Big Tech as VC Investors: More red flags than laudable deals.
Big Tech as VC Investors: More red flags than laudable deals.
Why has no one seriously challenged this dubious business to this day?
It is not uncommon, and certainly not new, for big tech companies to act as venture capitalists and invest in start-ups. Companies such as Alphabet GOOG 0.00%↑ , Apple AAPL 0.00%↑ and Microsoft MSFT 0.00%↑ have long had their own venture capital (VC) arms to manage these investments.
It is therefore not really surprising that Nvidia NVDA 0.00%↑ has become one of the most active venture capitalists in recent years as part of its meteoric rise. According to figures from S&P Global, Nvidia invested in 38 start-ups in 2023 alone, almost four times as many as in 2022.
The details of individual VC deals are generally kept secret. A look at Nvidia's latest annual report, however, provides some insight:
At the end of FY24, which ended at the end of January, Nvidia had more than 1.5 billion USD invested in corporate investments - up from less than 300 million USD a year earlier.
This means that in just 12 months, Nvidia has invested 1.25 billion USD in new corporate investments. With 38 investments, this represents an average investment of around 30 million USD.
What is the problem with Big Tech acting as a VC?
Nvidia generally only invests in companies that use Nvidia's infrastructure. Vishal Bhagwati, who is responsible for Nvidia's VC investments, is quoted in the Wall Street Journal as follows:
“We would not invest in companies that don’t use our infrastructure”
This means that all the start-ups in Nvidia's VC portfolio are also customers of the chipmaker, using Nvidia GPUs or software.
In other words, the money Nvidia provides for financing is largely spent by the start-ups to buy Nvidia infrastructure, which in turn leads to direct sales for Nvidia. Very often, Big Tech VC deals of this kind do not even involve money, but Big Tech gets shares in the start-ups in return for providing free infrastructure products such as GPUs or cloud services.
Renowned venture capital firm Sequoia estimates that by 2023, the AI industry will have spent around 50 billion USD on Nvidia chips, but generated no more than 3 billion USD in revenue. These huge revenues for Nvidia will only continue in the future if Generative AI delivers on its promise in the many new AI applications AND if the future winners among AI companies are deeply rooted in the Nvidia ecosystem.
As is common in the VC industry, Nvidia typically invests in a round as one of a number of investors. This means that the investment companies receive significantly more money in such a round than the pure Nvidia investment. The revenues that flow back to Nvidia are therefore not limited to the company's own investment, but can go far beyond that (often in the context of long-term supply agreements).
Unfortunately, I am not aware of any data on how much revenue Nvidia generates with its many associated companies. Given the large number of such deals (38 in 2023 alone), I assume we are talking about billions. So the topic is at least not insignificant given the total Nvidia revenues of 61 billion USD in FY24.
Malicious tongues claim that Nvidia “buys” the corresponding sales through its VC investments. Of course, it's not that simple. But these revenue streams are indeed problematic.
For me, it is not even the fact that actual sales are masked by such deals that is important. Much more serious is the potential distortion of Big Tech's valuation in the financial markets. Every dollar of Nvidia's revenue is rewarded with 30 times the stock market value - at least for now.
For Nvidia, an additional 1 billion USD in revenue means an additional 30 billion USD in enterprise value. It is always important to realise the dimensions of these big tech valuations.
Nvidia is not alone
The financial engineering around VC investment described above is not a problem specific to Nvidia: Rubrik's IPO RBRK 0.00%↑ a few days ago is a good example. Microsoft is the big tech investor here, and some concrete figures are known:
According to Bloomberg, Microsoft invested an estimated 20-30 million USD in cybersecurity vendor Rubrik in 2021. ("funding in the low tens of millions").
In return, according to the IPO prospectus that has now been published, Microsoft received revenue guarantees from Rubrik for Microsoft Azure cloud services worth more than 220 million USD.
In other words, according to this deal, from 2021 onwards, a multiple of the investment (a factor of 7-12?) will flow back into Microsoft's coffers over time. This sounds like a really good deal for Microsoft.
A bit too good for my taste. To be honest, I'm surprised that deals like this haven't been scrutinised more critically by the investment community or the regulators to this day.
It sounds to me like Big Tech is using its dominant market position to bind promising start-ups to itself and its own ecosystem.
That in itself is probably not reprehensible. However, when the investments are used to buy revenue for years to come with so called partnership contracts that become an existential risk for the junior partner if they are cancelled, then these revenue commitments are more than just a bad taste in my mouth.
When I try to put myself in the shoes of these start-up founders, it could almost feel a bit like “protection money”. This is then used to pump up the stock market value of Big Tech even more. Big Brother is watching you...
Conclusion
Unfortunately, there are still far too few details known about these VC deals by Nvidia, Microsoft and Co. This could change as more AI portfolio companies make it to the stock market in the coming years. Let's see what the IPO prospectuses with their extensive disclosure requirements reveal.
I have neither the time nor the interest to research this topic in detail. I'm not invested in either Nvidia or Microsoft, and that's unlikely to change any time soon. But I do know that my blog is also read by some business journalists. Perhaps someone would like to pick up the ball and shed some more light on Nvidia's and others' VC deals.
If you have the time and inclination to delve deeper into this topic, please feel free to contact me. I would be more than happy to publish and promote your findings as good as I can.
If you would like to follow the successes and shady deals of Nvidia, Microsoft and Co. together with me in the future, you can
*Disclaimer: The author and/or associated persons or companies do not own shares in Nvidia or Microsoft. This article is an expression of opinion and does not constitute any investment or financial advice.