OpenAI – Reality Test.

The valuation event will speak volumes.

• Although OpenAI is probably worth more now than it was 2 weeks ago, the share sale is unlikely to go through at $86bn and will serve as a measure of just how strong the AI-everything narrative remains after the Open AI earthquake.
• Despite the hot mess that became Open AI a few weeks ago, the planned share sale is going ahead where employees will be able to sell some of their shares to investors and realise some of the efforts they have put into creating OpenAI’s products.
• The real questions are what the appetite of investors will be to buy these shares and how much will they be willing to pay for them.
• Two weeks ago, I suspect that investors would have been quite happy to pay $86bn, but the sudden implosion and subsequent resurrection of OpenAI may cause investors to think twice.
• When it comes to valuation, I have long subscribed to the view that a share in a company is worth the sum of the present value of the cash flows attached to that share but there is also the narrative.
• The narrative is the story that is popular in the market such as AI in 2023 and The Metaverse in 2022.
• The problem is that, unlike fundamentals, the narrative can be very fragile as it relies heavily on how investors feel about a certain sector and the blow-up at OpenAI will have had a major impact.
• I think that OpenAI following from last week’s events will be more stable having largely dealt with the profit / non-profit conflict and more likely to generate higher cash flows and profits.
• Hence on a fundamental basis, it is probably worth more now than it was 2 weeks ago as its biggest risk has been at least partially addressed.
• However, this is not how OpenAI has been valued by the market which arbitrarily seems to have decided that it is worth $86bn which is far more than I think it has ever been worth.
• The problem here is that when there is no foundation being provided by company fundamentals then the valuation can fluctuate wildly with market sentiment.
• 7 days ago, there were serious doubts as to whether OpenAI would survive as a going concern which in market terms would have very likely resulted in a share price collapse of 50% or more.
• Confidence takes a long time to build but can be shattered in a heartbeat which is precisely what happened to OpenAI.
• Hence, I suspect that a lot of investors will have lost some or all of their confidence in OpenAI and are far more likely to baulk at paying a valuation of $86bn.
• This is why the valuation of the company will very likely have fallen from $86bn despite the improvement in fundamentals.
• How much it has fallen will be a key indicator of just how much sentiment has been dented by the OpenAI’s drama which will also impact how its peers and competitors are viewed although none of them have the same arcane structure that OpenAI did.
• Even if the valuation falls substantially, I don’t think that this is the pin that bursts the AI bubble.
• Instead, I think it will be when prices for generative AI services begin to fall from growing competition and revenue and cash flow targets start being missed.
• This is what will lead to unexpected investment rounds being required which will inevitably come at lower valuations.
• There is little sign of this yet, but I would not be surprised to see it within the next 12 months just as we did for autonomous driving.
• I would not be a buyer of OpenAI equity at the moment and even though Nvidia is very expensive, it remains the best AI play in the market.
• That’s where I would be if I had to have an AI play (which I don’t) but I would still not want to be holding it when the bubble pops.