To The Moon

Last week I wrote a post on the opportunity for Neoclouds. At the end I teased out an idea that these businesses could really surprise people if chips retained value after a 4-5 year useful life, and I wanted to unpack that a bit this week.

First - it’s important to go through some of the unit economics / business model of these Neoclouds to understand why the useful life of these chips matter. There’s largely three different types of “deals” different offtakers (ie labs, hyperscalers, AI natives, etc) make with these neoclouds. Bare metal, “managed kubernetes”, and “full cloud.” Bare metal is the most stripped-down offering.

The neocloud delivers the physical GPUs, networking, and power, and the customer brings everything else (their own scheduler, orchestration, storage layer, software stack), essentially renting the raw iron. Managed Kubernetes is the middle ground. The neocloud handles the orchestration layer on top of the bare metal (so the customer doesn't have to babysit cluster management, node failures, networking config, etc), but the customer is still running their own workloads and software.

Full cloud is the closest analog to what $Amazon.com(AMZN)$ AWS / $Microsoft(MSFT)$ Azure / $Alphabet(GOOG)$ GCP offer. The neocloud bundles compute with a full suite of services (storage, databases, networking primitives, managed inference endpoints, observability, etc), and the customer is effectively buying a "cloud" experience rather than just chips. As you move higher up (from bare metal to full cloud) generally you can charge higher rates / hour because you’re offering more.

For this post, I’ll use more “bare metal” assumptions. From the Neoclouds perspective this generally means they’re signing a single offtake site - one customer takes the entire site. It’s not a “cloud” where many different customers (ie scaling AI native startups) all use / share the resources.

To understand the unit economics, let’s first dig into the costs. Neoclouds generally buy the hardware (vs lease, there’s tradeoffs to both). BUT - buying gives you access to the residual value of the chips (which is the point of this post), and generally a lower cost of capital. The other point to highlight is many of these businesses are structured as “sub projects” or “sub entities".” Think of these projects as an individual data center. There’s a parent co (the Neocloud), with a number of projects (ie data centers) sitting beneath the parent.

To finance each project, the sources generally include some combo of project level debt, project level equity (think co-investors who invest equity for return on their equity), and equity from the parent co.

The debt is generally tied to the single contract for the site. The debt provider is looking at counter party risk. What is the likelihood that customer is around for the life of the contract? If they stick around and pay, we (the debt provider get paid). If they go away, go out of business, break their contract, etc, then the Neocloud has to find a replacement customer or they risk not being able to pay back the debt. So it really matters who the end customer is. If that end customer (the offtake) has high credit worthiness, a good reputation, etc, the debt provider probably gives a better rate.

When I say the debt is tied to the contract, what I mean is the debt is amortized over the lifetime of the contact. If the single offtaker is signing a 4-5 year deal, the debt will have a 4-5 year term (ie paid off in 4-5 years).

Ok - so let’s bring this back to the original point of the article. What are the implications of chips having a longer useful life than 4-5 years. After the Neolabs have “completed” a contract with an initial offtaker (ie 4-5 year deal), the debt has been fully paid off. IF the chips have value after that period, the Neolab can “recontract” the site. It will certainly be at meaningfully lower price per hour per chip,

BUT without an interest expense the profit margins can skyrocket. These recontracting deals will almost certainly be for inference vs training (folks will want to train on frontier chips), BUT if you believe inference will explode (which I do), there will be SOO much demand for inference compute in the future. And these recontracting deals could prove to be extremely profitable.

I’m writing this post much later in the evening than normal, and I think I’m starting to ramble / not write as clearly as I’d like…But the takeaway - I believe chips will have a longer useful life than the original contracts they’re being signed to support, and if they do we could see a meaningful lift to neolab profitability.

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