We’re watching a new trend in semiconductor stocks concerning circular deals. Here’s why we think investors should be keeping an eye on it, though they shouldn’t be particularly worried at this point.
What Is a Circular Deal?
Quite simply, these are deals between two or more parties where funds are flowing back and forth. The most notable recent example is Nvidia’s NVDA partnership with OpenAI, wherein Nvidia can invest up to $100 billion in the firm over time. The partnership can be considered circular, as OpenAI will likely buy gear from Nvidia, which will reinvest those profits in OpenAI, which will likely use those funds to buy even more Nvidia gear.
Nvidia’s partnership and investment with CoreWeave CRWV is also circular, or perhaps more of a web. CoreWeave funded some debt using Nvidia’s GPUs as collateral. Nvidia owns shares of CoreWeave. Nvidia also struck a deal to use any of CoreWeave’s excess capacity through 2032. Again, Nvidia’s investments might let CoreWeave expand its data center business even further, which means buying more GPUs from Nvidia.
Finally, OpenAI struck a partnership with Advanced Micro Devices AMD. It will receive warrants in AMD’s common shares upon certain milestones. We tend to think of this deal as less circular, because OpenAI might not necessarily use any windfalls in AMD’s stock to buy more of the firm’s GPUs. Still, the deal entangles the two parties a bit more than an arm’s-length supplier relationship.
Circular Deals Raise Some Short- and Long-Term Concerns
We think these types of circular deals are raising eyebrows among investors. In the near term, the circularity makes it plausible for Nvidia to push more GPUs into OpenAI—say, to meet a quarterly revenue target—it may have some influence on OpenAI’s investments. We don’t think this is the case today, and we don’t anticipate it in the future, since these types of short-term moves typically end badly for chipmakers. Still, the risk would be a bit more plausible if Nvidia were to take material ownership of shares of OpenAI.
For Nvidia and CoreWeave, we foresee similar short-term risks wherein Nvidia could conceivably push GPUs onto the company. That said, Nvidia is on the hook for any excess capacity at CoreWeave, so it likely has incentive to avoid this exact scenario. Still, the companies have a tight and integrated partnership.
At a higher level, investors during the dot-com era are also wary of vendor financing and circular deals, which were hallmarks of spending at that time. Anyone scarred by the dot-com bubble bursting is keenly aware of the risks of a circular deal in which firms pass funds back and forth to prop up a business. Again, we don’t think this risk is present today, and we’re skeptical this will occur in the long term, since AI demand is both real and booming, but it bears watching.
We Don’t Think These Circular Deals are Troublesome Yet
At this point, we are keeping an eye on these types of deals, but we’re not yet alarmed by them and think of them as arm’s-length transactions. OpenAI and CoreWeave must invest a good amount of their funds (wherever they can get it) to buy gear from Nvidia. Thus, it was previously a one-way transaction where the cash flows to Nvidia and the GPUs go to OpenAI and CoreWeave.
Nvidia now has the pleasant problem of what to do with all its newfound cash, and they also have a terrific view on where innovation is headed in AI. Both OpenAI and CoreWeave have been hot investments for private and public investors during this boom, and Nvidia could do far worse in finding places to invest.
Looking at OpenAI, Nvidia’s investments essentially “close the loop” from a one-way deal to a circular one. Despite the circular nature of this deal (either in perception or reality), Nvidia’s investment might be wise if OpenAI lives up to its lofty aspirations. As far as we can tell, there is no guarantee that OpenAI must put Nvidia’s investments back into buying AI gear. However, it’s likely that OpenAI will be buying more Nvidia gear anyway. Thus, it’s proper for investors to think of this deal as circular.
We view the CoreWeave-Nvidia deal as a bit more tangled. Nonetheless, Nvidia’s investments in CoreWeave have also paid off handsomely so far.
