CoreWeave’s Debt Insurance Costs Just Hit a Record. Can It Keep Funding Its AI Boom?
Key Points
Investors are demanding more protection against a potential CoreWeave default.
CoreWeave generated negative $5.7 billion in free cash flow last quarter.
Strong growth may not be enough if financing becomes harder to secure.
CoreWeave (NASDAQ:CRWV), one of the leading "neoclouds" racing to meet the seemingly endless demand for artificial intelligence (AI) computing power, is once again making headlines. This time, however, it's not for setting another record sales figure or inking a new deal with OpenAI or Anthropic.
Instead, CoreWeave is in the news because its rather large debt load is getting more expensive to insure. In other words, investors are worried the company could default.
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On Thursday, the spread on its five-year credit default swaps (CDS) reached a record level. By midday, it stood at 1,038 basis points, up 164% year over year. 1000 basis points is generally considered in "distressed" territory.
What is a credit default swap?
A credit default swap (CDS) is basically an insurance contract on a company's debts -- a contract where the buyer pays an ongoing fee (like a premium) in exchange for a payout if the debt goes bad. And just to be clear, you don't actually have to own the company's debt to buy a CDS.
Of course, the riskier the borrower looks, the more that protection costs, reflected in the spread -- the portion of the amount insured that the buyer pays each year. So, a $1,000,000 CDS on CoreWeave debt at today's rate -- 1,038 basis points or 10.38% -- would cost you $103,800 a year.
Why higher borrowing costs could hurt CoreWeave
CoreWeave has borrowed heavily to fund its growth and is now on the hook for roughly $51 billion in debt and lease obligations. That's a lot to carry for a company still losing money. Its net loss reached $626 million last quarter, up from $290 million a year earlier.
The cash picture doesn't look great. Capital spending jumped to $6.4 billion, helping push free cash flow -- cash from operations minus capital spending -- to negative $5.7 billion. Keeping that up requires enormous amounts of outside funding and more debt.
While rising CDS rates don't guarantee a default, they indicate the market is growing less comfortable with the risks of CoreWeave's model. Future borrowing -- or any refinancing of its current obligations -- could become more expensive. And if that happens, if lenders demand a higher and higher rate to provide more capital, the chances of a default go up as its cash flows face even more pressure.
CoreWeave's growth is still impressive
Of course, we need to be clear that CoreWeave is indeed growing like crazy. The company's latest quarter saw it bring in $2.58 billion, more than twice what it made during that same period a year earlier. And the company has an ever-growing backlog that has reached $104 billion in promised revenue.
Image source: Getty Images.
A financial tightrope with little room for error
That growth is impressive, and it's why investors have been willing to give CoreWeave so much money in the first place. But turning that backlog into revenue will continue to be a challenge that will only get harder if its debt keeps getting more expensive. If it gets too expensive or worse, if lenders refuse to extend more funding, the whole model could fall apart.
In my view, CoreWeave is walking a financial tightrope that leaves too little room for error and relies too heavily on debt. Today's spike in CDS rates shows the market may agree.
Johnny Rice has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.