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Talking Tech is produced by the Progressive Tech Team of George O’Connor, Ian Robertson and Gareth Evans. Our aim is to bring you up to date with the tech news cycle each week. We comment via blog and podcast on the slings and arrows of the sector at a time of huge change.

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June 11, 2024

Nvidia and Cisco – history rhymes, commentators repeat

It is something of a cliché now to compare the meteoric rise of Nvidia to that of Cisco, hinting at an inevitable precipitous crash.

As these commentaries are not investment advice you should not take my observations as criticisms, but there is an almost universal absence of any consideration of customers, or more precisely what stands behind the customers’ spending.

This highlights two common (and understandable) habits of investors and near-universal failings of sell-side research. First, the tendency to consider the stock as representing the technology rather than a business within a value chain and the wider finance ecosystem. Second, the reluctance to consider the nature of the downside.

Although this analysis, with its obligatory counterfactual, may leave you more comfortable about Nvidia than the direct Nvidia vs Cisco parallels, it might also leave you more worried about upsides than downsides because it places us far earlier in a bubble-building process.

nvidia and cisco share prices from float

Funding of customer matters

Microsoft, Google, Facebook, Amazon and others are spending huge sums with Nvidia but the actual nature and scale of the returns from these investments is unclear.  Likewise, Cisco’s big customers invested huge sums without clear visions as to the nature and scale of the returns.

It is not enough, however, just to categorize these as investments in the unknown.

Nvidia’s leading customers are hugely cash-generative businesses, typically with huge cash piles too. Cisco’s customers were technology infrastructure businesses spending money from investors and lenders.

The impact of possibly disappointing AI investment outcomes upon Nvidia’s customers’ spending is unclear.

Nvidia’s leading customers have shareholders, but these shareholders do not hold sway over those companies’ direction in quite the same way that the telcos’ lenders and investors did at the turn of the century.

And, of course, for some of Cisco’s customers it was not just a case of slowing spending as a result of disappointing returns but of stopping spending entirely because they went bust. Microsoft and Google are not going bust, no matter how off target their AI spend is.

Dawning realisation and acceptance vs smack in the face

While both sets of customers have invested in the unknown, the visibility and clarity of the results arising from AI investment are likely to be far less than with internet infrastructure. If AI is to disappoint, it will be a dawning realisation not a smack in the face. While investors might have reacted in horror in 2000 to the news of problems, no one in 2024 is going to be too surprised if AI does not live up to expectations. Some lessons have been learned.

Customers – One out, all out – not this time

As they made their internet investments, many of the telcos were ultimately fighting for a share of the same traffic.  This is not the case with Microsoft and Google. While their objectives overlap, their historical ability to coexist suggests that there is no terminal face-off in prospect.

Disappointment for one of Nvidia’s customers does not imply that for all. Their AI spend need not move in tandem – once this initial race for processing power is over.

Valuation – understood to be less demanding

Cisco’s share price collapse was not the reflection of an unravelling of the business with all the customers stopping their spending. Demand declined for a while, but things continued. The valuation collapsed, not the business.

As is widely commented upon, Nvidia’s valuation multiples are not as demanding as Cisco’s, although on the earnings side we must factor in Nvidia’s considerable operational gearing. Cisco had (and still has) good margins, but not extraordinary margins.

Counterfactual – a bit of rigour

To clarify our thinking, it is worthwhile running a counterfactual.

Would Microsoft and Google be spending this money with Nvidia if the financial markets were not so strong?

Yes, and I suspect they would still be spending substantial sums even in the face of adverse share price movements.

For Cisco and its customers, the answer would have been no.

Wider dangers linger on the upside too

Taking this further, companies aside, AI looks to be investor and investment driven, not banker and deal driven.

Sell-side analysts are asking companies ‘where’s the AI beef?’ Where and when is the benefit going to show through? There is no repetition of the dot.com act of faith (bank policy) when analysts never questioned the value of the internet.

Comforting as that might be, there remains the concerning prospect of more companies like CoreWeave that appear based upon a debt and equity, AI and the ‘field of dreams’ build it and they will come business model. The sort of investment case that perhaps only a banker could love.

This is not to say that all AI propositions give us such concerns. There will no doubt be  champions among the new ventures and there will be existing businesses that will fundamentally change for the better through AI, but the usual sound investment rules will still apply.

Although I have set out a possible downward path for Nvidia that is not as dramatic as Cisco, this is not reason in itself to invest. As ever, DYOR.

Ian Robertson

irobertson@progressive-research.com

07768 276595

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