1) Today, I'm following up on the blowup of Leopold Aschenbrenner's AI hedge fund, Situational Awareness, which I wrote about in Friday's e-mail...
My friend and the founder of Stansberry Research, Porter Stansberry, posted a brilliant X post about it over the weekend. He also addresses the AI market in general, arguing:
This was not an AI crash.
The S&P 500 stayed near its record throughout. This was a violent rotation out of the leveraged, capital-hungry, second-derivative end of the AI complex and into the profitable, cash-generating, asset-light end of it. Which is to say: the market rotated out of exactly what he owned and into exactly what he was short...
[Aschenbrenner] blew up quickly because of leverage. But he failed because he is simply wrong.
In particular, Porter believes – as my team and I have long argued – that many software companies will benefit from AI, not be crushed by it:
Aschenbrenner's software thesis rests on a single premise: that a company selling enterprise software is selling the work the software performs. If a model can perform that work, the company is worth nothing.
That premise is what a very smart 25-year-old engineer believes. It is not what anyone who has ever run a business believes.
Porter gives two examples of software companies he likes – Microsoft (MSFT) and Veeva Systems (VEEV). He asserts that what they offer can't be replaced with AI:
Nobody buys Microsoft because Microsoft writes the best code. They buy Microsoft because Microsoft is the rail everything else runs on. Active Directory is where your employee identities live. Excel is where your board deck's numbers come from. Teams is where the compliance-recorded conversation happened. Azure holds a FedRAMP High authorization and Department of Defense Impact Level 5 clearance, which means a defense contractor cannot casually swap it out for something cheaper without re-clearing the entire stack with the government.
Veeva runs the customer relationship management and regulatory document systems of the pharmaceutical industry. Nineteen of the top 20 biopharmaceutical companies use Veeva's regulatory information management platform... Those systems are validated under GxP – the good-practice quality regulations that govern anything touching a drug – and 21 CFR Part 11, the Food and Drug Administration's rule for electronic records and signatures. Every major release is formally qualified. When an FDA inspector arrives, the audit trail in that system is the company's defense.
In fact, these were the top two companies my team and I determined to be the least vulnerable to the threat of AI, which I covered in my April 28 e-mail.
Porter concludes:
The incumbents are not being disintermediated by artificial intelligence. They are selling it!...
Aschenbrenner thought AI would eat the applications. Instead the applications are selling AI as an upsell on top of a subscription the customer cannot afford to cancel – because it costs nothing compared to the value it delivers.
These software companies are computing toll booths: they're what enterprises pay to implement compute. And, as compute gets cheaper, they will generate vastly more revenue, not less. The proof is sitting there in their earnings and cash flows: they're riding on lower and lower cost of compute, which makes their business more and more efficient.
I couldn't agree more, which is why I've written favorably about software companies like Adobe (ADBE), Intuit (INTU), and Salesforce (CRM).
Plus, Microsoft and Software as a Service ("SaaS") provider ServiceNow (NOW) are open recommendations in our flagship newsletter, Stansberry's Investment Advisory.
We just published a new recommendation in this space – a cybersecurity company whose stock we think is poised to skyrocket...
Subscribers have access to this new report and buy-up-to advice, as well as our entire archive and portfolio of recommendations. You can become a subscriber by clicking here.
2) In his post, Porter also blasted Aschenbrenner's assumption that "because a technology is transformative, the capital that builds it will earn its cost":
There is no relationship between those two things. In fact, it's more likely not to be true.
[Aschenbrenner's] own essay contains the tell: "Over the past year, the talk of the town has shifted from $10 billion compute clusters to $100 billion clusters to trillion-dollar clusters. Every six months another zero is added to the boardroom plans."
He wrote that as a bull case. But it isn't. That is a recipe for a financial disaster.
He continued, using the historical analogy of railroads:
Between 1865 and 1873 the United States built the most consequential physical network in its history and destroyed an enormous amount of capital doing it...
A very large fraction of the capital that built the American rail network was lost.
And where the roads survived, competition took the returns...
Every additional mile of track made the network more valuable to America and less valuable to the men who had paid for it.
Porter also used another, more recent analogy:
In the five years after the Telecommunications Act of 1996, carriers poured more than $500 billion into fiber, switches and wireless networks. By the early 2000s no more than 2% of North American long-haul capacity was in use. Global Crossing raised roughly $20 billion, built 100,000 miles of undersea fiber, filed for bankruptcy in January 2002, and saw its assets change hands for about $250 million – roughly 1.25 cents on the dollar of invested capital. WorldCom filed six months later, at the time the largest bankruptcy in American history.
Applied to today, Porter wrote:
The AI build-out will have the same problem – but it will be much, much worse. Compute will be a pure commodity...
Which of the second-derivative names Aschenbrenner owned has route control, like a monopoly railroad? Bitcoin miners with retrofitted substations? Rented compute resold at a spread? Memory, an industry that has never once earned its cost of capital through a full cycle? Those are not toll booths. Those are the Northern Pacific just before bankruptcy.
The railroads made a fortune – but not for their investors.
Porter summarized:
But for people who are experienced in putting capital at risk, the pattern is not subtle or hard to understand. When an economy builds an expensive new network, the capital that builds the network earns a poor return because competition, obsolescence and overbuild strip it away. The businesses that ride on the network at near-zero incremental capital cost, and that own the customer relationship, the data or the standard, keep the profit...
[Aschenbrenner] believed the technology determines the return. But it never has.
It's the capital structure that determines the returns: who controls the standards, who controls the customer, and who owns the data?...
The money will be made where it was made in 1874 and again in 2004: by the toll booths riding on top of somebody else's ruinous capital expenditure.
Porter asserts that the "toll booths" that received the value are companies like Alphabet (GOOGL), Amazon (AMZN), Meta Platforms (META), and Netflix (NFLX)... Again, I couldn't agree more.
That's why my team and I at Investment Advisory have open recommendations in Alphabet and Amazon. It's also why my former hedge-fund partner Glenn Tongue and I pitched Netflix at the Value Investing Seminar in Italy a month ago (see my July 28 e-mail).
3) Also at the seminar, two speakers analyzed the AI infrastructure boom and reached the same conclusion: The hyperscalers will be the winners, as I discussed in my July 23 e-mail.
These two charts with data from Goldman Sachs Research reinforce this viewpoint, showing how hyperscalers' revenue is exploding:
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.
P.P.S. I spent the past month traveling in six countries all over Europe, with just one small backpack. How did I do it? I've recorded two videos describing all of my minimalist packing tips – a six-minute one from five years ago and a 19-minute one last month.
