Apple’s War On OpenAI Just Got Personal

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This week, unexplained to me, how to avoid being a flop. Find new episodes, Sundays, wherever you get your podcasts. Welcome to Profty Markets, I'm Ed Elson, it is August 5th, let's check in on yesterday's market vitals. The major indices climbed, with the Dow and the S&P 500 hitting record highs on hopes that the straight-off removers would soon reopen, Brent Crude oil dropped below $80 per barrel, the yield on 10-year treasuries declined, AMD shares dropped more than 8% despite posting record revenues, and finally, Palantir shares popped almost 30% a day after crushing earnings and raising its outlook. Okay, what else is happening? The legal war between open AI and Apple just heated up. Last month, Apple sued open AI, accusing the company of stealing trade secrets to build its own AI hardware device. At the time, Apple called the lawsuit "just the tip of the iceberg". Then, on Monday, Apple asked a federal judge to borrow open AI and two ex-employees from accessing using or disclosing information, it claims our trade secrets. Apple also asked the court to fast-track the case, arguing that there is a "imident threat to its trade secrets". Open AI then fired back in a blog post, calling the lawsuit "careless, aggressive, and oddly personal". The company also accused Apple's lawyers of mistakenly emailing the wrong person after confusing two people with similar Asian surnames. Open AI maintains it has no interest in using another company's trade secrets, and says the suit is "based on false information", the hearing has been scheduled for October 1st. Here, to unpack this drama, we are speaking with Alex Heath, author of the sources newsletter. Alex, it's good to see you. Let's just start with Apple's preliminary injunction, which was filed at the beginning of the week. What is Apple saying here? What are they accusing Open AI of now? Well, they're basically suggesting that there's more to the story than they've led on previously, that the corruption as they see it runs deeper, and I think most importantly, as you said in the intro, they're wanting a preliminary injunction. I mean, let's be real. Apple is trying to slow Open AI down, that's what they're trying to do. They're trying to keep this launch that they have for their first device later this year from happening, derail the whole thing, freeze, employees from continuing to work on things, and that's why I think we saw that Open AI response that you talked about. So what do you make of that response? They started with that point about Apple's lawyers emailing the wrong person, and they specifically mention that they confused the names of two Asian people, which is, I mean, that seems intentional. It's embarrassing. That's also something you put into a case like this to get people like us to talk about it rather than the merits of the evidence. It's a bit of a distraction. It's like a look over here thing. They're accidentally emailing people. You'll also notice, I'm no lawyer, but you'll notice like the very specific language Open AI has used, we have no interest in using trade secrets, like saying to my wife like after I snuck a cookie that I have no interest in eating cookies doesn't negate the fact that I maybe ate the cookie, right? These are very different statements like you could say we have not done this, and we're ready to fight this in court. They're not saying this. They're saying we have no interest in this. I think probably both parties have some embarrassing things that they don't want to come out as my read of the situation and the way they're messaging it. It's a very nasty lawsuit. I mean, Open AI was saying that this way that Apple's approached this has felt oddly personal and it's like, "Yeah, no shit. It is super personal to Apple." You hired Johnny Ive, who ran a design at Apple. You hired as Apple as put it, hundreds of ex-employees, and EQ Sun is working at Open AI on this hardware. It is very personal. Everyone knows each other. They go way back, and Apple takes these things very seriously. They've been very consistent, even back to Steve Jobs, on litigating these kinds of things, taking employee poaching very seriously, suing ex-employees for suspected leaking. This is not out of the norm of them to behave this way. I think Open AI going, they start with saying how much respect they have for Apple and then saying like this is beneath them. It's a tactic, but it also doesn't speak to the merits of what Apple has said. If you look at the texts that Open AI has produced to try to back up, I didn't see a smoking gun there that Apple's totally in the wrong here. I just see a lot of, he said she said, here say, "Yeah, maybe some ex-Apple employees reached out to the people at Open AI, asking just innocently for stuff back." And Apple is using that to say, "Oh, Open AI people are leaking proprietary info or taking it from Apple." There's just a lot of very messy energy to this that suggests these two companies hate each other. I haven't seen a smoking gun on either side. I see a lot of potential room for more embarrassment on each side. I think you see that even in the way Open AI has responded. Well, that was sort of what struck me in Open AI's response and in the blog post that they published is I was looking for them to make the actual counter-argument to the claim, but I couldn't find it. I thought I was seeing it when I was seeing all of their accusations because the language was very powerful and very accusatory, but to go with like your stealing cookies analogy, it kind of is like, "Hey, no, I didn't steal cookies." The accusation was you stole the cookies and then the response was like, "Yeah, well, you didn't do the laundry out of there." Or it's like, "I have no interest in the cookies. Maybe I did eat them, but maybe I did it accidentally." And that's like maybe where this lands is like, there were some unintentional transfers of trade secrets, and that's bad, and Apple's using that to really go for the jugular and slow things down. I would not be surprised if that ends up where this lands, but we don't know, right? Like, you and I haven't seen all of the discovery. It hasn't happened. Open AI is producing these texts. To me, these texts don't really meaningfully move anything forward on the arguments on either side. So I think we have to wait and see how Apple responds. It'll be really interesting if this settles or Apple gets the injunction. I mean, Open AI definitely responded because of the injunction because if that were granted, they'd have to pause work on their first device. I mean, what really is the point of posting this blog? If they're not actually addressing the merits of the case, and if it's not going to hold water really in the legal sphere, I mean, I know you're not a lawyer. Well, I don't know. So I don't want to speak to like, I don't know if it'll hold water as someone who's just following the case. To me, I didn't see a strong rebuttal. I did see, you know, like, Hawke Tan, like the most senior person that they're accusing at Open AI, the former Apple leader. You know, I did see Open AI have a very simple blanket. He always told people not to give him trade secrets, kind of response, didn't address like any specific. I mean, Apple's very specific about how Open AI employees allegedly coerced information out of people. And Open AI didn't get into detail on that and that's response. It was very blanket. And again, this like, we have no interest. It's not the same as saying you didn't do it. It seems really important. And it's like very, very specifically lawyer. But I've seen much forceful responses where, you know, usually the standard is like, oh, this is marvelous. We believe this case is marvelous. And we look forward to defending it in court, right? You're not seeing that here. You're seeing a lot of like, why is this so personal? We have no interest like, it's very like teenage angsty. Yeah. It's really interesting. What do you think this means for the launch of this hardware device? I mean, where do we even stand on this hardware device that's been that Open AI has been working on? still happening. I mean, the latest I've heard and the others have reported is they definitely are on track for an unveil sometime later this year of the first device, which is supposedly going to be this kind of Alexa HomePod like AI Speaker with a bunch of sensors on it that kind of sits at your desk or goes on a table and ambiently takes in the environment, maybe even interrupts you. Essentially has like an AI personality, maybe your AI chief of staff kind of in a way and takes in the world around you, and then obviously they have a family of devices they've said they're working on. I think we're going to see probably some kinds of earbuds, maybe a wrist thing, some glasses. They're not going to do a phone, but I'm sure Apple would love to slow down the release of this. I mean, I think Scott has been saying that as well that it's worth probably the legal fees just to like introduce chaos into this, a very competitive moment. Our open AI though is putting out the fall like it's not going to cannibalize iPhone sales. So there's a like near-term wrist apple here. I think it's more of like the principle that Apple feels very betrayed and yes it's clearly very personal, you know, hawk tan, the most senior executive at open AI, they're accusing of leaving Apple and taking secrets and coercing for secrets, you know, used to work very closely with John Ternus, right, the new CEO of Apple incoming, like these people go way back. And so it's also very telling, I think, an interesting that Johnny Ives is not named in the suit. I mean, I know that's been discussed before, but he continues to stay out of it. It was to me suggests there's some kind of blanket agreement there that I'm not reporting this. I'm just speculating that, you know, there's there's an intentional reason he's been left out of it and maybe it doesn't mean that he's not implicated, but Apple isn't able to include him. Say the preliminary injunction is granted, Apple wins that and the hardware launch is at the very least put on hold or maybe even just cancelled. How bad would that be for open AI? How important is it to them? Very bad. If there's any traction of Apple winning an injunction, you're going to see my prediction. You're going to see open AI go, you know, full court press on this and make a big mess of it and do a bunch of op-oh messaging against this. It matters a lot. There's a lot writing on them getting hardware right. It's a personal kind of thing for Sam Altman and Johnny and they spent over $6 billion on acquiring Johnny's hardware team. They've been working on the stuff. It would be very bad. All right. I'll see out things unfold. Alex Heath is author of the sources newsletter Alex always appreciate your time. Thank you. Thanks, Ed. After the break, a first look at SpaceX earnings. And for even more markets insights, you can subscribe to my weekly newsletter simply put @simpleput.proftymedia.com to do so. For the first time ever, you can try NetSuite Next for free. 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They are embracing candidates who are offering new bold ideas in the absence of those ideas from establishment Democrats. This week on America actually, Gen Z researcher Rachel Jamfaza joins us to separate Gen Z fact versus fiction. It's not rocket science, and this is, you know, I keep saying like young voters aren't that complicated after all. It's pretty simple. Catch us every Saturday on YouTube, or wherever you get your podcast. We're back with ProfG Markets. SpaceX made its earnings debut yesterday, and the results were strong, but investors still weren't happy. The company reported massive revenue growth of 92% year over year. And all three business segments, space connectivity and AI beat expectations. Just half an hour before the results came out, SpaceX also made a separate announcement, a partnership with Nvidia. The two companies are working together in an attempt to put data center computing into orbit. SpaceX stock initially had risen roughly 10% yesterday in anticipation of the earnings. However, after the earnings came out, in after hours trading, the stock fell 8%. So here to break down SpaceX's first quarter of publicly reported earnings were speaking with Nicholas Owens, equity analyst at Morningstar. Nicholas, thanks for joining us. This was better than analysts had expected on the revenue side, also on the operating income or loss side. What do you make of this quarter for SpaceX? I think you're referring to consensus. They actually came in $200 million light on my revenue and operating margin forecast. I'll say that one grain of salt is that we don't have a, first of all, it's a quickly pivoting business and we don't have a sense of what the seasonality of this business is in terms of what's a normal Q2 look like. So I don't think there's a huge much to be made there. They also spend about $11 billion more in CapEx than I forecast. So I think the anticipation was for a good quarter and that's what they delivered. The big Delta really is in the acceleration of AI revenue and these rental agreements, which I think we've talked about. And those were mostly announced along with the IPO. So I actually think the announcement about the partnership within Bidia has some interesting nuance in that previously they said they wanted to make custom chips, which is what I understand to be kind of the long term trend that a lot of people who want to build out all this AI infrastructure, they want to tailor the chips to tailor to their computation and their algorithms and so forth. The comments today where we really like these Bidia chips, we think they're the best ones. I think that is almost like a, we're going to buy those chips and rent them out. And it's less of an emphasis on the tailoring to rock. In terms of your expectations for capital expenditures, I mean, what do you make of the money losing side of this business? I mean, they have reduced their losses compared to loss quarter. Loss quarter, the losses were insane. This quarter, the losses are still crazy, but seemingly less insane. What do you make of the spending relative to the amount of money that they're actually generating on the revenue side? Well, a lot of what they're spending is still classified as R&D. I saw a few of the line items even for us to go up, admittedly, the CAPEX doesn't show up in the income statement, but the spending generally, right? So let's say R&D and CAPEX together, you can think of those as investments in this. in the future of the business, which they're doing hand over fist, which is appropriate for this type of project. And again, I think it's lumpy. I think they almost pulled forward a lot of their R&D type spending and they had, like you said, extremely low margins high spending last year. So in a way, we're looking at almost favorable comparison post IPO. The overall level, I mean, we don't expect them really to make much money for a while. It seems like the story of this company is kind of morphing into the story of any other hyperscaler, which is that the entire thing depends on the AI thing. And the potential for AI to work is an open question. That's where they're generating most of the growth. That is kind of what they say that the company is going to be about. It's going to be about AI, but also that is where the losses are stacking up. And when we look at how sustainable their business actually is, it seems like the reason that their losses were a little less bad than they were before is because their AI revenue increased and the reason that AI revenue increased is probably because they inked a deal with anthropic. And then that's why I was very interested to see a disclosure that they included, which was their customer concentration risk. What they told us is that 38% of the company's entire revenue comes from two companies, which they said were customer A, which makes up 18% and customer B, which makes up 19.5%. I assume one of those customers is anthropic, and that's basically the bulk of their AI revenue, and maybe the other customer is the US government. I'm seeing headlines today that anthropic is borrowing or in talks to borrow nearly $40 billion from Blackstone in order to buy compute from Google. So does that mean they're going to have to borrow tens of billions of dollars to keep buying compute from SpaceX? Probably. I mean, they're probably going to have to keep borrowing. They're going to have to keep raising money because clearly the profitability isn't working, at least on the frontier side of things. So it does seem to me at least that there is a real risk that you could have randomly in one quarter, 19% of your revenue disappear overnight, and suddenly the entire AI thesis is gone, or at least that's the concentration risk right now. Just looking at the price, the stock has come crashing way down from its highs of $225 per share. It was cut and half. That was one of my predictions. I'll ring the bell. We're now at a more reasonable place, but certainly not anywhere close to your fair value estimate before the IPO of $62 per share, it would need to get cut and half again. What do you make of the valuation at this point today? Still seems high, and I have no reason based on today to change my fair value. As we move forward and let's say gain new information about somebody's market dynamics, I think the scenario you're talking about, maybe to quote Elon Musk, there's a non-zero chance that that anthropic rent goes away, so you have to keep that in mind. I think the scenario in which you're describing is really some kind of a collapse, a house of cards falling down, or all these cross-funding deals being unwound. I'm thinking more along, kind of trying to be a little more, let's say, middle of the road and say in a model where scenarios where right now we're in this gold rush, this fantastical race to spend and invest and build and create even when the business model hasn't proven out or the profitability isn't there. I think a lot of people are working on this assumption or the mental model put forth by the head of Nvidia that there's this five layers cake of value and that over the very long term, the value should accrue to the top two layers, so that's products and apps which today looks like anthropic. Even though that's not happening in terms of their bottom line, that's the theory. It really boils down to what we think AI is and isn't going to do for people. If it's just going to become a plug-in to everybody's computer, like Microsoft Word was and everyone's expectation of other people's productivity goes up, that's one scenario that I think is plausible. It's not the one most people are talking about where they're talking about hundreds of millions of people being displaced and all this other stuff. But even with your middle of the road analysis where you assume that there wouldn't be some form of collapse, that the value would accrue to the application layer, i.e. the Open AI's and the anthropics. Even in that assumption, you still value the company at half of where it is today. You value SpaceX at half where it is today. That's correct. And that's running scenarios where mostly they are making money like they are now on these, let's call them economically attractive or generous rental deals. That has to really, really scale up to work out is that if the LLM that SpaceX has takes off and starts consuming more of their own computing capacity, ironically, that displaces these rental incomes that they might otherwise be able to charge. And so they have to keep making more of it and that costs money. I saw a headline the other day that they're buying land in somewhere, Arizona, like another colossus type installation, and I think on the call they talked about how many gigawatts they planned to have by the end of the year and by the end of the decade, and that implies more terrestrial investment. So they're continuing to expand that footprint, eventually they want to do it in space. They have to do that really fast for them to be able to sort of have their cake needed to have a very broad based adoption of the LLM that they own, so to speak, as well as renting out to the market. All right. Nicholas Owens is a critique analyst at Morningstar. Nicholas, we appreciate you, Tan. Thank you. Thank you. Blackstone is in early talks to provide $36 billion in debt financing to anthropic. This is according to reporting from Bloomberg, the loan will be used to fund anthropics leasing of AI chips from Google, which would imply that anthropic doesn't have enough money to buy compute from Google on its own. So it has to borrow billions of dollars from Blackstone, which is quite remarkable when you consider how much money anthropic has already raised. The company has received roughly $132 billion in venture funding so far. It's also borrowed another $35 billion just a couple of months ago, which basically means that $167 billion isn't enough money to cover their costs. They need more. It's also quite remarkable when you consider the company that already invested billions of dollars into anthropics, specifically Google. Yes, Google committed to invest up to $40 billion in anthropic back in April with an immediate cash injection of $10 billion, which means that even the money that Google wired to anthropic, so that anthropic could buy Google's chips, even that wasn't enough. Anthropic needed more. Why does this matter? Well, because it shows you just how financially unstable these frontier labs really are. Despite the rumors that anthropic was about to hit operating profitability, all the signs are telling us that the company is still losing money and lots of it. So much money that even the money they were given by their vendor wasn't enough to cover the cost of sending that money back to them. Now they're having to borrow to the tune of tens of billions of dollars. The takeaway is quite simple. Despite the hype, the LLM business is still a highly unprofitable business. If open AI and anthropic cannot resolve that problem, then the collapse of this AI trade won't be a question of if it'll be a question of when. OK, that's it for today. This episode was produced by Claire Miller and Alison Weiss and engineered by Benjamin Spenser. Our video editor is Proud Williams. Our research team is Dan Shalon, Chris Nodona, Hugh and Mia Silvario, and our social producer is Jake McPherson. Thanks for listening to Profty Markets from Profty Media. If you liked what you heard, give us a follow. I'm Edelson, I will see you tomorrow.