Moneycontrol Pro Panorama | Of balance sheets and innovation

The broader point is that innovation or audacious business ambition require strong financial support to have a fighting chance at being successful.

Dear Reader,

OpenAI’s data centre partners are taking on $100 billion (Rs 9 lakh crore) worth of debt to fuel the loss-making startup’s ultra-ambitious growth plans, reports the Financial Times (free to read for Moneycontrol Pro readers). While its high-stakes growth strategy and so-called circular deals have already raised investors' eyebrows, the current news could send them right above the hairline.

The FT analysis points out that OpenAI has very little debt on its balance sheet, but companies such as Softbank, Oracle and CoreWeave have borrowed at least $30 billion to invest in the startup or build data centres for it. More contracts are in the works. These are ones that can be directly linked to the startup, but there are others that may be indirectly linked and could take the total even higher. If you are wondering what the strategy is, the article provides an answer from a senior but unnamed OpenAI executive, “How does (OpenAI) leverage other people’s balance sheets?”

At the heart of all these deals sits the humble balance sheet. While the P&L account gets all the press, with more familiar terms like sales, profits and margins, leading to earnings per share and the much-loved P/E ratio, it’s the balance sheet that is the real backseat driver. It provides the capital required for spending both on capex and on operating expenses in the initial stages. A weak one will restrain investments, however great the business' ambition might be.

Consider this, while OpenAI has an expected annualised revenue of $20 billion in 2025, it has commitments to procure $1.4 trillion worth of computing power over the next eight years. Instead of taking on the responsibility of finding all the capital needed for that, it has outsourced that task to a willing network of data centres, chipmakers and financiers.

What these companies are bargaining on is the belief that OpenAI holds the reins to a humungous business opportunity centred on an innovation that could change the world as we know (knew?) it. It owns the idea. They have the money or the balance sheet heft. If it all works, OpenAI will be rolling in cash in a few years or maybe more, comfortably able to meet its commitments, which means these companies will get their share of this cash too, the banks will be repaid, and everyone will live happily ever after.

Of course, there are enough warnings that this is a giant, giant bubble that can or will burst and leave everyone and their portfolios in a miserable state. Let’s see.

But the broader point is that innovation or audacious business ambition require strong financial support to have a fighting chance at being successful. While OpenAI’s scale of ambition is no doubt scary, we are seeing balance sheet support play out in India as well. Take for example, the government’s Rs 7,300 crore rare earth mineral incentive scheme, which we pointed out makes private investment viable but cautioned public investors against jumping the gun. Without the government putting its balance sheet to use (in a manner of speaking), these investments would never see the light of day. Similar incentives in other fields under the government’s production-linked incentive scheme (PLI) have seen investments being made in industries where India lacks competitiveness. Without government support, these investments would not have happened unless industry conditions changed.

While plugging gaps in manufacturing is quantifiable and visible, an equally important but less visible area where the government (Centre and states) can play a key role is in innovation. This FT article ‘Is China winning the innovation race?’ (also free to read for Pro subscribers) starts off with how German company Volkswagen developed, tested and commercially deployed driverless car technology in just 18 months in the country. Back home, this could take 4.5 years. Now, German colleagues travel to China to learn from them. One statistic quoted in the report stands out. In 2007, China was spending $136 billion on R&D compared to US’s $462 billion. In 2023, the gap has narrowed substantially, at $781 billion to the US’s $823 billion.

If India has fallen back on manufacturing, necessitating government intervention, then the gap on the R&D front is yawning. Just as in manufacturing, there has been enough exhortation to private companies to spend more on R&D. But it’s not easy, so they have been hesitant. Even in pharmaceuticals, an industry where India has had a sustained global presence, this article from today’s edition points out that domestic companies’ R&D spends at 5 percent is nowhere close to what global companies spend. MNCs are losing interest in the market, but they are setting up GCCs to support global operations. Even then, points out the article, “…while these centres enhance India’s profile in the global innovation chain, they do not substitute for deep-country R&D, early-stage discovery, or India-centric clinical development. GCCs primarily support global pipelines rather than generate India-first molecules, leaving a strategic gap in domestic innovation.”

The kind of innovation backed by R&D that India needs requires policy shifts, of course, especially in areas such as education and university-industry linkages. But to expect industry to fund R&D from their balance sheets may be asking for too much.

Earnings growth itself has tapered down to single to low double digit levels for many companies, due to various reasons. Spending a percentage point or more of sales will bring them down sharply. Shareholders won’t be pleased at that unless they can see returns on these investments, which in the case of R&D investments will take time to reflect.

It requires a strong external balance sheet to support these investments, with a stake in the profits if it succeeds but with the capacity to bear the blows if it comes to naught. The government, of course, knows this and has set up a research development and innovation fund in FY26 with an announced corpus of Rs 1 lakh crore, with participation from the government and private funders. It will provide funding of 50 percent of the project cost and can be in the form of low-interest loans, equity financing or even contribution to deep-tech funds. Whether this proves to be a catalyst or not in fulfilling India’s innovation ambitions is a question whose answers should become available some years later. 

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