Allbirds Is Now an AI Company, and That Should Strike Fear Into Anyone Investing in Its Competition

Silicon Valley may have abandoned its favorite shoe company, but Allbirds (NASDAQ: BIRD) isn't abandoning Silicon Valley. The venture-capital-backed direct-to-consumer shoe company was once worth $4 billion. In March, the company sold its shoe brand for less than 1% of that value, $39 million.

But Allbirds is like a phoenix. From the ashes of its eco-friendly shoe business, it's emerging as an artificial intelligence (AI) company. A $50 million financing agreement will help it pivot into being an infrastructure-as-a-service cloud provider, similar to CoreWeave (NASDAQ: CRWV) or Nebius Group (NASDAQ: NBIS). And it comes with a fancy new name: NewBird AI.

Allbird's stock got a massive pop when it made the announcement, growing by nearly sevenfold in value. And while the share price has settled significantly lower since the announcement, it's still up by about 167% from its pre-pivot price. The market's reaction to the news should put some fear in AI stock investors, especially those buying shares of businesses in the same line as NewBird. And not because the new competitor is a major threat to those more-established AI businesses, but because it says something about how investors are valuing them.

Image source: Getty Images.

We've seen this story before

This isn't the first time a struggling company has made a shift into a trendy business that's completely unrelated to anything it has done in the past. Allbird's rebrand calls to mind how some companies behaved during two other significant periods in recent market history.

In 2017, Bitcoin was booming. The cryptocurrency market and anything related to blockchain were attracting tons of capital. Companies were looking at how to incorporate blockchain technology into their operations to improve security or speed. And a struggling iced tea company decided it could invest in blockchain, too. And thus, a microcap beverage company called Long Island Iced Tea transformed itself into Long Blockchain.

The stock popped on the announcement and stayed elevated for a while. But the announcement also coincided with a cyclical peak in Bitcoin. Over the next year, the cryptocurrency would lose 75% of its value. Meanwhile, Long Blockchain was delisted from the Nasdaq, accused of misleading investors about its intentions to invest in blockchain technology.

Bitcoin Price data by YCharts.

We might also recall the dot-com bubble, when dozens of companies chose to add ".com" or ".net" to their names, and the market rewarded them for doing so. Some completely overhauled their names such that it wasn't even clear what they did or what they once were. Those stocks were rewarded even more. Of course, most of those stocks lost almost all (if not all) of their value when the dot-com bubble burst.

While the debut of NewBird AI doesn't necessarily signal that this phase of the AI trend is peaking, or that it's due to face a similar fate, it should give investors caution. And that caution should be particularly high when it comes to companies like CoreWeave, Nebius Group, and others in the neocloud space.

The big challenge for neocloud companies

Investor enthusiasm over Allbirds' pivot is a sign that most investors don't perceive there being significant barriers to entry into the neocloud business. That's further evidence that CoreWeave and Nebius Group don't have meaningful competitive advantages that will enable them to generate high returns over the long run. They're selling a commodity-like product that's experiencing incredible demand right now, but that could change.

Furthermore, these businesses are highly leveraged, taking on heavy debt loads to finance their data center build-outs. While their risks are mitigated because they're partnering with some of the biggest and best-capitalized, highly cash-flowing businesses in the world, their valuations are based on the premise that their returns on invested capital will exceed their cost of capital. That could be tough to deliver if a lack of product differentiation saps their pricing power.

If the Allbirds announcement is the type of harbinger of a peaking cycle that we saw in the late 1990s and 2017, we could be heading toward a downturn in artificial intelligence spending. If that occurs, neocloud companies could find themselves in a precarious situation, and they could see their share prices collapse.

Adam Levy has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.