Michael Burry -- the famous investor who bet against the housing market before the 2008 crash, a contrarian move that ultimately inspired the Hollywood blockbuster The Big Short -- is not a fan of Nvidia (NVDA 1.30%) stock right now. Importantly, Burry isn't oblivious to the massive growth in artificial intelligence technologies, or of Nvidia's dominant market share for AI GPUs.
Instead, Burry's bearish position revolves around his belief that many AI businesses are participating in "one of the more common frauds of the modern era."
NASDAQ: NVDA
Key Data Points
Nvidia is at the center of a massive fraud, according to Michael Burry
When investors think about fraud, images of dramatic scams or heists may come to mind. However, fraud is often simply a matter of accounting. Consider Enron -- perhaps the most well-known fraud of the early 2000s. The root of this fraud involved the use of off-balance-sheet entities and deceptive financial reporting to conceal massive debt and inflate profits. In short, it was a numbers game, a fraud that played out mostly on paper.
By manipulating numbers, Enron was able to artificially inflate its profits, leading investors to believe the company was more successful than it actually was. This is exactly what Burry believes is currently unfolding in the AI space.
Following massive advancements in AI and machine learning, tech companies are accelerating their investments in the hardware necessary to train and execute AI models. At the root of this spending surge is the GPU -- a critical component that enables these companies to perform the complex computations necessary for AI models to function properly. According to most estimates, Nvidia currently has at least a 90% market share for GPUs destined for AI purposes. At one point, its new GPU architecture was sold out for 12 months, and reports suggest that cloud provider and data center companies are begging Nvidia's CEO, Jensen Huang, to deliver more GPUs to them.
From an accounting standpoint, all of this new hardware spending needs to be depreciated over time. Let's say a cloud infrastructure business buys $6 billion worth of Nvidia GPUs and expects these chips to generate revenue for six years, after which the company will need to replace them. Instead of realizing the $6 billion expense all at once, it would be realized as annual depreciation, potentially $1 billion per year for six years.
This is roughly what many AI companies are doing today, but Burry thinks the chips should depreciate more quickly, given how rapidly the technology is evolving. If the chips were depreciated over three years instead of six, for example, the annual depreciation charge would be approximately $2 billion per year. So, by assuming a longer depreciation cycle, companies can theoretically boost earnings over the short term, masking the true costs of the business.
"Understating depreciation by extending useful life of assets artificially boosts earnings -- one of the more common frauds of the modern era," Burry recently told clients. "Massively ramping capex through purchase of Nvidia chips/servers on a 2-3 yr product cycle should not result in the extension of useful lives of compute equipment. Yet this is exactly what all the hyperscalers have done."
Image source: Nvidia.
Remember that most experts are still betting on Nvidia stock
Michael Burry has put his money where his mouth is. His current portfolio is heavily betting against tech companies exposed to what he believes to be reckless accounting practices. For example, his second-largest position is put options on Nvidia stock -- a bet that will pay off if Nvidia's stock falls. So, while his arguments about improper depreciation schedules largely concern Nvidia's customers, he clearly believes Nvidia's stock is also overvalued.
But here's the thing: Burry is in the minority when it comes to expectations for Nvidia stock. Most analysts still have a hold or buy rating on the stock. And Alex Karp, the CEO of Palantir -- the most heavily shorted position in Burry's portfolio -- had some choice words for the contrarian bet. "I do think this behavior is egregious, and I'm going to be dancing around when it's proven wrong," he recently told CNBC. "With the shorts it's very complex," he added. "Honestly, I think what's going on here is market manipulation. We delivered the best results anyone's ever seen. It's not even clear he's not doing this to get out of his position. I mean these people, they claim to be ethical, but they are actually shorting one of the great businesses of the world."
Indeed, this is a very complex situation, and only time will tell who is right. But Burry has a strong track record of successful contrarian bets, and investors should at least familiarize themselves with his arguments.
