California Dreaming (of a generative AI induced demand inflection)…
Who? Trent Masters Where? California, USA When? March 2023
What was I looking for?
When the Mamas and the Papas wrote “all the leaves are brown, and the skies are grey” I’m not sure if they were using the macro environment facing tech in 2023 as their inspiration. But if they were they wouldn’t have been far from the mark as some spending exuberance that found its way into businesses on the back of what were thought to be Covid induced structural gains now need to be unwound.
This trip to California (Los Angeles then San Fran for the MS TMT Conference) was about testing the macro environment, and how companies are responding to the end of the free and infinite capital period post Covid. It was also a trip to see where potential demand inflections may emerge, especially given the explosion of interest in generative AI as Chat GPT crashed its way into the public consciousness.
What did I discover?
Environment
The external environment for tech remains difficult as companies look to constrain spending. Deals are harder and taking longer to land as there is much greater scrutiny on every dollar spent. In this environment, companies must be demonstrating value, and what they provide needs to be a “must have” as opposed to a “nice to have”.
This newfound restraint is flowing through to all corners of the tech landscape. In hardware, existing equipment is being held for longer, and we are seeing this in weak PC markets as well as more constrained data centre spending. We are seeing it in cloud where migrations are becoming more selective, and “optimisation” of consumption is an over-riding theme. And we are seeing it in software where it is the essential or productivity enhancing platforms that are holding demand while the less essential platforms are seeing demand fall away
Company responses
Most companies “get it” that the days of free and infinite capital are over, and that profitability has supplanted top-line growth as an imperative. Although some companies “get it” more than others. In big tech, Meta appears to get it the most, and are taking out significant headcount (-24%) and embarking on a “year of efficiency” across opex and capex. At the other end, Google is trimming staff by 6% and looking to hide the staplers. But in general, across tech the language has changed appreciably towards a healthier balance between growth, profitability, and free cash flow generation. The days of Kombucha on tap, Aesop soap in the bathrooms, private dining rooms and on-site masseuses seem to be slowly drawing to a close.
Potential demand inflection
Turn the clock back to this same trip 1 year ago and there was incredible excitement around Web 3, the metaverse and crypto architecture. At the time, and still today, despite the Venture Capital fervour around these concepts I thought that these were “all sizzle and marginal sausage” (or “all hat and no cattle” for any Texan readers).
However, for me the potential demand inflection from generative AI, triggered by the crashing of Chat GPT into the public consciousness (described as the I-phone moment for Ai) looks real. From a step change in existing functionality across Search, Chatbots and Ecommerce to Enterprise applications around knowledge bases, content creation and development efficiency. And even to entirely new businesses shaped around health care, advice or travel, the impacts have the potential to be profound.
With these applications come increases in required compute intensity along with greater demands for semiconductors and networking equipment. Companies on this trip spoke of either commencing or accelerating Ai efforts in the coming year providing some element of hope for demand beyond the current economic malaise.
What does this mean for the portfolio?
Given the continued focus on efficiency, the tech component of the portfolio remains shaped around earnings resilience, with some exposure to growth opportunities from tech advancement. In terms of resilience, we see cyber as being a relatively more durable area of spend and have a position in Fortinet (FTNT-US). In tech advancement, key players in the semiconductor design and equipment space such as Cadence Designs (CDNS-US) and ASML (ASML-NA) are also portfolio holdings.
Generative AI has also created tangents that we continue to explore, from semis to software to networking. What we continue to weigh is the need to quantify the potential AI demand inflection, balance this with impacts from the macro environment, then bound the analysis with valuation considerations. While the AI opportunities are exciting, it is another significant step to satisfy the quantification plus valuation requirements for portfolio inclusion.
What were the 3 most interesting things from the trip?
- Sam Altman Presentation (co-founder and CEO of Open AI): Watching Sam Altman present at the Morgan Stanley TMT conference gave a sense of watching someone who has the potential to be one of the most influential shapers of how the world works over the next decade.
- The speed in which a bank can collapse: The Silicon Valley Bank took the Ernest Hemingway two-step approach to bankruptcy; gradually then suddenly. The CEO presented at the Morgan Stanley TMT Conference on the Tuesday, the bank was wobbling by Thursday and gone by Friday. An astonishingly fast collapse for a bank revered by Venture Capitalists on the US West Coast.
- The interest in semi cap equipment is huge (or maybe it’s just Elon?): The presentation by the semi cap equipment company LAM Research was one of the most packed presentations from the trip. It was standing room only with participants lining the walls. Surely, they weren’t just getting their spot for the following session with Elon Musk?……
In what remains a very volatile investing environment, good luck out there.
