The Capital Cycle Podcast - Where's the Cash?

Episode Date: September 30, 2026

Deals based on dreams in the AI world versus cash transactions in the Old World.Edward Chancellor talks to Charles Carter, a European Equities Portfolio Manager. For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello and welcome to another episode of the Capital Cycle podcast. This is Edward Chancellor, and I've got with me Charles Carter, who's a European portfolio manager with Marathon. Welcome, Charles. Great to see you, Eddie. So Charles, we're going to talk today about how investors are entranced by the AI bubble, which may or may not be entering its final stage. But at the same time, there are plenty of investment opportunities in Europe that in your view, have been neglected or are being neglected. And a two-tier market has opened up similar in many respects to the one that appeared during the TMT bubble of the late 90s and early 2000s, the

division between the so-called new and old economy stocks. And back then, Marathon kept faith in the old economy stocks and eventually did very well by sticking to its guns. Now, anyone who's been paying attention recently. We'll have noticed that the AI boom is being funded with complex and risky debt structures that you believe are typical of past booms. And your thesis is about following the money, which companies require money and which companies are spitting out money. Classic capital cycle theme. But let's start with the AI investment boom at the moment. Well, I think all technological revolutions require financial innovation to get them off the ground. And at risk of teaching grandmother to suck eggs, the railway boom in the 1840s was largely financed by the innovation

of Scrip where you could basically just pay a small fraction of the capital upfront, something like 10% of the share capital. And then later on in the TMT bubble, obviously in the late 1990s, you saw the use of vendor financing, various barter deals, a well-timed IPO, the use of tracking stocks, all of these innovations, which helped that investment in the Information Super Highway in the late 1990s. Which was looking at our capital account book, was roughly in the US about 500 billion in telecoms investment in that period. Anyhow, right today, the investment is much bigger, both in nominal and real-term. about money going into AI. And I think I read that roughly half of the ongoing trillions of dollars being invested in

AI are debt, which is a lot of leverage, given the relatively small, if fast-growing, revenues. There's not a lot of cash changing hands, a lot of promises, IOUs, the use of options, and Vendor paper, all of which is redeemable at an indeterminate date in the future, based on a vision of a transformed and highly profitable new world. And while the AI world is based on promises of future cash flow that may never materialise, you believe there are investment opportunities that offer cash today rather than at some indeterminate stage of the future, as the title of your piece says, where's the cash?

Yes, and I think you talked at the beginning about a two-tier market opening up. I think if you contrast what's going on in the AI world with, for example, what's going on in the very unfashionable corner of European smid or small and medium-sized company investment, you're seeing there at the moment quite a lot of cash bids for companies at valuations which the public markets have lost all interest in defending. And these are businesses which generate cash from customers. they pay their workers, they pay their suppliers, they generate profits and cash flows, which they then return to shareholders. And that sort of contrasts with the sort of the cashless society of AI built upon future promises. On the topic of future promises in AI, you provide an example of rickety financial structures that support the AI data centers or neoclows, as they're called. Yes, well, we came across this Australian.

company called IREN. It was a failed Bitcoin miner that has transformed itself into a neocloud provider. And it's been able to secure something like $19 billion of funding over the last 12 months through the issuance of convertible notes, chipped-backed debt, customer prepayments, and equity. And Nvidia, the chip giant, is at the centers of an AI financing spiders web involved in vendor financing or what's called circular financing deals that are much bigger than anything we saw on the TMT bubble. It's also involved with Iran. Yeah, that's right. They did a deal back in May, which involved a five-year contract worth $3.4 billion to rent capacity from Iran for Nvidia's own workloads. And at the same time, it took up rights to acquire

$2.1 billion of IRN stock at a premium valuation contingent on the delivery of 600,000 Nvidia chips to the company. And this financing might not be as secure as it appears? Yeah, it's not cash. It's an option. It's not a settled transaction. It's more of a five-year framework. And it's not proven revenue.

It's contracted backlog. Of course, Mr. Market got very excited on the day the deal was announced. The stock price was up 27%. But J.P. Morgan was unimpressed talking about the circular nature of the deal and the way in which NVIDIA is using the capacity for its own needs. Undeterred by that skepticism, Iron is planning to invest to cool $30 billion over the next 12 months. And the co-founder and co-CEO, Daniel Roberts, appears to have been drinking the Kool-Aid. Yeah, I mean, he's been quoted.

in the financial times, obviously very, very optimistic. His skills as a forecaster one might want to question, given what happened to the previous Bitcoin venture. But he is proposing what sounds like a perpetual growth machine. He was quoted as saying, this industry is potentially unique in the sense that every unit of supply you bring online actually feeds a multiple of that additional demand rather than solving the existing demand. Again, in the capital account book, we mentioned that executives that the so-called alternative telecom carriers said and possibly even believed much same thing, namely that investing a dollar in fiber optic cables would create a dollar of extra demand. And you could say this turned out to be true in the sense that in the end,

cheap broadband fueled internet growth, but that didn't help the alt-nets because they all disappeared. Now, Roberts, you know, didn't stop there. He also said that the measure of success in the data center business was how many Nvidia GPU chips you controlled, which struck me as a perfect example of late stage capital cycle hubris. Now, a point I made in a recent column that you also make is that the neoclads, the AI data centers, appeared to face an uncertain future, just like the alternative telecoms companies did back in 2000. Yeah, for this all to work, you need the contracted backlog to convert to revenue. You need the revenue to exceed the costs,

and you need to earn a return investment or an ROI before the hardware depreciates into obsolescence. And, of course, underpinning all of this is the need for the AI dream to be turned into reality. But that in itself is a necessary, but not sufficient condition, because ultimately you need a moat around these businesses to protect them from competition that would otherwise bid away the profits. And that, I think, is a very important point because all the good investors I know point out that there aren't any identifiable moats either among the makers of the AI models, but in particular in the AI data centre business.

And I spoke recently with the well-known short-seller Jim Chaynoss, who believes that the AI data center companies will never earn their cost of capital. And we'll see about that. But meanwhile, you're attracted to companies with proven cash generating capabilities rather than proven cash-raising capabilities. Yeah, there is this alternative world where there are companies that generate a lot of cash and are now themselves attracting cash bids. The opportunities you're talking about are in Europe, which is your geographical specialities.

Yeah, one example in our European portfolio is a company called Intertech, which is one of the world's leading testing, inspection and certification companies, which issued a profit warning earlier in the year, and then saw its share price declined by 25% in the following weeks to settle at a level of around £36 per share. And the company came into Sears and they were saying that this was the cheapest valuation the company had been at at any point in its history. Subsequently, EQT, a private equity firm, appeared on the scene. And after a series of bids landed on a final offer of £60 per share.

So that's a 67% premium to the undisturbed price, if you like. So Charles, that's a high premium, but still not enough for this particular. to stock in your view. Yeah, I mean, just looking at this from a very simple valuation perspective, that equates to around a 5% free cash flow yield, which is something that we would consider to be fair value for the stock. Normally, in a takeover situation, you expect a premium for control of around 30%, which we're not getting in this case. And there are several other European midcaps that are simply being misvalued by the market, you believe? We've had a bid for, for another company in the portfolio DCC, which is an Irish-based international distributor of energy and fuel.

And that company had been trading at around £50 per share, KKR and their partner, Energy Capital Partners, initially made a bid of £58, which was viewed as rather stingy. It was subsequently raised to just over £65 plus the dividend, which the board accepted, despite it being, in our view, a low valuation given the company's cash generation and its growth plan, which was all self-funded. So we came out against that bid, and we've had management talking to us recently trying to persuade us to change our minds. This is because they need to get 75% of the shareholders to vote in an EGM. And 30% of the company is now in the hands of Arbs, very smart people who don't actually want to buy the shares outright because they would

have to pay stamp duty, so they can't actually vote in the transaction. Why does the boss of this company have so little faith in its future? Well, I think the view really is that the institutional or public equity markets have just lost interest in this company and that the current low valuation is just going to persist forever into the future. And he cited the fact that they'd met with something like 340 institutional investors over the last 12 months, but they hadn't been able to persuade a single one of them to join the register. And this is a business, as you say, that is doing the right things.

Yeah, I mean, it's generating lots of cash. And you contrast that with IRN and not generate any cash and having its valuation bumped up by $4 billion on the announcement of the NVIDIA deal. So it's a mad, mad world in case you didn't know. But let's turn to another example in Marathon's European portfolios. A more recent example has been Irish Continental, which is a ferry operator that operates ferries on the Irish Sea and across the English Channel. And there, the chief executive has orchestrated a management buyout of the company at eight euros a share, which represents around 2.3 times sales and 10 times earnings before interest. tax depreciation and amortization. And those levels are significantly below where the company

traded back in 2018. The chief executive is taking some money off the table. He has quite a significant stake already. But then he's using debt, some 450 million euros of preferred equity with a 12% coupon and 800 million euros of bank debt to buy the company and land up owning the lion's share himself. So this is a similar case where the management is taking the company private because they feel institutional investors don't have enough interest in it. Like the CEO of DCC, the CEO of Irish Continental has been urging us to accept the bid on the basis that the stock is unloved. Not a single new long-term investor has entered the share register in five years and an advisory process canvassed 20 potential buyers over a similar period and drew a blank.

And the largest existing outside shareholder has been reduced to urging the board to find someone, anyone, prepared to take the business off their hands. In the long run, it's a company's capacity to generate free cash flow based on the economics of the business, which determines investment returns, rather than the fleeting fads and fashions of the investment community, or as Ben Graham, famous, said in the short run, the market is a voting machine, but in the long run, it's a weighing machine, and that weighing is done for the most part in cash. And during bubble periods, this simple investment truth is forgotten. Yeah, from our perspective, these arguments ring hollow. And just

because a stock is out of favour now doesn't mean it's going to be out of favour forever. And you know, part of our job is to find undervalued out of favour shares. And, you know, we're wait patiently for Mr. Market to come to his senses. And I think the CEO of Irish Continental probably takes a similar view and naturally wishes to own more of the company if he can get at a low price. For this reason, we rejected the offer only to see the other shareholders vote narrowly to accept it. And private equity has been nibbling at other undervalued stocks in Marathon's European portfolio. Yes, there's another example of EasyJet where the company had been hit, by the turmoil in the Middle East and concerns about rising fuel prices. There was a profit warning

and then talk about strategic investments and additional resilience measures. And all that knocked the stock price down to below £4, which is roughly where it was trading during the low points of COVID. And that's when opportunistic outside investors pounced. Yeah. So on an earnings valuation basis, which is typically how the market currently values these types of businesses, there is an alternative, which is more of an asset-based evaluation. EasyJet has got some very attractive assets. It owns 58% of its fleet. It's got a lot of these very scarce Airbus A320 and A321 NEOs and backlog of planes on order. And then it's got some very attractive slots at constrained airports like London Gatwick or Geneva. After several

attempts to persuade the board, Castle Lake, which is involved in aircraft lease financing, made an initial formal offer at £6.50 per share. That was subsequently raised to £6.90. And then in July, Apollo, private equity giants, entered the battle at £7.15 a share, which is an 81% premium to the undisturbed price. Charles, you're pointing to a stark asymmetry between the fashionable but cash poor AI world and the neglected but cash rich European value stocks. In the AI sphere, a company with negative free cash flow is able to secure a rising valuation on the back of a chip vendor's option to buy shares in five years' time, financed in the manner in which the same dollar can be counted as revenue for one party and investment for the other, more or less simultaneously.

In the other world, you've got companies generating real cash flows valued at mid-to-high single-digit free cash flow yields that are unable to attract new long-term institutional shareholders and are eventually bought out for cash by whoever still has a checkbook and the patients to exploit the gap between price and value. I should add that insiders at the neoclouts appear to be attracted to cash as well, at least from a personal perspective, since the co-founders and CEOs of Eren, who are both brothers, cashed out $66 million worth of shares last September. And there's been heavy insider selling at the largest AI data center operator CallWeave.

And insiders are anthropic and open AI have also sold over $10 billion dollars worth of stocks. It's as if they believe their companies were going out of business. Capital has concentrated so heavily around the promise of an uncertain, transformed future, that it's crowded out or starved investment in other areas of the market, which creates an opportunity for people who have the patience and nerve to invest for the future cash returns. And there'll be a final reckoning. Well, I think the AI complex eventually has to settle its accounts in the same currency, in cash, collected, not promised. And it's then you'll find out for sure how much of the value

currently being ascribed to promises is actually there. And in the meantime, the question that's worth asking any company in any sector, fashionable or otherwise, remains the oldest one in investing, which is where precisely is the cash? To which the answer during bubble periods is usually in the insider's bank account. Thank you, Charles. That's a good talk. Thank you very much, Eddie. Thank you for your time today. I hope you will listen to the next edition of the capital cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information,

including important disclosures.