Debt-laden neocloud firms at centre of Silicon Valley's AI economy debate

A once-obscure corner of the AI ecosystem has come under intense scrutiny as investors question whether the sector is financially sound, and what recent stumbles might signal about the broader AI economy. The companies at the centre of the debate are known as neocloud firms, including CoreWeave and Nebius. They operate large warehouses packed with expensive computers, which they lease to major AI developers such as Anthropic, OpenAI and Meta. Neocloud firms typically finance themselves by signing long-term lease contracts with major tech customers that need rapid access to computing power. They can then borrow money using those contracts, along with the AI chips they purchase, as collateral, according to analyst Cory Johnson of the IPO research outfit The Quiet Period. He said debt is common across the sector because the hardware must be paid for up front. CoreWeave, the industry leader, is a fraction of the size of some of the Big Tech companies it serves. Johnson believes lenders sometimes weigh the creditworthiness of CoreWeave's customers, such as Microsoft or Meta, more heavily than that of CoreWeave itself when extending loans. This, he said, helps explain how the company accumulated 35.1 billion dollars, or 26.3 billion pounds, in debt. Investors appear to be having second thoughts. CoreWeave stock has lost a quarter of its value over the past month, and shares in other neocloud firms including Nebius, IREN and Applied Digital have shed similar amounts or more over the same period. Debt investors have also grown wary, demanding higher returns from several firms in the sector. The concerns are reflected in industry forecasts. Analysts at Gartner predict that by 2030, 80 percent of neocloud firms will cease independent operations, while Forrester's experts expect at least three of them to be imminently acquired as finances get shaky. US Treasury Secretary Scott Bessent sought to downplay the worries on Thursday, telling CNBC that neocloud firms are a small component of the overall external ecosystem. CoreWeave chief executive Mike Intrator has said the market is acting irrationally and has expressed confidence in the company's business model, noting that some of the world's most consequential companies are queuing up for its infrastructure. Several neocloud firms trace their origins to the volatile crypto mining industry. CoreWeave was founded in 2017 with a focus on mining Ethereum, while IREN, Core Scientific and Applied Digital also began in crypto. Their existing infrastructure left them well positioned when AI spending surged after OpenAI introduced ChatGPT in 2022. Nebius is an outlier, having been known as Yandex NV when it was part of Russia's version of Google before splitting off and rebranding in 2024. The firms' fortunes now hinge on major AI developers and hyperscalers, the even larger data centre operators that often count as key customers. Melissa Otto, head of Visible Alpha Research at S&P Global, described an enormous amount of spending being injected into the system, calling it an arms race. Forrester vice president and principal analyst Charlie Dai said the trade-off of the neocloud model is greater financial risk in the face of change, including any adjustments Big Tech customers might make to their spending plans. When Microsoft and Google forecast less AI spending than Wall Street analysts had projected this past week, shares in several neocloud firms tumbled. Much also rides on Anthropic and OpenAI, both of which are expected to begin selling shares to the public in the months ahead. Bradley Tusk of Tusk Ventures warned that if AI proves to be a bubble and bursts, neocloud firms would face collateral damage. Their future also depends on their ability to keep borrowing, which becomes more expensive as interest rates rise. Elon Musk suggested in a recent social media post that this challenge could lead more than 200 neoclouds to see what he called guppy-level death and consolidation, with the smallest firms most vulnerable. Some will make it through, but not many, he added. For now, analysts at Yorkville Ives say demand for computing power still exceeds supply, and that neoclouds fill an important gap larger data centre companies cannot. But recent developments have unsettled some observers. Microsoft recently cancelled a deal with the British neocloud firm Nscale amid power supply issues that could last through to 2030, and Australia's Firmus shelved plans to sell shares to the public. These developments come amid a public backlash against data centres and lingering questions about how much value AI can add to worker productivity. There is reason to worry, Johnson said.