Investors Are Growing Wary of AI-Related Debt

Hyperscalers -- the giant AI companies now racing to build AI data centers as quickly as possible -- have been issuing reams of corporate debt over the past year to fund their efforts.

Morgan Stanley estimates that AI-related global debt issuance totaled $236 billion as of May 31 -- 4 times as much as one year prior. And the investment bank expects AI bond issuance to grow to $570 billion by the end of 2026.

Just four companies, Meta Platforms (NASDAQ: META), Alphabet (NASDAQ: GOOGL)(NASDAQ: GOOG), Amazon (NASDAQ: AMZN), and Microsoft (NASDAQ: MSFT), are expected to spend a total $700 billion on capex this year, with most of it going toward AI-related outlays, and the forecasts suggest that over the next few years, such spending is only going increase. Such companies have long relied on strong cash flows to cover their capital investment needs, but the sheer scale of the AI data center build-out has sent the hyperscalers to the bond market for funding.

At first, investors rushed to snap up the bonds issued by these companies. But they're rapidly losing their appetite for all this AI-related debt.

Demand for hyperscaler debt is waning

How do we know?

Well, cover ratios -- the ratio of asset demand to supply -- for hyperscaler bonds have decreased markedly this year, from 5x in February to just 2x in July. That's according to Apollo Global Management. That suggests that if these AI companies want to keep borrowing via bond issuance, they're going to have to pay higher rates on the bonds they issue, Apollo says.

Image source: Getty Images.

That's not the only AI debt investors are growing tired of. I recently wrote about the debt issued by Elon Musk's Space Exploration Technologies (NASDAQ: SPCX), better known as SpaceX, which went public in June. Investors were eager to get their hands on SpaceX stock, bidding it briefly up to more than $225 in the first couple of days, far above its opening trading price of $150. As of the close of trading Wednesday, the stock had fallen back to $135.27 -- just a hair above its IPO price.

Bond investors have been much more skeptical of SpaceX. The company's bonds were recently trading at an average 1.62-percentage-point premium over Treasuries, a credit spread that puts them in the BB category, which is technically non-investment grade, also known as "high-yield" or "junk" bonds. SpaceX carries a whopping $29 billion in long-term debt.

For all of these companies, the trends in bond prices, demand, and spreads may be an early warning signal to equity investors. That's because bond investors tend to prioritize capital preservation and cash flow, so changes in bond prices and demand can indicate shifts in a company's financial health before they appear in the stock market.

Of course, the AI revolution is still young, and these massive AI investments, while still a bit speculative, could certainly pay off in a big way. But investors in hyperscaler stocks would do well to keep an eye on the bond market, too.

Matthew Benjamin has positions in Alphabet and Microsoft. The Motley Fool has positions in and recommends Alphabet, Amazon, Meta Platforms, and Microsoft. The Motley Fool has a disclosure policy.