"$117 billion trap": what risk did a Downgrade Game investor find in Nvidia's report
Cult short-seller Michael Burry, who reported a bet against Nvidia last year, believes the chipmaker will repeat the fate of dot-com bubble-era Cisco due to an abnormal rise in purchase commitments
Burry warns that rising purchase commitments are leaving the company vulnerable / Photo: Shutterstock.com
Behind Nvidia's record earnings lies a catastrophic threat, says Michael Burry. After studying the company's annual report, the investor discovered Nvidia's dangerous dependence on the supply chain: obligations to partners grew almost six times during the year. According to Burry, such a burden makes any cooling of demand for AI fatal for the company and turns its stock into a "binary" bet.
Ultimatum from TSMC
Burry sees the main risk to Nvidia's sustainability as an explosive increase in purchase commitments, from $16.1 billion to $95.2 billion as of Jan. 25, 2025. This cost increase is dictated by the demands of TSMC, which manufactures semiconductors on behalf of Nvidia: due to the extreme complexity of new chips, the fab needed long-term contracts and upfront payments to reserve capacity.
"Until recently, this was not part of normal business practice. It's a testament to what extremely sophisticated 'monsters' Nvidia chips have become"
Nvidia itself warns in the report that these commitments will continue to grow and become a major part of the supply chain. As a result, the company is forced to place irrevocable orders long before actual demand becomes clear, which deprives the business of financial maneuverability.
"This looks like a structural change in the trajectory of product development, not a temporary phenomenon."
The magic of cycles and frozen billions
Burry points to a slowdown in capital turnover: key performance indicators - inventory holding period and liquidity conversion cycle - have not returned to normal after the shocks of previous years. The company's resources remain "locked up" in production longer than they used to be. Total supply commitments (finished inventory plus contracts for future purchases) have reached $117 billion, he estimated. That amount is comparable to Nvidia's annual operating cash flow, depriving the company of its financial cushion. On the accounting charts, such a surge in risk looks unprecedented: the company is "freezing" money for a much longer period of time than ever before in history, the investor wrote.
"This is not business as usual. It's a risk. Huge supply commitments relative to earnings and cash flow make any downturn a potential risk to the existence of the entire company. Any crisis, when it comes, will be much more severe, perhaps even catastrophic to Nvidia's revenues and balance sheet"
The ghost of Cisco
The situation with Nvidia reminds Burry of the Cisco case. In 2000-2001, the networking giant was also expanding orders with the expectation of perpetual revenue growth of 50% per year, but after IT spending cuts, it was forced to write off 40% of its inventory and liabilities.
"Cisco's stock has collapsed catastrophically. The same thing happened to Intel, Lucent, JDS Uniphase and other "star" vendors of the "picks and shovels" boom of the 90s"
While Nvidia's current 71% margin is higher than Cisco's during the boom (~65%), Burry cautions: these margins are "hyped" by scarcity and the price rally. If demand weakens, these margins are likely to revert to average very quickly.
"Recently, we have seen factors causing a sharp drop in demand: sanctions, embargoes, export bans. All this is possible, and, as we have seen, these processes are reversible. A far more permanent event would be Taiwan coming under Chinese control - Polymarket estimates the risk of a Chinese invasion at 10% by the end of 2026 and around 30% by the end of 2030. This is no longer such an unlikely "tail risk". Nevertheless, it's not Nvidia's biggest problem right now"
Binary risk: in or out
The market is changing its attitude towards Nvidia: investors no longer see it as a stable technology giant, Burry believes. They realize that investing in the company is turning into a "binary" and cyclical bet.
Unlike the situation in 2000, accumulated liabilities rob stocks of predictability, making any cooling of demand fatal to the balance sheet, he writes. Demand for AI could falter without major geopolitical upheaval: OpenAI and Microsoft have already begun to reassess their spending plans. Nvidia CEO Jensen Huang has started to spend a lot of time promoting secondary lines of business: Burry notes.
"Perhaps the cycle is starting to unfold, perhaps not. Regardless, it's a risky position - one that Nvidia would prefer not to be in, and one that shareholders would suggest the world's largest company should not be in."
Context
Last year, Michael Burry, known as the prototypical character in the book and movie "The Downgrade Game," reported a bet on Nvidia's stock price decline. He criticized the chipmaker for circular deals in which the company finances tech giants that buy hardware from it or leases computing power from companies that in turn buy its hardware. Burry also argued that Nvidia's customers artificially inflate their financials because they underestimate the amortization on AI chips in their reporting. They are unlikely to be able to last more than five years, Burry estimated, and are written off at six-year terms. The longer the term, the lower the annual costs and the higher the profit - which is what the financier believes is distorting the results.
Nvidia has denied his claims. The company said it extends the life of its AI processors through special software that allows new versions of custom programs to run on older chips.
This article was AI-translated and verified by a human editor
