AI is complicated. The financial challenge facing CoreWeave is easier to grasp: Its returns need to exceed its borrowing costs.
And no amount of hype tied to the promise of AI technologies can change that.
It's a lesson CoreWeave is confronting, and one that could spread across the broader AI landscape over the coming months as borrowing costs remain elevated, inflation pressure keeps the Federal Reserve on rate hike watch, and competition for capital intensifies.
CoreWeave shares reflect that concern, having tumbled nearly 70% from their peak in late October of last year year to trade below $60 in early Tuesday trading.
The move also pegs its equity market value at just $34 billion, around one-third below the $51 billion in debt and lease obligations sitting on its balance sheet.
What's driving the stock lower, and stoking even greater concerns in credit markets that track AI borrowing, is a fundamental concern: whether CoreWeave can earn returns that exceed its borrowing costs.
And for a company that plans to spend nearly $40 billion building out its data center business this year, while generating around $13 billion in overall revenue, the financing challenge is significant.
The bond markets have noticed.
The group's debt due in 2031 is trading at around 79.5 cents on the dollar, while its June 2030 bonds are changing hands at 83.1 cents.
Credit default swaps on CoreWeave debt are trading well north of 1,000 basis points and at levels that suggest a greater-than-55% chance of default over five years.
Buying protection against a CoreWeave default costs around $1.1 million each year, over the next five years, for $10 million worth of bonds. That signals concern about the interest rates the company could face on its next round of borrowing to buy more chips and place them in newly constructed data centers.
But that also comes amid pressure on potential returns, given the decline in AI token costs and intensifying competition from players in China and elsewhere, which are building out data center capacity with cheaper chips and lower-cost systems.
HSBC estimates CoreWeave will earn around $12 million in annual revenue for each megawatt of data center power it leases next year, a tally that's around one-third lower than its competitors and some 70% lower than it earned from short term deals signed this year.
"The AI math problem (i.e., aggressive spending versus unknown future profits) is receiving more scrutiny," said Anthony Saglimbene, chief market strategist at Ameriprise. "Investors are becoming less willing to finance growth in the current environment without a clearer path to stronger returns."
That likely puts the tech-sector earnings season, and the updates from hyperscaler giants such as Amazon, Alphabet, Microsoft, Meta Platforms and Oracle, in sharp focus.
"We expect analysts to ask the hyperscalers more pointed questions about spending discipline on earnings calls," Saglimbene said. "Given that they're likely to spend over $1 trillion in capex over the next 12 months, we doubt management will get a free pass from explaining why they can't slow their spending down in order to better protect their balance sheets.
That's significant for CoreWeave, which relies on Microsoft, Meta and AI startup OpenAI to deliver the bulk of its $100 billion revenue backlog.
And, as Jim Reid, Deutsche Bank's global head of macro research, "megacap capex is the revenue of almost every infrastructure winner" in the market.
As such, "the AI trade probably cracks if megacap spending unexpectedly slows -- or if investors stop believing that spending is generating an adequate return," he added. "So although investors are no longer simply just investing in the megacaps, they are relying on their budgets and increasingly discriminating between the companies spending those budgets and those proving they can monetize them."
Few expect interest rates to fall anytime soon, given inflation metrics, the Fed's coded messaging on policy tightening, and the recent surge in global crude prices, to happen anytime soon.
Broader fiscal issues, meanwhile, have benchmark 10-year Treasury yields trading near the highest levels in two decades, and investment-grade borrowing costs pegged at the highest levels in nearly three years.
Further down the credit spectrum, where junk-rated CoreWeave will need to borrow cash, investors are demanding an extra 320 basis points on top of Treasury yields to part with their cash. And some of CoreWeave's outstanding debt already trades with yields as high as 15%.
"This may hamper the company's ability to finance speculative capacity or capacity that is backed by only short-term contracts," said HSBC's senior technology analyst Abhishek Shukla in a note published Tuesday. "This removes one key upside for the stock, in our opinion."
"We also note that consensus is assuming a significant reduction in the interest rate that CoreWeave will need to pay on its debt, which seems increasingly unlikely to us," he added.
And therein lies the simplicity.
Whether CoreWeave triggers a new and sharper assessment of the market's biggest trade of the past four years, or merely becomes a cautionary tale about the risks of debt-fueled expansion, remains to be seen.
What's certain to linger, however, is the gap between the company's $80 billion equity valuation in June of last year, tied to the promise of seemingly limitless AI growth, and its struggle today to convince investors that the financial math works.
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