Growth of Circular Financing

Bloomberg

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00:00Just the scale of desire to hold and buy into debt. We think of oracles, sale and bonds. We've

00:05got leveraged buyout now being clearly taken down by banks because they think they can syndicate

00:09this. What does it signal about the wash of cash that we have in the market and the valuations

00:15we're getting on companies? Well, there's two separate components that are coming through.

00:19First, we're seeing more and more evidence that the cash flow that is the prodigious cash flow

00:23that's come through many of the technology companies now has claims against it. And taking

00:28on debt is simply a way of pulling that forward. You've effectively said the $2 billion of

00:33free cash flow that Electronic Arts currently has is going to go to servicing debt as compared

00:37to significant investment. And this is, I'll be honest with you, this is part of a signal

00:43that we are very, very interested in actually buying debt. We have incredible tightness in

00:48both the high yield market and in the investment grade market. The demand for debt is very,

00:54very high given the retirement needs of the baby boomers. And interestingly enough,

01:00people are trying to deliver into that. This is very, very similar in a lot of ways to what

01:04we would have done in the historical time periods of manufacturing IPOs. If that's what's demanded,

01:08we're seeing that on the platforms like Robinhood and Coinbase, where there's a ton of demand

01:13for new IPOs. The older generation really wants to own investment grade debt and high yield debt.

01:19Michael, I just scrambled a bit, if I'm being honest, but I think you guys do have

01:23like less than a thousand EA shares. I don't know why, whether that's sort of a historical

01:27or tangential fact, but just talk a little bit more about that. You know, biggest leveraged

01:32buyout in history has big shiny headline. We've reported that JP Morgan's going to do like 20

01:38billion of the debt. You sort of interested in a mechanism like that?

01:43Well, if we have exposure to electronic arts, it's going to be through one of our index oriented

01:50products. We're not going to select shares in electronic arts. So I would be misspeaking if I

01:56spoke about a particular insider desire that drove that. I would just highlight that ultimately,

02:03when we think about the quantity of debt that is being offered, there is tremendous demand for debt,

02:08both in actual form, as we're discussing, and then also in synthetic form. You know, Eric Bakunas of

02:15Bloomberg speaks often of boomer candy, the idea of products that offer extremely high yields.

02:21The type of call overriding is just a way of creating synthetic debt exposure. So that is

02:26demographic demand that's driving through on all of this stuff. And I think this is just telling you

02:31there is more of that out there. There is an alternative to market-based debt. And that's a

02:37mechanism that we're seeing from NVIDIA. It's called circular financing to some. You give an equity

02:43investment or capital to a company, and they use some of that to then buy the product that you're

02:49known for. Can you talk a little bit about that, Michael? Yeah, a lot of people are starting to

02:54become increasingly aware of this component of vendor financing. And it's not just vendor financing.

02:59We see it not just with NVIDIA, with their deals with CoreWeave that are circular, and an equity

03:05investment is made into CoreWeave. That then flows back into repurchases of NVIDIA products,

03:10one that reduces the price competition associated with it. If NVIDIA is giving me the equity

03:17investment or lending me the money to make the purchase, I'm going to be less willing to

03:21negotiate. It speaks to NVIDIA's extraordinarily high margins and the protection of those. The more

03:26transactions that are going through in that form, the more, I would argue, we have to be thinking

03:30perhaps the margin is not as sustainable as it actually appears.

03:34The second thing that I would emphasize is if we look at other types of debt that are being taken

03:40on, they're being taken on. Meta in particular has taken on an extraordinary amount of debt

03:44where they are simultaneously financing or underwriting the debt for the financing of

03:49building of data centers. And they are also entering into operating lease agreements where they

03:54are effectively committing on both sides of the equation. We're seeing more and more evidence of

04:00this. And one of the great ironies I would highlight is that all of this is equity finance

04:05at its core. It's really not subject to the whims of Federal Reserve rate policy. It tells us nothing

04:12about whether policy is restrictive or not. Michael, it's interesting that below the surface,

04:17when you think about the money that's being promised to OpenAI from NVIDIA, many had said actually

04:22it then helps OpenAI itself go out and take on debt because they've got this backing from NVIDIA.

04:27More broadly, is this an asset class you want to be piling into at this moment? What are the

04:32risks clear for everyone to see? And what are some of the hidden risks when you're piling into

04:37a very few names who are going all in on each other and indeed data center more broadly?

04:43Well, I think that there are two really, really interesting components to it, right? One is remember

04:47that the vast majority of people are piling in here without any explicit thought behind it. You guys

04:52obviously know the work that I spend talking about the impact of passive investing. The average

04:57American investing into their 401k, putting money into a target date fund has no interest in NVIDIA or

05:02Microsoft or has any critical evaluation of it. It's simply the way we plan our retirement today.

05:09And so a huge chunk of the money that is flowing in is not being sent through thoughtfully,

05:14it's being sent through mechanically. So people are very allocated to this regardless of whether it's

05:19discretionary or not. The second component that I would emphasize is that this type of circularity

05:25is again a byproduct where in many situations you would look at this and you would say, wait a second,

05:29this really seems like antitrust activity. Google just lost a verdict in terms of antitrust. The

05:36judge failed to force remedies and immediately they turn around and engage in the activity that they

05:42were actually dinged for working with Apple to basically lock in a monopoly position in Apple's user

05:49interface. So we're seeing this circularity across multiple components of it, whether it stops,

05:55whether it continues to be enabled by the way that we invest, we simply can't know yet.

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