2023-10-19 07:35:00 ET
Summary
- Generative AI has massive potential to transform the workplace of the future.
- Technology builders, adopters, and enablers will likely benefit from the potential but come with varying investment risks.
- I am loading up on the 8.5% yielding preferred shares of a critical Gen AI enabler.
Co-authored with “Hidden Opportunities.”
Generative AI (Artificial Intelligence) is the talk of the town in 2023, and several companies are seeing massive capital inflows as everyone is trying to board the AI train before it departs the station.
What is Generative AI?
Generative AI is a type of artificial intelligence technology that can produce various types of content, including text, imagery, audio, and synthetic data, based on the specifications of the requestor. The recent buzz around generative AI is primarily driven by the simplicity with which individuals can get high-quality text, graphics, and videos created in a matter of seconds.
According to the latest annual McKinsey global survey , nearly one-quarter of surveyed C-suite executives say they are personally using Gen AI tools for work, and more than one-quarter of respondents from companies using AI said that Gen AI is on their boards’ agendas. 40% of respondents say their organizations will increase their investment in AI overall due to the advances made by Gen AI.
Why is it such a big deal?
Generative AI has massive potential to reduce human intervention in highly manual, time-consuming, and repetitive tasks. For example, jobs that involve entering data from printed reports to a digital form, moving data from one system to another, or proofreading extensive transcripts can be done in seconds.
Not just that, Gen AI can eliminate several jobs and is creating anxiety among a wide range of employees, as seen from the Hollywood strikes . Gen AI can be used to write, test, and troubleshoot code and perform complex data analytics and decision-making tasks performed by employees currently collecting six-figure salaries. From an industry lens, Gen AI has tremendous applications in the following:
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Improving customer service and experience
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Boosting employee productivity
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Enhancing Creativity and Content Creation
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Accelerating Process Optimization.
Gen AI should not be confused with Robotic Process Automation. The former handles cognitive tasks requiring intelligence (passing an MBA exam), whereas the latter is used in highly repetitive tasks requiring high accuracy (processing payroll periodically).
How to invest in the potential of Generative AI?
You could invest in companies inventing the assets that help this technology grow and become more powerful. Tech giants like Alphabet/Google ( GOOG ), Microsoft Corporation ( MSFT ), Meta Platforms ( META ), and Nvidia Corporation ( NVDA ) are popular firms investing in providing Gen AI offerings as part of their products and services. There are younger firms with more targeted business segments, but profitability and competitive landscape are critical considerations before they make suitable investments. Source .
As income investors, we seek sustainable dividends from our investments and choose to invest in firms that provide the infrastructure that enables these AI platforms to grow and achieve their objectives.
DBRG - A Leading Digital Infrastructure Asset Manager
DigitalBridge Group, Inc. ( DBRG ) is a unique company operating a private equity fund management business focused on digital infrastructure assets.
AI workloads require massive computational power and are projected to consume 80% of data center power over the next 15 years, and this will drive the infrastructure market to dwarf today’s $300 billion global public cloud market. Hyperscalers, edge data centers, mobile towers, fiber, and small cells are vital components of this growing digital ecosystem, and DBRG is well-positioned to see rapid growth as capital pours into these essential building blocks. Source .
DBRG’s transformation from a REIT to an alternate asset manager is progressing rapidly. Previously, the company had a shrinking “Operational” business that owned data centers through its investment in Vantage and DataBank. During Q2, the company completed the deconsolidation of DataBank and is well-positioned to do the same with Vantage by the end of the fiscal year.
Today, DBRG’s core business involves raising funds from third parties and deploying the capital into the acquisitions and development of digital infrastructure assets, such as data centers, cell towers, and fiber networks, which are then actively managed by DBRG. As an investment adviser and general partner of these funds, the firm collects a management fee, a percentage of FEEUM (Fee-Earning Equity Under Management)). These revenues are recurring, predictable, and stable, and the funds are long-term, with an average life of over ten years.
DBRG reported a solid Q2, with assets under management ("AUM") growing to 72.2 billion (up 51% YoY) and $29.1 billion FEEUM (up 53% YoY). As a result, the company's fee income was $66.5 million during the quarter (up 47% YoY). Profitability remains solid with $10 million in distributable earnings, providing adequate coverage for the currently small common dividend payment. The company also made a $200 million payoff of its 2023 convertible notes, resulting in a 14% reduction in its total debt.
But DBRG common stock offers a paltry dividend, and we look higher up in their capital stack for better income.
Deeply Discounted Preferreds For High Yield
In general, preferred shares provide safety and higher yields than common stock, and are accompanied with lower volatility. They are perfect investments for income investments and retirees. However, they are sensitive to interest rates, and in today’s elevated interest-rate scenario, are trading at pennies on the dollar.
DBRG preferred shares offer high yields protected by the lucrativeness of its operating industry. DBRG's +8% yielding preferreds are trading post their call dates, and management seeks to purchase them in the open market at these deeply discounted prices and has been steadily pursuing these purchases in recent quarters. They see it as a risk-free 10% return on their investment. During Q2, the company spent $920,000 to purchase some preferreds on the open market.
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7.125% Series H Cumulative Redeemable Perpetual Preferred Stock ( DBRG.PR.H )
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7.150% Series I Cumulative Redeemable Perpetual Preferred Stock ( DBRG.PR.I )
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7.125% Series J Cumulative Redeemable Perpetual Preferred Stock ( DBRG.PR.J )
"We have a ton of liquidity as we just discussed. Our debt levels are low and significantly lower every single year. So, we’ve got a ton out there, firepower to deploy towards M&A. We continue to look at other GPs. We’ve talked about this. And we would like to get -- continue to look at new products and get bigger. So doing that analysis in terms of buy versus build is important for us. And we continue to look at those opportunities to the degree that there is excess cash that we are not going to deploy towards M&A. We will continue to look at redeeming some of those preps because the benefit of that is certainly -- it’s a 10% return guaranteed risk-free, but then that unlocks additional firepower for potential upsizing of common dividend because of the recurring cash flows that we’re just generating from the business and the scale. So the first order of business is if we can find good GPs and investment managers that we can buy, and that’s going to give us a return that’s well in excess of 20%, 30%, of course, we’ll do that. Certainly, if not, then we’ll take that liquidity and waterfall that down to other uses, which is a prep redemption." – Jacky Wu, CFO .
DBRG is in a comfortable liquidity position with $426.8 million in cash and cash equivalents as of June 2023. During the first half of FY 2023, the company generated $20 million in distributable earnings and paid out ~$3.5 million. The common dividend is comfortably set at a 17.5% payout ratio. During this period, DBRG spent $29.3 million on preferred stock dividends (down from $31.5 million last year), and this expense enjoyed adequate coverage from $92 million in net cash from operating activities.
At this time, all three preferreds present a similar current income of 8.5% and offer 19% upside to par. Readers are encouraged to consider whichever security presents the best deal at the time of purchase.
Conclusion
Generative AI has excellent potential to transform the workforce of the future. While investing in the technology creators or users could offer an upside, it comes with competitive pressures, execution risks, and profitability concerns.
DBRG preferred stock presents the Income Method of investing in the backbone of the digital transformation of Gen AI. DBRG common stock recently received an upgrade from JPMorgan (JPM), given industry tailwinds supporting capital inflows and strong capital formation momentum, and the company is rapidly growing its digital asset management portfolio. Gen AI is resource-hungry and computation-heavy, making it a growing long-term digital tenant in DBRG’s portfolio. I sit back and collect my fees through the deeply discounted 8.5% yielding DBRG preferreds.
For further details see:
Generating Magnificent Dividends From Generative AI; 8.5% Yields