The Bond Market Is Sending a Warning to Nvidia Shareholders

Even if you don't hold any bonds in your portfolio, paying attention to the market can offer some very valuable insights about your stock portfolio. Some investors may have found that out the hard way recently.

CoreWeave (NASDAQ: CRWV), the leading neocloud company backed by Nvidia (NASDAQ: NVDA), saw its stock pummeled after venture capitalist Chamath Palihapitiya shared a chart on social media showing its recently issued bonds set to expire in 2032 touched a 15% yield. CoreWeave issued the bonds with a 9.625% coupon in June. Reuters later reported that the 9.75% notes CoreWeave issued in April due in 2031 topped a yield of 16%.

The rising yields on CoreWeave's debt indicate the market believes CoreWeave's risk of default is increasing. Doubts are starting to creep in about whether the neocloud company can generate returns on its invested capital that exceed the cost of capital, especially amid a rising interest rate environment. Other neocloud companies such as Nebius (NASDAQ: NBIS) face similar pressures.

That's bad news for Nvidia and its investors.

Image source: Nvidia.

Nvidia's future is tied to CoreWeave and the neoclouds

Nvidia's biggest customers may be the big investment-grade tech companies building out robust platforms and their own AI stacks, but the neoclouds present one of its biggest sources of growth going forward. Nvidia made efforts to ensure that when it made strategic investments in CoreWeave and Nebius earlier this year. The chipmaker invested $2 billion in each of the neoclouds. As such, any decline in their stock prices has an immediate impact on Nvidia's balance sheet.

Nvidia also signed an agreement with CoreWeave last year to buy any unused capacity from CoreWeave through 2032. While Nvidia CEO Jensen Huang says he doesn't think the company will have to step in, it's still a liability that hangs over the company. CoreWeave cites its $104 billion backlog of contracted revenue as a defense against the need for a backstop. Management says that's more than enough to cover its debt obligations.

Most importantly for Nvidia, the neocloud companies are dedicated to building with Nvidia. Nvidia's strategic investments and willingness to help finance purchases are key reasons. But if the rising cost of capital catches up with the neoclouds before they can deliver returns, a key driver of Nvidia's sales growth could become a massive drag.

While the hyperscalers have much deeper pockets, they're all looking to add more of their own custom-designed AI accelerators, or XPUs, to their data centers instead of Nvidia GPUs. Amazon CEO Andy Jassy has said that using its Trainium chips saves it tens of billions in capital expenditures every year. Alphabet's Google Cloud CEO noted that the payback period for its custom TPUs is less than half that of its average server. Microsoft recently indicated plans to expand the use of its Maia chips for inference starting next year. In short, Nvidia can't rely on its largest customers to drive sales growth, even as they spend more on building AI data centers.

What it means for Nvidia investors

Nvidia is unlikely to let CoreWeave or its other neocloud partners fail. But any signs of failure for the businesses will put pressure on its finances and growth.

Nvidia could end up lending CoreWeave more money through its financing arm. However, Nvidia's plans to finance up to $500 billion in AI build-outs have faced objections from its banking partners over the residual value of its GPUs. The chips Nvidia sells to its partners are used as collateral for the debt, so if they retain less value than Nvidia claims, Nvidia will have to cover more of the default risk itself.

The chipmaker is reportedly in talks with insurance companies about offloading some of the liability. Either way, it's a drag on Nvidia's finances in order to keep growing its sales. What's more, the bond market is saying those loans may be riskier than Nvidia originally thought.

That risk will fall to Nvidia by extension. The good news for investors is that the market already appears to be pricing in the risk of such financial pressure. Investors currently pay just 23 times forward earnings expectations for the stock, which is a low price for a company that just grew its bottom line by 126% year over year. The bond market just showed exactly why investors probably shouldn't be willing to pay more than that, though.

Adam Levy has positions in Alphabet, Amazon, and Microsoft. The Motley Fool has positions in and recommends Alphabet, Amazon, Microsoft, and Nvidia. The Motley Fool has a disclosure policy.