(Bloomberg) -- Nvidia Corp.'s commitments to backstop the artificial intelligence boom seemed to be swelling by the day. There was the reported $250 billion to help kickstart a massive data center for OpenAI in Ohio, the latest in a string of big financings it was involved with.
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While the news heartened AI evangelists, it fueled fresh worries in credit markets that the chipmaker was inflating an AI asset bubble with circular financing — loans to customers that will bring more sales for Nvidia now, but potential pain later if those customers fail. In less than three weeks, a gauge of Nvidia's credit risk nearly doubled. On Monday, Nvidia Chief Executive Officer Jensen Huang said he'd enlisted some of the biggest names in finance to reassure investors. The pitch: outside money, sophisticated eyes on deals and Wall Street's stamp of approval. Nvidia cited a coalition of six major investment firms including BlackRock Inc. and Goldman Sachs Group Inc. that are lining up more than $500 billion to help fund the AI build-out. The group will independently judge individual deals and their own participation level, while Nvidia's contribution will be relatively limited, and only factor into some deals.
There were early signs of relief. On Tuesday, the cost of protecting Nvidia's debt against default dropped and the company's bonds rallied, with risk premiums over Treasuries dropping back to where they were last week.
The commitment from some of Wall Street's biggest firms "is a positive development to take out some of the uncertainty about both infrastructure build-out and customers' future spending," said Brett Kozlowski, portfolio manager at GW&K Investment Management in an interview.
Surging Derivatives
Nvidia is a key player in the $5.5 trillion global race to profit from artificial intelligence. Its powerful computer chips were originally designed for graphics and can perform multiple tasks simultaneously, making the latest generations useful for data centers.
Demand for its chips has helped make Nvidia the most valuable publicly traded company in the world, with its market valuation topping $5.2 trillion. But investors have grown concerned about whether the company's customers were too reliant on Nvidia's financial support to pay for chips and data centers that have grown ever-more expensive in recent years.
In late July, Bloomberg reported that Nvidia was in talks to backstop as much as $250 billion to help OpenAI lease computing power from an Ohio data center hub that a SoftBank Group Corp. unit is developing. It would be among the chipmaker's biggest financing deals with a customer. Nvidia was also in discussions to finance $350 billion of OpenAI's purchases of its chips for the project, people familiar with the situation said at the time.
Nvidia also announced a partnership with SK Group that would build more than 2 gigawatts of data centers on the Korean peninsula, part of a tie up with the South Korean business group worth more than half a trillion dollars. That sum is mostly future purchases of memory chips by Nvidia from SK Hynix, Huang later clarified. The latest $500 billion of outside capital isn't tied to the SK deal, Nvidia said.
Money managers fretted that the company was taking on what amounted to circular financings: deals that might boost sales now by lending money to data-center customers so they can buy Nvidia chips — but with potential for losses later on if the AI infrastructure they build doesn't make enough money.
Those fears showed up in the market for credit derivatives, where investors can buy a form of insurance that pays out if a company defaults on its debt. When money managers are more concerned about a company defaulting, the price of buying that protection will rise.
In late July, the cost of protecting Nvidia's debt for five years climbed to as high as $82,000 a year for every $10 million of principal protected, after hovering at about half that level for much of the year. On Tuesday, that figure was closer to about $73,000, or 73 basis points, down around 4 basis points for the day.
Limited Exposure
The new deal will bring in capital raised by firms including Apollo Global Management Inc., Blackstone Inc., Brookfield Asset Management, and KKR & Co., in addition to BlackRock and Goldman Sachs. The firms will independently evaluate each project and decide whether to supply capital. Nvidia, for its part, said it's setting up a marketplace for independent suppliers of capital to match up with users of the funds, referring to its role as providing a platform.
The result will be "dedicated pools of capital at significant scale at attractive rates for Nvidia customers," the chipmaker said in its statement.
The company will support some projects by guaranteeing as much as 25%, using something known as a residual value mechanism to help limit losses if a project runs into trouble. The company didn't provide much detail, but said its chips can be used by a wide array of its customers, which can presumably help minimize Nvidia's losses.
For example, if a project stumbles, a residual value guarantee might mean that Nvidia provides financial support after steps have been taken to recover value, like finding new firms to lease capacity, or selling off chips. 'Panic Capital'
But there's still risk, said Alberto Gallo, chief investment officer and co-founder of Andromeda Capital, speaking generally about the AI build-out and credit environment.
The credit market is increasingly becoming a bet on the demand and the value of computing power in the US, according to Gallo, and investors in that market probably aren't getting paid enough for the risk they're taking, he said in an interview. Defaults can come because there will be winners and losers in the breakneck competition to expend trillions of capital on data centers and other infrastructure.
"There is essentially panic capital expenditure," Gallo said. "Who is going to pay for losses? It's bondholders, it's life insurers, it's policy holders."
For now, Nvidia itself is highly profitable, giving it ample cushion to withstand credit pressure. Free cash flow in the fiscal year ended January 25 was nearly $100 billion, and now investors are concluding there's less chance Nvidia will have to absorb big losses since outside firms are taking on much of the risk. "Nobody knew what the $500 billion potential financing meant," said Sal Naro, chief investment officer of Coherence Credit Strategies. "Today you have an idea that they're getting everybody involved and that their exposure isn't as serious as investors originally feared."
--With assistance from Ian King. Most Read from Bloomberg Businessweek
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