Tech investor Orlando Bravo says ‘valuations in AI are in a bubble’

Are AI valuations in a bubble? That’s the question Thoma Bravo co-founder Orlando Bravo is posing, drawing parallels between the current fervor surrounding artificial intelligence and the dot-com boom of the late 1990s. In a recent interview, Bravo cautioned investors about the lofty valuations being assigned to AI companies, suggesting a potential disconnect between market hype and fundamental business realities.

Bravo, whose private equity firm manages over $181 billion in assets, specializing in enterprise tech with a strong cybersecurity focus, argues that the numbers simply don’t add up in many cases. “You can’t value a $50 million ARR (Annual Recurring Revenue) company at $10 billion,” he stated. “That company ultimately has to produce a billion dollars in free cash flow just to deliver a reasonable return. Even with the best product and market, that’s a huge managerial challenge.”

His concerns come as AI companies are attracting massive investments and achieving eye-popping valuations. OpenAI, the creator of ChatGPT, recently completed a secondary share sale reportedly valuing the company at a staggering $500 billion, despite projected 2025 revenues of $13 billion. Furthermore, tech giants like Nvidia are reportedly committing significant capital, potentially up to $100 billion, to support OpenAI’s infrastructure development, including leasing AI chips and building supercomputing facilities. This commitment, while demonstrating Nvidia’s belief in the future of AI, also highlights the immense capital expenditures required to compete in the burgeoning AI landscape.

The froth isn’t limited to private markets. Publicly traded companies with a strong AI narrative are also seeing their market caps surge. Palantir, for example, has climbed to a valuation of $437 billion, placing it among the most valuable companies in the US, while AppLovin now boasts a $213 billion valuation. Even seed-stage AI ventures are attracting unprecedented attention, such as Thinking Machines Lab’s recent $12 billion valuation after a $2 billion seed round, a deal that raises eyebrows even within the already exuberant AI investment community.

The rapid escalation in valuations begs the question: are these AI companies truly justified given their current revenue and profitability, or is the market driven by speculative exuberance? Bravo acknowledges the potential for long-term growth in AI, but emphasizes the need for a rational approach to valuation, grounded in realistic projections of future cash flows.

While acknowledging the potential for a correction, Bravo also differentiates the current environment from the dot-com era. He points to the presence of established, well-capitalized companies driving the AI revolution. “Now you have some really big companies and some big balance sheets and healthy balance sheets financing this activity, which is different than what happened roughly 25 years ago,” he explained. This infusion of capital from established tech players could provide a more stable foundation compared to the dot-com bubble, which was fueled by inexperienced companies and readily available venture capital.

However, the involvement of these large companies also injects complexity into the ecosystem. Their investments are not purely philanthropic; strategic aims often drive their decisions, like vertical integration or gaining competitive advantages. It remains to be seen whether this strategic funding will foster sustainable growth or instead lead to market distortions and an uneven playing field for smaller AI startups.

Bravo’s commentary serves as a reminder to investors to conduct thorough due diligence and critically evaluate the long-term potential of AI companies before jumping on the bandwagon. While the transformative power of AI is undeniable, a dose of caution and realistic valuation is essential to avoid repeating the mistakes of the past.