The next artificial intelligence (AI) boom is underway, but market excitement is obscuring real questions about profitability, says Jason Walsh
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Now that the courtroom pantomime is over, we can expect both OpenAI and SpaceX, which owns xAI, to turn to the public markets in a dash for cash.
Indeed, SpaceX’s long-expected initial public offering (IPO) was announced this morning, and has already been described as record-breaking.
It seems to me that both flotations should give pause for thought.
SpaceX first, as it is first out of the traps: the rocket company, best known for its Starlink satellite broadband system is, in fact, a mini-conglomerate of sorts. In February this year, the company paid a reported $250 billion (approx. €215 billion) to take control of xAI. A month later, xAI paid $33 billion (approx €28.4 billion) to take over the troubled social network X, formerly known as Twitter.
We can assume, however, that SpaceX shares will not offer the traditional ‘conglomerate discount’ that markets slap onto unwieldy businesses that get rolled up together for no obvious reason.
Indeed, Musk’s car company Tesla is already known for trading on ‘vibes’, with a valuation entirely unsupported by the company’s sales – or indeed, any actual potential for sales. Tesla’s profit to earnings (P/E) ratio is just shy of 500. A P/E of 20 means investors pay $20 for every $1 of profit.
Toyota’s P/E, as of the time of writing, is just under 20.
Turning to OpenAI, which is also expected to float this year, the Financial Times noted last year that the company had an inflated valuation. That may or may not be interesting, but, according to a report published by Bloomberg in March, it, and SpaceX, could be fast-tracked into stock market indices, bypassing rules around profitability and waiting times.
That is interesting.
“S&P Dow Jones Indices LLC is considering changes to rules governing how companies join the S&P 500 Index, a move that would potentially fast-track SpaceX’s entry after its IPO,” Bloomberg wrote.
At present, companies must be profitable and listed on the stock market for a year before they are admitted to the index.
The immediate impact of a change to these rules would be an immediate jump in share prices, delivering outsized winnings to the private investors who subsidised the companies as their shares are placed on the public markets.
The S&P 500 is a simply a collection of the 500 most valuable (by market capitalisation, which is to say the total value of all outstanding shares) companies in the US, and is used by investment companies to package up investments as it is seen as a useful proxy for the most productive part of the American economy.
Passive (lack of) income
In simple terms, so-called ‘passive investors’ would wake up to find out that they not only suddenly owned shares in an unprofitable company, but that they had purchased these shares at an extremely high price.
Bluntly: anyone with any investment in market indices, which is to say almost anyone with a pension or life assurance contract, will be forced to buy these companies. That is how passive investing works: the pensions and funds automatically buy the shares in a given index based on their market value. No human intervention occurs and no consideration is given to business fundamentals.
Passive investing has succeeded as it bypasses the need to pick winners, instead buying the entire market, or a proxy for it like the S&P 500, and experiencing the drift upwards as successful companies’ share prices outpace less successful ones.
If the rules are changed, the approximate $24 trillion (approx €20.7 trillion) currently invested in the S&P 500 will be rearranged, something which, in turn, would create a short-term boom in share prices. Short term.
John Bogle, the father of passive investing, warned before his death that markets’ ‘price discovery’ mechanisms would start to fail if too many investors blindly bought the biggest companies. More immediately, though, the question here is one of regulation. Why should longstanding rules about profitability be abandoned?
Notably, this is all happening at a time when the ‘free money’ era of 0% interest rates is a distant memory, meaning tech companies are no longer able to bamboozle investors with profitless ‘blitz-scaling’ and promises of jam tomorrow.
Forcing the public to buy shares in your company does not sound, to me, like a good idea so much as it sounds like an exit strategy.