Coreweave is on borrowed time

Three years ago, OpenAI launched ChatGPT, sparking a surge of interest in AI and sending the stocks of many of the world’s largest technology companies soaring. However, in addition to the likes of Microsoft and Nvidia, shares in many smaller companies have also rocketed thanks to their role in building the infrastructure required for the adoption of AI. However, investors are starting to wonder whether all this investment in the new technology is likely to prove profitable.

Their doubts are having a knock-on effect on some of the more contentious AI-infrastructure plays, such as Coreweave (Nasdaq: CRWV). Coreweave makes its money from building data centres full of high-end computer hardware that provide the vast amount of computing power needed to train firms’ AI models; it leases the data centres to companies willing to pay for them. So far, this seems to have worked well, with explosive demand causing sales to rocket from $15.8 million in 2022 to an estimated $5.1 billion this year, a figure expected to more than double again to $11.9 billion by the end of 2026.

Coreweave's business model is unsustainable

However, if you look more closely, it becomes clear that the business model is unsustainable. Running data centres is a business that rewards scale, says Sahm Adrangi of Kerrisdale Capital, which is why it is dominated by large cloud-computing providers such as Amazon Web Services, Microsoft Azure, Google Cloud, and Oracle.

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Coreweave’s relatively small size means that to compete with these players, it has had to offer large discounts and slash profit margins. What’s more, renting computer power can be a risky business because Moore’s Law means that most computer hardware becomes obsolete within a few years.

Andrangi argues that even in the best-case scenario, where demand for computing power continues to expand, Coreweave will struggle to make enough money to recoup the upfront costs of building the data centres, let alone make a decent return on investors’ money. If demand falters, the hardware becomes obsolete more quickly than planned, or firms start building their own data centres, then Coreweave could be in serious trouble, especially as it has taken on huge debts to finance its investment. Other red flags include the fact that the key insiders have started selling their shares in the company.

With Coreweave currently valued at around 10 times current sales, investors’ expectations for its future success are extremely high. And the market has been starting to get cold feet recently, with the stock falling by nearly a quarter in the last month alone. It is now down more than 50% from its highs this summer. This suggests that it is a good time to go short at the current price of $88, at £22 per $1. Given tech shares’ volatility, I suggest you cover your position if the price hits $132, which gives you a total possible downside of £968.

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