Investment bank Morgan Stanley has issued a report expressing concern over the complex and increasingly circular financial relationships within the artificial intelligence industry. The analysis highlights a trend where major AI technology suppliers are also investing in their own customers, creating a system that may obscure the true state of market demand.
According to the report, these intertwined deals, which involve cross-ownership and revenue-sharing agreements, make it difficult for investors to assess the long-term sustainability of the current AI investment boom. The bank is calling for greater transparency from the companies involved.
Key Takeaways
- Morgan Stanley has raised concerns about the circular nature of financing in the AI industry, where suppliers fund their own customers.
- Analyst Todd Castagno's report points to a lack of transparency in deals involving major tech companies like Nvidia, AMD, Microsoft, and Oracle.
- Specific examples include Nvidia's investments in customers such as xAI, CoreWeave, and OpenAI.
- The report questions whether current AI demand is sustainable or artificially inflated by these complex financial arrangements.
- Despite these warnings, stocks for AI infrastructure companies like Nvidia, AMD, Dell, and Super Micro continue to perform strongly.
Understanding Circular Financing in AI
Morgan Stanley's report focuses on a financial structure it describes as an "increasingly circular" ecosystem. This model involves a feedback loop where capital flows between companies that are simultaneously partners, suppliers, and investors in one another.
In a report authored by analyst Todd Castagno, the bank detailed its observations. "The AI ecosystem is increasingly circular — suppliers are funding customers and sharing revenue; there is cross-ownership and rising concentration," he stated. This creates a complex web of relationships that is not always clear to the public or the market.
The core issue is that when a company like a chipmaker invests heavily in a startup, and that startup then uses the funds to buy chips from the investor, it can create the appearance of robust, organic demand. However, this demand is partially funded by the supplier itself, making it difficult to gauge genuine market traction.
What is Circular Financing?
In the context of the AI industry, circular financing refers to a pattern where a large technology provider (e.g., a chipmaker) invests in a smaller AI company or startup. The startup then uses a significant portion of that investment to purchase essential products, like AI chips or cloud services, from the investing company. This creates a cycle where the investment capital essentially returns to the original investor as revenue.
High-Profile Examples Under Scrutiny
The concerns raised by Morgan Stanley are not theoretical. Several recent high-profile deals exemplify the trend. Chip giant Nvidia, a central player in the AI hardware market, has been particularly active in this area. The company recently disclosed an investment in Elon Musk's AI startup, xAI, to which it also supplies advanced processors for data centers.
This is not an isolated incident for Nvidia. The company also has similar supplier-investor relationships with cloud provider CoreWeave and AI research leader OpenAI. These arrangements position Nvidia not just as a supplier but as a key financial stakeholder in the success of its largest customers.
Nvidia's primary competitor, Advanced Micro Devices (AMD), has also entered into such agreements. AMD recently announced its own supplier-investment deal with OpenAI, further illustrating the industry-wide nature of this practice.
"Investor attention is increasing to the intertwined relationships of AI players," Castagno noted in the report. He argued that these complex transactions pose a risk to the industry's long-term health.
The Call for Greater Transparency
A central theme of the Morgan Stanley report is the urgent need for more detailed financial disclosures from the companies involved. Castagno argues that the current level of transparency is insufficient for investors to properly evaluate the risks.
"The entities within the entangled ecosystem have provided limited information about customer concentration, vendor financing, revenue-sharing agreements and related-party transactions," he wrote. This lack of clarity makes it challenging to understand the true financial health and demand drivers for these companies.
The report specifically mentioned publicly traded giants like Microsoft and Oracle as other companies with AI data center deals that would benefit from greater transparency. Because these corporations have massive business lines outside of AI, their dealings with smaller AI firms often do not meet the standard quantitative thresholds for detailed disclosure.
The Materiality Threshold Issue
Public companies are generally required to disclose information that is "material" to an investor's decision. For massive companies like Microsoft or Oracle, a multi-million dollar investment in an AI startup might not be considered quantitatively material relative to their total revenue. However, Morgan Stanley argues that because AI is a primary driver of these companies' high stock valuations, these deals are qualitatively material and should be disclosed in more detail.
Castagno emphasized the importance of this information for valuation. "AI is the key driver of valuation for these companies, supporting their high multiples," he explained. Without clear insight into these deals, investors might be overvaluing the stocks based on a potentially inflated picture of AI demand.
Market Performance vs. Underlying Risk
Despite the cautionary note from Morgan Stanley, the market has shown little concern so far. Stocks related to AI infrastructure have been among the top performers, with several reaching record highs. The demand for the hardware that powers AI models remains exceptionally strong.
Companies at the center of this ecosystem are seeing their valuations soar:
- Nvidia (NVDA) and AMD (AMD), the two leading AI chipmakers, are trading at or near record levels.
- Server manufacturers essential for building AI data centers, such as Dell Technologies (DELL) and Super Micro Computer (SMCI), have also experienced significant stock price increases.
The long-term question posed by the report is whether this growth is sustainable. The success of the current investment cycle depends on the ability of AI applications to generate real, durable cash flows that can provide a return on the immense capital being invested.
"The sustainability of the current investment cycle ultimately depends on whether AI generates durable cash flows to support returns on the significant capital being committed," Castagno concluded.
The report suggests that without clearer financial reporting, the market is taking on increased risk. The intricate web of investments and revenue-sharing could be masking underlying weaknesses or creating a fragile ecosystem that is highly dependent on a few key players continuing to fund their own growth.