NEW YORK, Nov 21 (Reuters) – Investors are growing worried that a rapid increase in public debt used for AI investments could strain the U.S. corporate bond market and ultimately make tech stocks less attractive, even though leverage for most large companies remains low for now.
Big tech companies are aggressively turning to the bond market in the race to build AI-enabled data centers, a change for Silicon Valley companies that typically rely on cash to fund investments.
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Investors say they are not too concerned about the impact of recent financings on stock valuations so far because these companies remain underleveraged relative to their size.
“With all the hyperscalar issuance, I think the market has woken up to the fact that AI is not going to be funded in the private credit markets, it’s not going to be free cash flow. It’s going to have to come from the public debt markets,” said Brij Khurana, portfolio manager at Wellington Management Company.
“We need capital from somewhere to fund this,” he says. “What’s happening now is the realization that we need money to move from stocks to bonds.”
Rising debt among technology companies is adding another source of concern to the market. Despite being buoyed by expectations of high returns from AI, the market remains wary that the technology is not yet delivering the returns needed to justify such large capital investments.
“There are questions that have come up in recent weeks when it comes to the AI spending story, and it’s related to the need for companies to be able to finance their AI spending, and that includes debt financing,” said Larry Hathaway, global investment strategist at the Franklin Templeton Institute.
AI capital spending is expected to increase to $600 billion by 2027, from more than $200 billion in 2024 and just under $400 billion in 2025, and net debt issuance is expected to reach $100 billion in 2026, investment management firm Sage Advisory said in a recent note.
Microsoft and Oracle declined to comment. An Amazon spokesperson said the proceeds from the recent bond sale will be used to pay down business investments, future capital expenditures and future debt maturities, noting that these financing decisions are part of the company’s routine planning. Alphabet and Meta did not immediately comment.
market constraints
Demand for recent high-tech bond deals has been strong, but investors have demanded significant new issue premiums to absorb some of the new securities. Janus Henderson said in a note that Alphabet and Meta paid about 10 to 15 basis points more than the company’s existing debt in recent debt issuances.
“Credit spreads have been tightening for most of this year, but the recent flood of supply, particularly from tech, may have changed that,” Janus Henderson said.
Indeed, the shift to debt is expected to represent only a small portion of total AI spending by big tech companies, with UBS recently estimating that around 80-90% of planned capital spending still comes from cash flow. According to research from Sage Advisory, top hyperscalers are expected to keep debt at a moderate level, with leverage still below 1x from holding more cash than debt, meaning their total debt will be less than their earnings.
“Supply bottlenecks and investor appetite, rather than cash flow or balance sheet capacity, are likely to constrain near-term capital spending,” Goldman Sachs analysts said in a note this week.
Excluding Oracle, hyperscalers could absorb up to $700 billion in additional debt but are still considered safe because they can keep leverage below the level of a typical A+-rated company.
“These companies still have very strong lines of business and they’re just spinning off a lot of cash,” said Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions.
Reporting by Davide Barbuscia in New York. Additional reporting by Louis Krauskopf, Anirban Sen and Chuck Mikolajczak in New York. Editing: Megan Davis and Matthew Lewis
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