Investor sentiment around artificial intelligence (AI) debt has seen a slight improvement following recent market volatility. However, the sector faces further scrutiny as Meta, Alphabet, and Amazon.com prepare to release key financial updates this week. Alphabet and Amazon are scheduled to report quarterly results after the market close on Wednesday and Thursday, respectively.
Meta Platforms' recent announcement of a $95 billion stock offering played a significant role in calming the markets. This move helped reduce its credit-default swap (CDS) spreads, which had previously spiked following the company's report of negative free cash flow in the third quarter. Richard Cheng, head of Nuveen's investment-grade corporate sector team, noted that the absence of a large bond deal from Meta was a relief to investors, contributing to the tightening of AI-related spreads.
Despite the recent easing, CDS spreads remain elevated compared to the previous year, driven by increased debt issuance and negative free cash flows across the AI sector. Meta's CDS spread has surged 177% year-to-date, while Amazon's has increased by 129%. These movements are largely influenced by technical factors and market sentiment rather than fundamental changes.
As Alphabet and Amazon prepare to announce their financial results, analysts are particularly focused on their capital expenditure (capex) plans and free cash flow forecasts. Both companies reported negative free cash flow in the second quarter, a trend expected to continue. FactSet consensus estimates suggest Alphabet will report a free cash flow of -$2.3 billion against $55.2 billion in capex for the third quarter, while Amazon is expected to report -$9.9 billion in free cash flow with capex of $58.7 billion.
Looking ahead, S&P Global Ratings predicts that these hyperscalers will continue to experience negative free operating cash flow through 2026 and 2027. The trajectory of capex guidance remains a critical focus for investors, as highlighted by Cheng. He emphasized the importance of understanding the capex needs across the hyperscaler space.
While some analysts view the elevated capex as a sign of strong AI demand, others, like Chalfin, do not anticipate major new bond issuances from the hyperscalers around their earnings reports. Oracle's updates may carry weight due to its $117 billion in long-term debt, but the The company is perceived as more stressed compared to its A-rated counterparts, trading more like a high-yield credit.
One complicating factor in assessing AI debt is the use of off-balance sheet arrangements by these companies for data centers and chip financing. These commitments, such as data center leases or chip purchase agreements, are not always reflected as debt, digital infrastructure sector lead at S&P Global Ratings, pointed out the need for greater transparency to provide a fuller picture of these obligations.
Despite these challenges, the hyperscalers benefit from diversified revenue streams, strong interest payment coverage, and the capacity to increase leverage if necessary. Cheng remains optimistic, noting that the market is primarily concerned with the trajectory of capex needs and the supply of debt to fund them, both of which are on the rise.
