UBS says neocloud sell-off does not derail AI boom, favours hyperscalers and chipmakers

The UBS view separates two trades that moved together last week: highly leveraged neoclouds, whose models depend on cheap funding, and cash-rich hyperscalers and chipmakers, whose earnings continue to grow. If that distinction takes hold, it could support a rotation within tech rather than a broad exit, with semiconductor names and the large cloud platforms holding up better than specialist GPU renters. The rates backdrop is the key swing factor. With bond yields elevated across developed markets, any further rise in funding costs would weigh most on the neocloud segment. Hyperscaler results over the coming weeks will be the next test, with UBS expecting cloud revenue growth to accelerate.---The UBS note was before the bounce on Monday, kudos to them!investingLive Americas market news wrap: AI trades rebound but so does oil--- Specialist AI cloud firms are feeling the squeeze from higher rates, but UBS argues that is a funding problem for one corner of the market rather than a crack in AI demand itself.Summary:Shares of neoclouds, specialist providers that rent out AI computing capacity, came under heavy pressure last week on concerns about their growth models as rates stay higher for longer.The sell-off helped drive a weekly fall of about 4.5% in the Nasdaq, its biggest weekly loss since June, with competition from China and revenue worries at AI labs adding to the pressure.UBS says the weakness does not undermine the broader AI investment cycle and expects AI capex to rise 33% to $1.2 trillion in 2027, with neoclouds under 10% of that spending.GPU rental prices continue to rise: rates for four-year-old chips are up nearly 30% this year, and for two-year-old chips about 35%.UBS says strong results from TSMC and ASML support the view that AI demand remains robust.The bank limits exposure to neoclouds and favours well-funded hyperscalers, quality chip and hardware names, and defensive areas of tech.UBS says last week’s sharp sell-off in so-called neocloud stocks reflects funding and execution risks in one corner of the AI market rather than a weakening in demand for artificial intelligence, and the bank remains positive on the sector’s structural growth.Neoclouds are specialist providers that rent out graphics processing unit (GPU) computing power for AI workloads. Their shares came under intense pressure last week as investors questioned their business models against a backdrop of higher-for-longer interest rates. Competitive threats from China and concerns over revenue growth at leading AI developers added to the selling, which helped push the Nasdaq down about 4.5% for the week, its steepest weekly decline since June.UBS argues the distinction between neoclouds and the large hyperscale cloud providers is central. Neoclouds typically offer a single product and must invest heavily upfront before contracted revenue turns into cash flow, which leaves them exposed to rising funding costs. Hyperscalers are also borrowing more to finance their AI buildout, but their broad cloud platforms generate diversified revenue. UBS estimates their cost of debt at a manageable 6.5% to 7%, against returns on new data centre investment of around 25% or more.The bank expects the overall impact on AI spending to be limited while computing capacity remains scarce. It forecasts AI capital expenditure rising 33% to $1.2 trillion in 2027, with neoclouds accounting for less than a tenth of that. A further sharp rise in funding costs could still hit the neocloud segment, UBS said, though strong customer credit quality and large advance orders should provide some protection.Rental prices offer one of the clearest signals. UBS said rates for four-year-old GPUs rose 7% over the past month, taking their gain this year to nearly 30%, while rates for two-year-old GPUs are up 35% year to date. Rising prices for older hardware point to demand still outstripping supply.Third-quarter results support that view. UBS noted that TSMC said demand remains strong and expects its capital spending over 2026 to 2028 to be meaningfully higher than in the previous three years, while ASML reported strong order intake for 2028, with interest stretching into 2030. UBS also expects hyperscalers to report accelerating cloud revenue growth.The bank acknowledged that funding and execution risks could feed on each other, with tighter credit slowing deployment and delays postponing the cash needed to service debt. It recommends a selective approach: limiting exposure to neoclouds, favouring well-funded hyperscalers and high-quality semiconductor and hardware names, and considering defensive tech areas such as payment networks, select consumer electronics and select software.  This article was written by Eamonn Sheridan at investinglive.com.