CoreWeave’s main risk is refinancing its fixed-price contracts

Transcript

Transcribed by machine (Whisper) from the episode’s audio, so a word may be off here and there.

1. 6:01

   financial innovations, I would say, with CoreWeave. The most important thing that you should always look at is how the sharps, the super smart money, prices risk. And when you're dealing with companies like CoreWeave or Nebius or iRent, et cetera, that have to borrow a lot to fund these boxes, the smart money is trading what's called a credit derivative swap. Okay, this is default insurance. And these default swaps are meant to ensure the bondholders against a potential default.

2. 6:40

   That risk spiked this week to about 953 basis points, which it doesn't matter what that number is. But as an imputed risk, it's about a 16% chance of a default in any given year. And over a five-year duration, what that math implies is about a 55% chance of a default. So it's a coin flip, whether they default or not. That's not what I'm saying. That's what the insurance market was saying about their debt. And I think that's something to look into because those guys, I think, are the smartest money in all of this. So why did they do this? I started to dig into it. And here's a couple of charts that explains a little bit of what I learned.

3. 7:25

   Okay. So the first thing is just a market check. We've talked about this, but we have a problem in the United States, which is that the US is moving the risk-free rate higher and higher. Who is doing that? These are the central bankers. These are the bond vigilantes. These are the people that say, because of inflation or other long-term risks that are not getting put out of the system, we need to get paid a lot more money to own the safest, riskless asset.

4. 7:55

   As that goes up, basic way to think about that is as the 10-year bond goes up. up, everything else goes up. And so this black line represents the average price that you have to pay for junk debt. And what you see is that as the 10 year went up, and people were like, man, the risk free rates going up, the junkiest junk bonds need to pay more and more and more. And then the purple line here is what core weave has to pay. And what you see is that it also has started to stick up and has moved up relatively violently. And so the question is, why has it done that. Okay, so let's go to the next chart. Michael is right that he is in the business of creating these boxes and then putting in contracts and GPUs, but he also needs to put money in those boxes. And the way that he puts the money in the box is he has to go out and borrow that money. So

5. 8:49

   he goes to a lender and says, give me the money and I will pay you that back plus some interest. What you see here is what is inside of the box effectively. So the gray bar is how much money he's guaranteed to get into the box. These are all the deals he sold to all of his customers. These are contracts. Yeah. These are contracts. Now, and it's important to know because I'll get to this in a second.

6. 9:14

   It turns out that these contracts are fixed price. So meaning if what you could sell in the spot market goes up, you don't really generate that revenue because you've already pre-sold it at a fixed number. So Michael creates the box, he gets a long-term contract, which is great because you have surety around the revenues you're getting, but he sells that. Then he goes and has to finance it. And then some of that financing comes due. He's got some bonds that are due and some loans that are due. What this basically says is at the midpoint, he has to raise another $35 billion of debt to get all of the contracts that he signed, financed, right? All the boxes financed and up and running. So he has about $35 billion of debt. He needs to raise another $35 billion of debt. But as you saw in the chart before, that's ticking up. And that has nothing to do with him. It is because the broader

7. 10:07

   market is essentially saying the risk-free rate goes up, everybody has to pay more because your spread above the risk-free rate has to track with it. Okay. So today, across all the different pockets of money in which that they have used to fund those boxes, their average interest rate that they pay is about 8.5%. The problem is that in this last little while, the Sharps basically said, hold on, this is getting too close to the knife's edge. You're going to have to pay more interest. That's what I tweeted, which was just one of the sleeves of interest.

8. 10:45

   this is the GPU loan DDTL 1.0, spiked to 15%. The problem is that could theoretically now be the rate that they have to pay for all of the future. And remember, half of it's financed, half of it is still unfinanced. Right now, these guys are at a pretty good place because they have about 78, 80 billion of assets and only 35 of debt. So they're well covered. So I think that this idea that they're at risk is not on the surface true. But the reality is that they have this problem, which is they have extreme customer concentration. 75% of the revenue comes from three companies. Some of those companies are walking down what their revenue expectations are into the future. So you have this situation now where you have to go out and borrow at a much higher rate. You have a bunch of debt you need to go to fund the boxes, and you have a fixed amount of

9. 11:39

   revenue going into the boxes. So what is the trade or what is the setup? It's basically a coin flip now on the following idea. I think the market is saying that if they are able to finance this stuff at a reasonable rate, and the life of the GPUs that they buy from Jensen are longer than what they think, they're going to be okay. But if the financing goes up and into that 10, 11, 12, 13, 14, 15% range, these guys are getting very, very, very close to not necessarily being able to cover all the obligations that they have.

10. 12:16

    My team's estimates is that they're plus or minus about $5 billion away from that breakeven point. So I think that's why the CDS spike, which then caused the bond yields to spike and caused the bonds themselves to lay off. So in order of operations, number one, I think they've created this very novel structure that everybody else has copied with the boxes. Number two, they've sold these fixed contracts. That's super smart, guaranteed a bunch of revenue into the future. But we have this situation where as the risk free rate goes up, their cost of borrowing goes up, that erodes the margin that they have, that then brings them close to this break even point that causes the CDS to react, which then causes the bond yields to react. That's the negative reflexive loop that they're in.

11. 12:59

    So they just have to find a way to break out of that. I don't think that they're in real risk. But as we all know, this is sort of a confidence game.