM, of course they know more, which probably make it a lot less regarded.
I would not be happy with this trade if I had any $JPM.
It was a waste of time to read. TLDR is if OpenAI were a random startup it’d be strange but because it has credible shareholders that stand to lose in a bankruptcy (weirdly constructed argument), it’s probably safe enough.
Duh. Basically the author wrote a word salad to say the bank calculated the probability of them losing money would be lower than what the author pulled out of their ass at the beginning of the article, refuting their own hypothetical point.
All that text to somehow not realize that large companies routinely take on banking relationships, including debt, specifically to start cultivating the various relationships/trust they'll want access to in the future. Apple and Microsoft both did this at massive scale even though they didn't have to, in order to prime the debt markets in regards to relationships/trust.
I mean, let's be honest there. This is much different than the blockchain bubble, in which 2/3 of the population is actually utilizing or interacting with AI daily.
While, yes, it's overhyped and takes up too much of the spotlight, it isn't going anywhere and is going to continue to be a staple in our lives moving forward, and will continue to increase in impact as it improves.
Blockchain will always be blockchain, and it was absolutely a bubble. Will it improve? Sure. Will it ever be as impactful to the everyday individual as AI? Maybe, but most people will not know or care. It will mostly be a passive experience.
AI will/has fundamentally changed how we work in the matter of 3 years. So, financial system jumping on board this, is much safer than jumping onboard crypto hype trains.
(I'm not saying crypto is bad / is a bad investment, but lots of crypto and ai startups are both trash, well, most startups are trash, I say that as a founder who has had many trash ideas)
"AI will/has fundamentally changed how we work in the matter of 3 years"
The past 3 years or the next 3 years or 1.5 years both ways?
It hasn't really done that yet. The work from home zoom meetings has made a bigger impact. Maybe in a few years? Its on par with the metaverse at this point.
> I mean, let's be honest there. This is much different than the blockchain bubble, in which 2/3 of the population is actually utilizing or interacting with AI daily.
You do remember that by the time the blockchain bubble burst, literally everyone and their mother were "interacting" with it?
> AI will/has fundamentally changed how we work in the matter of 3 years
For people in bullshit jobs creating workslops, yes its probably an absolute blessing. Enjoy it while it lasts.
They don't need an IPO. "Private equity funds" are already being offered to retail investors. Less oversight and a way to pass the risk to gullible retail investors.
He's calculating EV above cost. If you look at the calculation, the first term is -1000 to account for the initial investment. So the final value is tell you that you got back the initial money plus 900 more.
What a weird analysis.
A company that has revenues and is extremely well-capitalized gets debt finance. That is not news. That is totally commonplace. "Shouldn't all their capital come from investors?" No. Companies at all stages typically use a mixture of debt and equity finance.
His EV calculation is completely flawed also. Debt finance is typically senior to equity in recovery at bankruptcy, so when JPMC do this analysis (and believe me they did this analysis) they are not assuming 0% recovery. They are thinking it is most likely in a bankruptcy that they get some x>0% recovery.
Finally, banks don't think about their relationship with a multi-billion-dollar company in terms of the ROI on a single revolving credit. (even though this will in all likelihood be very profitable for JPMC). They think about how giving this revolving credit makes it more likely they get advisory on any future bond issuance and I-banking work when OpenAI want to do takeovers, and a foot in the door at IPO time etc.
Yeah, I thought it was weird right away too, but brush it off as a tech blog... but then I realized it's actually a finance website. Ruins the credibility of the website instantly.
The $4B revolver will likely sit undrawn. When it gets drawn, there usually a specific plan to reduce it back to zero. It's not for building data centres, a revolver typically used just for timing differences like a credit card is used (and the lenders will be paying attention). Also, when things get bad, there are covenant triggers which would allow lenders to renegotiate.
The other part is that it's a revolver, not a bond.You only pay what you use. It's not uncommon in VC. If you need to buy stuff now but your next round is in 2 months the revolver saves your ass. And once you raise you pay it back.
Agreed. Crucially, it doesn’t ask _why_ they want this line of credit and assumes it’s to serve as an equal source of financing as capital investment. Yet, I think the reason for this credit line is rather straight-forward risk management: it is not at all inconceivable that any one of the numerous legal proceedings the firm is already entangled in (to say nothing of ones surely to come) conclude in settlements that would be existential without it. If I were an OpenAI investor, I would certainly want a story for how they would handle such an expected emergency. A few other high-growth startups are publicly known to have obtained such a line of credit at a similar stage.
Are there other examples of well capitalized technology startups that have significant revenues that have also opted for significant debt financing?
Amazon issued $1.25 billion in convertible debt in 1999: https://www.wired.com/1999/01/an-amazonian-debt/
Convertible debt is very different: if you do the same (simplistic) analysis as in the article, it behaves almost like the equity example, not the debt one.
We had way more debt than venture financing in the pre-ipo days of DigitalOcean. Thanks Michael Dell!
I'm going to paraphrase Matt Levine here -- the central trick of bankers is to divide debt into tranches of claims of different seniority, with different rates of return. Debt is a way to borrow money from investors where they actually have a generally low rate of return specified and have a senior claim on being paid back in the case of insolvency. Stocks are a way to borrow money for investors where they get basically _nothing_ in the case of insolvency, but they expect a higher return from either dividends or stock buy backs, or just from company growth. Different investors have different goals in terms of risk/reward for what they want out of a company they invest in, and providing investors more options unlocks more opportunities to raise money.
Amazon?
https://www.seattletimes.com/business/amazon-pays-off-its-hi...
This is literally the reason behind the collapse of Silicon Valley Bank. Debt keeps your cap table untouched, its very tempting at certain stages
> well capitalized technology startups that have significant revenues that have also opted for significant debt financing?
Debt is almost always cheaper than equity. Particularly if you can collateralise.
Well-capitalized companies rejecting debt is more of a Silicon Valley outlier in the global economy. (It likely stems from dot-com trauma.)
Are there other examples of well capitalized technology startups
I think we're well beyond the point where OpenAI can be called a "startup."
Pointless argument unless you define what startup means.
Different dictionaries provide different definitions.
A common one is that it's small and recently started business, but it's a very vague boundary.
1) If OpenAI goes bankrupt, JPMC will get more than 0 on their loan. For some reason I have yet to comprehend, when I was sitting on a credit desk pricing CDS, they always used 40% as the recovery rate. I ran into a credit guy who taught finance at two very famous universities, and he also immediately said 40%, with no explanation.
2) It's a revolver, it's not all being used
3) If things go great and OpenAI ends up buying smaller guys or getting bought out (probably MSFT?) then JPMC will be right in there with those young bankers who don't sleep. They will pull in many many millions in fees with very little expense.
4) If things don't go great, OpenAI will be looking for more financing. Guess who will help them?
5) It's really only in case there's an Enron things are terrible for JPMC. Like if it turns out the whole thing was a bunch of guys in India answering every ChatGPT query, something like that. If there's actually an AI business, and despite JPMC's history of due diligence misses (Javice case) that's probably the case, then there's deals to be done.
The 40% historical recovery rate comes from a long line of companies that actually built things and produced products, often in factories with equipment in them... and a warehouse full of product that didn't sell at full price.
If OpenAI folds, there are two basic scenarios:
- one: the LLM crash has come, and OpenAI barely has any material assets. Microsoft isn't putting more money into it, and they won't take it over -- people with seven figure salaries will be looking for six-figure jobs.
- two: somehow, only OpenAI crashes, and the rest of the LLM boom continues. This likely involves OpenAI being extraordinarily outcompeted, so it's a long slow decline as contracts run out and are not renewed. 40% is probably high, but if JPM can retract the revolving debt before it all goes out the door, not ridiculously high.
> the LLM crash has come, and OpenAI barely has any material assets
They have claims on the use of assets via their leases.
More directly, if AI crashes in the next 2 years, they get bailed out. Between OBBA, tariffs and immigration enforcement, the American economy less AI is probably already in a recession. Trump and the GOP would get desperate if the political leash the AI boom has granted them is shortened. Borrowing another few trillion dollars to fix it would be worth the gamble.
4) If things don't go great, OpenAI will be looking for more financing. Guess who will help them?
Who? I can only think of the Saudis/UAE and SoftBank.
If Softbank buys OpenAI, they don't just sign a contract and send a cheque. They need powerpoint slides from JPMC to make the deal happen, and that costs money.
The math is wrong:
> Cost: $1,000 Case 1 (90%): OpenAI goes bankrupt. Return: $0 Case 2 (9%): OpenAI becomes a big successful company and goes 10x. Return: $1,000 + 5% interest = $1,050 Case 3 (1%): OpenAI becomes the big new thing and goes 100x. Return: $1,000 + 5% interest = $1,050
The actual math is that if OpenAI succeeds, then there's a nod and a wink that JPM will land the lead role in the IPO or any mergers/acquisitions, which translates into huge fees.
Not to mention the risks that OpenAI even if it does goes bankrupt sells for less than 4b is not anywhere close to 90%.
a company with 800 million weekly active users, and only losing $10B-$15B before implementing ads - which IMO is coming fast and soon to the LLM world - i would never calculate a 90% chance their shares end up at $0 before an exit option
This is the easiest money and best relationship JPM could imagine
> a company with 800 million weekly active users
Wow, that's slightly more than Yahoo has. Well, had.
This is correct.
This isn't a financial transaction. This is a "relationship" transaction.
Also, if OpenAI goes bankrupt, you _much_ prefer to have loaned them money to having bought shares in the company. People who own shares in a bankruptcy only recover anything after all the people that loaned them money are paid back in full.
Or the banks own the most valuable, exclusive, world-changing IP in decades. Nobody else really has a shot at that IP besides a few other extremely-capitalized AI companies.
I'd loan them the money for that opportunity. It's possible that the IP will somehow turn out to be worthless; I don't know what will happen, but I am confident ruling out worthless. Could the lender could refuse Microsoft's payment - from a minority shareholder? OpenAI could accept Microsoft's money and pay the bank; with that offer, OpenAI would have leverage to play Microsoft and the lender against each other.
OpenAI could go bankrupt for many reasons having nothing to do with the value of their IP. For example, they could overinvest in developing it - a positive outcome for the lender.
Which IP is that?
This author obviously has no experience with investment banks.
OpenAI is massive, fairly risky, associated with Microsoft, etc. all true. What matters to JPM is potential future business. There’s potentially an enormous IPO in the future. The credit line is just good business. They are fostering the relationship.
I’m pretty sure the banks view the intellectual property value as the security for their loan not the potential profits of the company.
I’ve worked for enough startups that even if your company folds and goes bankrupt with no business plan the ip generally can easily cover the outstanding loans.
I think that's got to be highly variable. I've worked for a couple of startups that went under and the IP had basically zero value. Who is going to pay for a failed implementation of a failed idea?
I don't think OpenAI will be one of those companies. I can't imagine a world where OpenAI sells for less than 4b.
Well, the question isn't what OpenAI's intellectual property is worth right now, or what you expect it to be worth, but what it is likely to be worth after OpenAI has become insolvent (and few/none of the current employees are working on it). The most likely causes for it becoming insolvent are probably that another company out-innovates them, or that the revenues never come in (despite OpenAI being a market leader). In either case, OpenAI's IP is unlikely to be sufficiently superior to the competition's to warrant a large premium.
I am not sure how differentiated OpenAI's IP is, so I don't have a strong opinion, but it seems to me that OpenAI is worth a lot more as a package than it would be as a collection of pieces.
Their web-application is worth $200,000. The software of the training infrastructure is worth perhaps $2M; the inference infrastructure is worth perhaps $500,000. Their hardware is worth nothing in 3 years. Their B2B relations are worth perhaps $5M. The "data" they have is worth nothing in 5 years, because a sufficiently smart model will be able to learn without human feedback.
They have no moat. So, how do you get to $4B?
I think the models are wrong way too often for relatively simple queries, so unless they give a secret prompt like "be wrong a lot in the free version" to users, it's basically worthless.
Too bad that's not how much they spent on that all of that, though.
Where are you getting these numbers? And how would you appraise the value of the windsurf IP which sold for 2.4b?
He's probably estimating the cost to produce these, after the fact.
> The "data" they have is worth nothing in 5 years, because a sufficiently smart model will be able to learn without human feedback.
This is a huge assumption.
> I’m pretty sure the banks view the intellectual property value as the security for their loan not the potential profits
Naa that takes too long to get any value from. If openAI goes pop, their IP isn't going to be worth much, because it'll die from competition, or the economy going to shit.
Depends if they end up in a position to shake down the rest of the industry, as Google can with the Transformer patent(s).
Who buys the IP?
Like he said Microsoft is the most likely person to want to acquire the IP and employees. Amazon could be a potential second. Google paid 2.4b to license Windsurfs technology, OpenAI would go for far more.
Microsoft already has rights to the IP. If OpenAI goes bankrupt, they can hire the employees without buying the company (similar to their offer in 2023 when the board tried to fire Sam Altman). Although if OpenAI goes completely bust, that probably means interest in AI across the industry has tanked, so an acquihire makes little sense over just hiring available talent on the market.
It must be nice to put IP up as collateral for a loan. I know myself and a few other founders have tried and basically been told to go pound sand.
That was one of the key parts of Silicon Valley Bank's business model. And that part worked pretty well: their collapse was caused by mismanaging interest rate risk and they never took many losses on loan defaults.
Parts of SVB got picked up by JPM.
At this point I would rather consider this kind of large loans to be "political" than "technical", that is say, they may or may not make sense in terms of $$$, but may make a lot of sense in other areas.
> Case 1 (90%): OpenAI goes bankrupt. Return: $0
The loan value in case OpenAI goes bankrupt depends on the details of the deal.
It's almost certainly not $0 for JP Morgan. It might be $750 or $400 or whatever but it's not $0.
Big banks will give sweetheart loans to startups and officers of startup for the opportunity to take a company public. They’ll make billions on the IPO.
> This Reuters article claims OpenAI is going to generate $3.6 billion in revenue this year, but the costs will lead to a loss of more than $5 billion. It expects a major revenue jump next year to $11.6 billion
The article linked[0] is from last year.
A recent article[1] from this year says "OpenAI looks to meet its full-year revenue target of $13 billion and a cash-burn target of $8.5 billion, the report added."
[0]https://www.reuters.com/technology/artificial-intelligence/o...
[1] https://www.reuters.com/technology/openais-first-half-revenu...
Aren’t they still deep in the red? What’s the justification for claiming they’ll become profitable?
Yeah, this is a pretty major error. They already have a higher revenue than the article's quoted "jump next year" (which was this year and was an underestimate).
Don't worry, people in the thread are now going to pivot to "Uhh, those numbers don't matter! Here's an opinion from some tech blog about the financials of a private company!"
I'm no expert in corporate finance, but whether or not OpenAI goes bankrupt feels like the wrong question to me (in thinking about this loan). Wouldn't a bank be more concerned with (1) the likelihood that OpenAI can raise another round of financing from which to repay the bank, and (2) the likelihood that OpenAI will have assets worth >10B when/if they do eventually declare bankruptcy?
The bank's risk seems quite a bit lower than the VC's risk.
Also 5% would be a ridiculously low rate for this sort of corporate finance. You would expect more like 8-12% I think?
Plus the post seems to only include 1 year of interest.
Unless we know the terms, I don't think we can necessarily calculate EV from JP Morgan's perspective. I would say that they aren't usually carelessly giving away money though... They probably have terms where they can get out early if OpenAI's position weakens etc.
> feels like the wrong question to me
I agree but had different questions. TFA mentions the consideration of whether failure cases are correlated, but of course if OpenAI wins big, there's a good chance this directly or indirectly creates much instability and uncertainty in many other loans/partners. What's the EV on whether that is net-positive considering this is a loan at 5% and not an investment?
On the other side, if OpenAI crashes hard, is it really such a sure thing that Microsoft will be the on the hook to pay off their debts? Setting aside whatever the lawyers could argue about in a post-mortem, are they even obligated to keep their current stake / can they not just divest / sell / otherwise cut their losses if the writing is on the wall?
JPMorgan Chase might not mind ending up owning much of OpenAI's IP if they default on the loan. Banks have largely been locked out of making equity investments in OpenAI so far so perhaps they see this as the next best alternative?
> Luckily for us, banks exist!
Exactly. If they completely fail and threaten to take the economy with them then they can just say "Luckily for us, taxpayers exist!"
Have you even read the article before posting?
Yes. Then I got to the point where it suggested, rather blithely, that the primary function of banks is to understand and absorb risk. I thought that deserved a reply. Did it bother you?
All the money lent to banks via TARP during the 2008 crisis was paid back with interest.
The government(and taxpayers I assume) actually made out pretty well on the bailout loans. Considering the government still owns 99% of Fannie Mae and Freddie Mac, after retaining billions in profits over the last decade and a half.
Yes, US Treasury has gotten profit from Fannie/Freddie. However, there is concern from OMB that risk is not properly being calculated and thus in event of small housing crisis, US Government would have to back stop them again and possibly wipe out any profits gained.
TARP was a collection of programs and not a general loan facility.
The primary bailout during the 2008 housing crisis went to homeowners, not to banks through TARP. The secondary bailout was to banks, the Fed bought up trillions of dollars worth of garbage housing assets. That homeowner bailout was never paid back: it damaged the economy in the form of dollar debasement (ie lower purchasing power for everybody holding dollars). The Fed increased its balance sheet 400% in six years, and never looked back. The housing bailout was trillions of dollars, meant to keep that gigantic housing asset pool inflated artificially. We did it again during Covid, with another gigantic consumer bailout.
See: gold at $400 vs gold at $4,000. Aka the destruction of the USD.
Inflation was stable and pretty low for the 10 years after the financial crisis.
Gold wasn't at $400 per oz before the financial crisis, and the spike in gold prices was fairly recent.
Basically the financial crisis response didn't cause inflation, the covid response did.
Paid back with interest but also inflation.
Secured debt doesn't go to zero in the 90% failure mode...
- a company with 800m weekly actives is not going bankrupt
- existing models are profitable if cutoff future training and focused on inference
- debt is senior to equity
- if my life depended on one company not going bankrupt over the next decade I’d pick OAI over Citibank
- banks use revolving credit as a break even or loss leader for higher fee business
- high fixed cost businesses use debt and equity to scale
- lead investors would very rarely pay down the debt of an investment, that’s not the backstop
- unlikely for revolving credit, but a convertible structure could mitigate any perceived asymmetric downside
Banks are pretty chill about these things. I've been controller on something with a billion+ revolving facility myself.
You can basically throw the entire analysis out on a single point:
>Case 1 (90%): OpenAI goes bankrupt. Return: $0
It won't be $0. Creditors have liquidation priority and banks make very sure they're confident in the quality of the collateral before handing out billion dollar facilities.
Interesting that they seem to misunderstand the difference between Equity Risk and Debt Risk, they also misapplied bond spreads.
Anyway, J.P. Morgan's OpenAI loan isn't strange, it's calculated exposure to Microsoft.
This is not a serious person.
Taken from the About page:
Who are you? Hi, I'm the author. I've been dabbling in investing since 2015 and I decided to get more serious about it in 2023.
Is this financial advice? No. In fact, everything you read here is be half-baked by design. If it were fully-baked, then I wouldn't have felt the need to write about it in order to distill my thoughts.
Ad hom
> Ctrl-F "convertible"
> 0 of 0 matches
Some analysis.
> However, there's no speculation about what their earnings will be because they're currently selling their services below cost and there isn't really any story as to how they'll turn this profitable.
Do we know they're selling their services below cost? I'm pretty confident they're making money on inference and burning through large piles of cash on capex and research.
I used to work in IB and I'm not that surprised: * Revolving credit facilities tend to have the highest priority of corporate debt when it comes to going after assets in the event of default * RCFs are often about relationship management rather than making money as others have pointed out * Credit agreements (that set out the terms of RCFs) often include a lot of triggers/rules about how much can be drawn and at what rate to protect lenders. e.g. If revenues are below Y you can only borrow Z
I've determined that it's a bad idea for me to write an article like this because every time I've seen one of these they're absolutely riddled with errors and incomplete information. I have no doubt I'd do worse!
This just reminds me of how flimsy cases are bolstered as soon as you put numbers and formulae in them.
The loan is likely secured by OpenAI's assets, including hardware, facilities, and IP.
The scenario and assumptions used in this are not just wrong, but they are simple and wrong.
>OpenAI is not a profitable company.
People have to stop saying this with NO evidence to back it up. And by evidence I do not mean random investors opinions, anonymous "insider" infomation, etc. Give numbers. Saying the same thing 1000x doesn't make it true.
What do you mean "no evidence"? The Information had just published a concrete analysis showing the OpenAI is spending the threefold of what they collect in revenues. And many other bloggers, Ed Zitron being one of the better known ones, have been writing about it forever.
Nope, proven wrong upthread :)
>A recent article[1] from this year says "OpenAI looks to meet its full-year revenue target of $13 billion and a cash-burn target of $8.5 billion, the report added."
[1] https://www.reuters.com/technology/openais-first-half-revenu...
Well, OpenAI "looks to" a lot of things (AGI by the end of 2025 was also one stated goal), but unfortunately, facts are something else. Your artical sums up the costs for running ChatGPT to 2.5B + another 6.7B for "research and development", a.k.a. bunch of PhDs tweaking the model weights - so that is a total of what, roughly 9B USD? Congrats, their burn for the first half was not 3x times the revenue, it was "only" slightly over 2x times that. I am not sure where did they pull the projection for ~13B revenue for the whole year, if they generated only a third of that in the while first half of it? Maybe from that latest pivot, erotica-ChatGPT, but otherwise...no.
There’s a lot of motivated reasoning going on around here. People want AI to fail so it doesn’t threaten their $300k developer salary.
No nothing to do with that. Read up on the report by The Information about how much OpenAI spent in the first half-year vs. how much they collected in revenues, maybe that will clear things up ?
This kind of comment isn’t helpful. Of course, people around here also want AI to succeed for various reasons. Everyone has an agenda. Judge based on the merit of the argument.
The issue is that motivated arguments aren’t honest. It becomes like arguing about politics or religion.
If it turns out that OpenAI becomes wildly profitable, they’ll just shift to some other argument about the environment or the specialness of human thought or whatever.
But they aren’t profitable, and there’s no clear path for them to become profitable. The people you’re railing against aren’t exactly wrong to be skeptical.
The “clear path” is they stop building new datacenters and spending billions on R&D to train new models. This would make them profitable overnight.
Surely the burden of proof lies on the more unbelievable side?
Show me how a company setting never before seen piles of money on fire is profitable. Until someone can i'll happily keep claiming they're unprofitable.
The burden of evidence is on the side of the person making the claim.
The claim is that they are profitable -- all businesses are unprofitable until proven otherwise. That's the null hypothesis for business profitability. The null hypothesis is what must be disproven with evidence.
That's not the definition of null hypothesis buddy
I am not convinced by your assertion there, friend. Do you, in fact, have evidence they are profitable?
Obviously we cannot assume every business is profitable unless proven unprofitable. That's why reporting and audits exist.
Note that they totally could be! I'm not asserting one or the other. But unprofitable is the default, absent evidence.
Huh? I never said they were profitable. In fact, I never even said they were not unprofitable.
Right, I am saying there is no evidence they are profitable, so we fall back to the default, that they are unprofitable.
Indeed, the other poster seems right: "The burden of evidence is on the side of the person making the claim" is simplistic and reductionist. "The burden of proof lies on the more unbelievable side" is more appropriate.
Taking an example: If I said the earth was not flat, and someone else told me to prove it, that proof would be unnecessary, because the earth being flat is more unbelievable than the alternative.
>Taking an example: If I said 1+1=2 and someone else told me to prove it, that proof would be unnecessary, because 1+1=2 is more believable than any alternative sum.
Oh, so you are just trolling. Got it.
It's not just strange, but completely regarded, _assuming_ no more information, but since it's JPM, of course they know more, which probably make it a lot less regarded.
I would not be happy with this trade if I had any $JPM.
It was a waste of time to read. TLDR is if OpenAI were a random startup it’d be strange but because it has credible shareholders that stand to lose in a bankruptcy (weirdly constructed argument), it’s probably safe enough.
Duh. Basically the author wrote a word salad to say the bank calculated the probability of them losing money would be lower than what the author pulled out of their ass at the beginning of the article, refuting their own hypothetical point.
All that text to somehow not realize that large companies routinely take on banking relationships, including debt, specifically to start cultivating the various relationships/trust they'll want access to in the future. Apple and Microsoft both did this at massive scale even though they didn't have to, in order to prime the debt markets in regards to relationships/trust.
Mixing the AI bubble with the financial system. What could possibly go wrong.
I mean, let's be honest there. This is much different than the blockchain bubble, in which 2/3 of the population is actually utilizing or interacting with AI daily.
While, yes, it's overhyped and takes up too much of the spotlight, it isn't going anywhere and is going to continue to be a staple in our lives moving forward, and will continue to increase in impact as it improves.
Blockchain will always be blockchain, and it was absolutely a bubble. Will it improve? Sure. Will it ever be as impactful to the everyday individual as AI? Maybe, but most people will not know or care. It will mostly be a passive experience.
AI will/has fundamentally changed how we work in the matter of 3 years. So, financial system jumping on board this, is much safer than jumping onboard crypto hype trains.
(I'm not saying crypto is bad / is a bad investment, but lots of crypto and ai startups are both trash, well, most startups are trash, I say that as a founder who has had many trash ideas)
"AI will/has fundamentally changed how we work in the matter of 3 years"
The past 3 years or the next 3 years or 1.5 years both ways?
It hasn't really done that yet. The work from home zoom meetings has made a bigger impact. Maybe in a few years? Its on par with the metaverse at this point.
> I mean, let's be honest there. This is much different than the blockchain bubble, in which 2/3 of the population is actually utilizing or interacting with AI daily.
You do remember that by the time the blockchain bubble burst, literally everyone and their mother were "interacting" with it?
> AI will/has fundamentally changed how we work in the matter of 3 years
For people in bullshit jobs creating workslops, yes its probably an absolute blessing. Enjoy it while it lasts.
The lead bank in OpenAI’s IPO will take something like 4-5% of the biggest IPO in history.
In the 1% scenario, JPM could be looking at tens of billions on the upside, if this loan secures them the lead.
"We're the primary lender for the AI boom" has some $$$ value as well.
My very first thought was that somebody needs to take the lead for the IPO circus...
(Also, a revolving credit facility is not a loan, which this discussion misses)
They don't need an IPO. "Private equity funds" are already being offered to retail investors. Less oversight and a way to pass the risk to gullible retail investors.
It's silly to assume that they have a 90% chance of failure just because startups have a 90% failure rate or whatever.
TLDR - MS won't let OpenAI go bankrupt/get seized by JPM so they're loaning with the concept that MS is backing it.
The first example has a miscalculation; if you invest 1k and the EV is 900, then your choice has negative ROI, not positive.
He's calculating EV above cost. If you look at the calculation, the first term is -1000 to account for the initial investment. So the final value is tell you that you got back the initial money plus 900 more.
However, the article is technically inconsistent in framing.
The calculation that arrives at 900 has already subtracted the 1000 from the start.
it's correct. the EV is 900 after accounting for the 90% probability of -$1000. that's what the first term in the sum is for.