TheChek News Flow

The Takeaway

Until a year or two ago, big tech firms like Google had relatively simple balance sheets, stuffed with cash that covered any debt several times over. Nowadays, thanks to massive AI spending, Google and others are adopting techniques long used on Wall Street to expand their business without taking on all the risk themselves.

Google, for example, disclosed last week that it had agreed to cover as much as $44 billion worth of lease payments on data centers owned by others, if the tenant defaults. That figure, which has risen from $6.5 billion as of the end of September, reflects Google’s efforts to supply Anthropic and others with its alternative to Nvidia’s AI chips.

This exposure is just one sign of how radically Alphabet’s capital structure has changed over the past year as its huge AI investments have forced it to raise money beyond its own cash. Its debt has grown to $98 billion as of June 30 from $23.6 billion a year earlier, while it issued equity for the first time in more than two decades. The reason for the fundraising became clear last week, when Alphabet reported it had burned cash—on a free cash flow basis—in the second quarter for the first time as a public company.

But the $44 billion of exposure to potential defaults of data center tenants isn’t on Google’s balance sheet, although it is disclosed in the footnotes. The balance sheet shows a much smaller figure—$815 million—reflecting Google’s estimate of its likely exposure.

Google has taken on these commitments—also known as backstops—as it expands its sale of AI chips known as tensor processing units. While Google rents servers powered by its TPU AI chips through Google Cloud, it is now expanding TPU use by putting them in data centers operated by other companies. These include some developed by former crypto miners, such as Hut 8 and TeraWulf, that have pivoted to running their facilities for AI.

In taking on the commitments, Google is calculating that the revenue to come from TPU sales will outweigh the financial obligations of providing backstops on the leases for the data centers that will hold them, according to two people with direct knowledge of the company’s thinking. Company executives feel confident that the financial calculus pencils out well in Alphabet’s favor, one of the people said.

In many of the deals, cloud startup Fluidstack is leasing and operating the planned data centers and filling them with TPU chips, then renting that capacity to Anthropic, according to people familiar with the arrangements and company disclosures. Alphabet executives look through the Fluidstack lease when they think about the backstops to consider if the end user will default on a payment or go insolvent, one of the people said.

Alphabet has backstopped leases on about 2.4 gigawatts of capacity across roughly ten projects, one of the people familiar with Alphabet’s thinking said. None of those projects are yet complete, which means Alphabet’s backstops are not yet in force.

The actual TPUs going in the data centers are financed separately, many via arrangements where Broadcom, which works with Google on the TPU’s design, provides a guarantee of its own.

The setup means Google is essentially acting as a corporate guarantor for space to house the chips, allowing the developers to secure cheaper debt and build capacity faster than they could on their own. The figure that the company discloses in its securities filings is the maximum amount of future payments it could be on the hook for—what Google calls the notional value.

A smaller figure reflects its estimate of what it is likely to pay under the guarantees. Changes in this figure, a derivatives position carried at fair value, flow through to Google’s profit and loss statement.

Alphabet’s estimate of the fair value is based on its assumptions about the probability and timing of defaults and any amounts it could recover.

Recent filings show how Google’s exposure has mushroomed. In October, Google said that even as the notional value was $6.5 billion, the fair value was not material. In the most recent quarter, the fair value recorded on the balance sheet was $815 million, while the notional value had ballooned to $43.8 billion.

Jordan Chalfin, head of technology research at CreditSights, cautioned against getting too concerned about Alphabet’s notional numbers, at least at this point in time. “The figures that they do disclose are the max possible loss, so keep that in mind,” Chalfin said in an interview. And, he said, “there are various kinds of things that could mitigate the exposure.”

Indeed, Alphabet’s disclosures say it has several options if a tenant defaults. It generally retains the right to assume the underlying lease for its own use or the use of customers, adding scarce capacity, or lease the data center space to others. Also, the company notes that many of the leases carry terms of up to 15 years, and the potential exposure declines over time.

Alphabet even has the option to terminate the backstop, though two people familiar with how the termination payments can be structured said that would likely require a hefty one-time payment to compensate bond holders who relied on the backstop when they purchased the debt. The payment would effectively get converted into an ownership interest in the project, with the size of the stake based on the size of the payment and the total cost of the project, one of the people with knowledge of Alphabet’s thinking said.

Not all of Alphabet’s backstop arrangements are created equally. In one transaction with Hut 8, where Google is responsible for the entirety of a 15-year lease payment if Fluidstack defaults, neither party can get out of their obligations if there’s a major construction delay, according to Fitch Ratings. That’s a contrast to deals with other developers including TeraWulf and Cipher, where there’s a termination provision for delays, Fitch said.

The Hut 8 data center lease has a contract value of $7 billion, as well as another $2 billion in other expenses such as power and property tax insurance, CEO Asher Genoot said on a conference call when the deal was announced.

Yet to Commence

Google’s approach reflects one approach to financial engineering supporting the build-out of AI infrastructure. Its competitors have employed others. Meta, for example, has entered into joint ventures as a minority partner to build data centers in Louisiana and Texas and keep them off its balance sheet. Oracle has also relied on arrangements off the balance sheet to support its ambitions.

In addition to the backstops and other guarantees, Alphabet, Meta, Oracle and others have signed hundreds of billions of dollars in data center leases that have not yet begun, keeping them off the balance sheet for now. In most deals, the leases don’t officially begin until the data center is built, the chips are installed and the facility is turned on.

For Alphabet, those yet-to-commence leases totaled $85.2 billion at the end of June. Another obligation, financial guarantees that act as backstops allowing its partners to secure power and energy equipment, totaled an additional $7.6 billion.

And more backstops are coming that Alphabet will likely have to account for. It said it has agreed to provide another $24.1 billion of future backstops to support data center and energy assets, subject to the finalization of terms.

Google’s business remains strong, to be sure. The company generated more than $185 billion in operating cash flow over the past 12 months, and despite its recent stock and bond sales, it still has a robust ability to raise more funding. If the worst were to happen, Alphabet could also dial back on spending.

Anubhav Arora, a credit analyst at Fitch Ratings, underlined the importance of that financial strength when the firm rates debt related to the data center deals. He explained that Fitch relies “very heavily on the backstop that Google has provided” to assign the projects an investable rating. He doesn’t anticipate Google’s activity slowing down anytime soon.

“We continue to see more deals with Google backstops for unrated tenants, so I clearly expect the trend to continue,” he said.

Sharing in the Upside

At the same time, Google has structured many of its deals so it stands to collect some of the upside if the data center developers’ shares perform well.

In some cases, but not all, the company has collected equity warrants in return for its backstop. It holds warrants, for example, that would allow it to own 14% of TeraWulf, which is building a data center for Fluidstack in Barker, N.Y. Google also has warrants potentially worth 5.4% of Cipher Digital, which is building a data center in Colorado City, Texas, in a similar arrangement.

There’s one notable exception so far. When Hut 8 announced its own deal with Fluidstack and Anthropic in December, the company didn’t give up warrants in return for Google’s backstop.

That deal, one of the people with knowledge of Alphabet’s thinking said, was an anomaly and isn’t likely to be repeated.