OpenAI's Path To Profitability Is Closing. Is It a Warning for AI Stocks?

OpenAI was the genesis of the AI boom with the launch of ChatGPT in Nov. 2022, and it has been a juggernaut basically ever since.

In the private markets, the AI start-up's valuation is now $852 billion, but in recent months, cracks have begun to form in OpenAI's facade.

After grabbing the earlier lead in large language models and the brand awareness with ChatGPT, rivals like Google Gemini and Anthropic's Claude have caught up. A few months ago, OpenAI issued a "code red" in the face of stiff competition from Google and Anthropic, aiming to improve its core technology and reclaim the lead in the AI race.

At the same time, OpenAI's financial prospects began to look messier, even as it has raised roughly $200 billion in its history, including a round that brought in $122 billion that closed a month ago, to fund its breakneck data center expansion.

While OpenAI has grown rapidly, it's also putting up increasingly wider losses, and it needs the business to continue its rapid pace of growth to sustain the business and pay for the chips and computing power it needs to run its models.

According to The Wall Street Journal, OpenAI is now failing to do that, missing key internal growth targets that put the future of the business in question.

Image source: Getty Images.

What's happening at OpenAI

OpenAI is now expressing doubt about its ability to hit its financial targets and pay for future computing contracts, which could spell trouble for the rest of the AI sector as OpenAI has future spending commitments of around $600 billion to chipmakers like Nvidia (NASDAQ: NVDA) and AMD, cloud infrastructure partners like Microsoft, Oracle,and CoreWeave, and others.

The "expand-at-all-costs" to secure computing capacity strategy that has guided the company since the launch of ChatGPT has now left it in a difficult spot, especially as both its user and revenue growth rates have slowed. Meanwhile, Anthropic seems to have grabbed the mantle as the leading disruptor in AI as its updates have rattled the software sector, sparking sell-offs on multiple occasions. Its Mythos AI model was even deemed too powerful to be released to the general public.

According to a report in The Information from last September, OpenAI is planning to burn through $115 billion by 2029 as it ramps up on computing capacity. However, that cash burn forecast could be significantly larger now, given the slowdown in growth. If OpenAI's prospects continue to dim, its valuation could collapse. Investors are betting the company will eventually be highly profitable, despite its current spending spree, or it wouldn't have received a valuation of close to $1 trillion.

What it means for the AI sector

A troubled OpenAI would be a problem for partners like Nvidia and Microsoft that are counting on revenue from the AI start-up, but it doesn't necessarily doom the broader AI sector. OpenAI's slowdown seems to be a result of its weakening competitive position against rivals like Google and Anthropic, rather than questions about long-term demand for AI capabilities. For investors, it depends on whether OpenAI's loss is the gain of Anthropic or another AI model company.

Still, it's not surprising that stocks like Nvidia pulled back on the news, and the Nasdaq Composite fell more than 1% on the report on Tuesday. OpenAI has been the flagbearer for the AI industry since it's took the market by storm, though we could be seeing a changing of the guard as Anthropic just reached a valuation of $1 trillion in private secondary markets.

If the WSJ report is accurate, OpenAI could be forced to significantly retrench. For now, that doesn't seem to be cause for alarm. However, if Anthropic faces similar growth and cash burn issues, then the industry could be in real trouble.

Jeremy Bowman has positions in Nvidia. The Motley Fool has positions in and recommends Nvidia. The Motley Fool has a disclosure policy.