$25B Investor: AI Cycle Extends Beyond Chips

The artificial intelligence boom represents a real and substantial opportunity, but focusing solely on chips overlooks the larger cycle, according to Scott Goodwin of Diameter Capital Partners. AI infrastructure, such as data centers, has attracted heavy investment, yet valuations raise questions about sustainability. Diameter Capital sees AI as a long-running, disruptive cycle that extends across various sectors.

Goodwin described this perspective during an appearance on the Goldman Sachs Exchanges podcast. The firm, which manages about $25 billion in assets, targets areas where AI demand creates bottlenecks visible in credit markets. Buying the most obvious winners, like chipmakers, is not the only approach to capitalize on this trend.

This cycle is characterized by its duration and impact. As one partner noted through Goodwin, it qualifies as a "super-duper micro cycle that will outlast many investing careers." Such longevity suggests opportunities in supporting infrastructure and applications beyond initial hardware investments.

Targeting Less Obvious Bottlenecks

Diameter Capital Partners has concentrated on credit opportunities arising from AI's infrastructure needs. The firm identifies shifts in demand as AI evolves from training models to deployment, creating needs in networks and connectivity. This approach led to strategic debt purchases in 2023.

One key investment involved the unsecured debt of a midsize telecommunications company. The rationale centered on data exiting data centers via commercial fiber networks, or "pipes," to reach users. As AI applications expand, reliance on these networks intensifies.

The telecommunications firm subsequently secured more than $10 billion in contracts with hyperscale cloud providers. This development allowed the debt to rebound to face value, validating the investment thesis.

Bets on Satellite and Spectrum Assets

Another significant wager targeted a satellite company linked to wireless spectrum. This bet aligned with AI's demand for broad connectivity solutions. The company later sold spectrum assets, resulting in the debt returning to face value and delivering returns for Diameter Capital.

• Unsecured telco debt purchased in 2023 based on network demand projections.
• Over $10 billion in new contracts signed post-investment.
• Satellite company bet tied to spectrum, resolved through asset sales.

These moves highlight how AI's growth influences diverse credit markets, from fiber optics to satellite technology.

While opportunities abound, certain segments of the AI credit market carry substantial risks that are difficult to quantify, particularly in chip finance. Scott Goodwin cautions that investors pursuing these areas may underestimate potential downsides. The rapid pace of technological advancement exacerbates these concerns.

Investors often take on residual risk, the riskiest portion of chip-financing deals, which depends on hardware value years into the future. Cutting-edge firms frequently refresh technology, rendering chips obsolete for some customers. This uncertainty affects long-term projections.

Goodwin shared insights from consultations with experts: "We call up really smart people in Silicon Valley, we call up really smart people at Big Tech companies and ask them what the residual value is on these chips three, four, five, six, seven years forward." The response is consistent: "None of them have a clue." Such ambiguity underscores the challenges in pricing this risk accurately.

These warnings occur against a backdrop of debate over sky-high AI valuations and whether investors are missing tied opportunities. Balancing potential rewards with unpriced risks remains critical in the evolving landscape.

Beyond infrastructure spending, the AI cycle enters a phase focused on competitive dynamics rather than capital expenditures. Scott Goodwin points to the adoption of AI as a key differentiator among companies and entities. This shift will separate leaders from laggards in various industries.

Goodwin posed essential questions: "Who are the companies, who are the entities that are going to adopt AI and take a step forward versus their peers? And who are going to be the losers?" This competitive disruption forms a longer cycle than initial capex investments, offering sustained interest for investors.

The implications extend to broader economic and technological transformations. As AI integrates into operations, its disruptive potential will reshape markets over time. Diameter Capital's focus on credit markets positions it to capture value from these developments.

In conclusion, the AI boom's full scope demands a nuanced approach. While chips and data centers drive initial growth, opportunities in connectivity, spectrum, and adoption create a multifaceted landscape. Investors must navigate risks, especially in volatile areas like chip finance, to participate in this enduring cycle effectively. The real value lies in recognizing and addressing the interconnected bottlenecks that sustain AI's expansion.