Valuation expert Aswath Damodaran trimmed his valuation estimate for AI giant Anthropic to $1.45 trillion, from his earlier estimate of $1.475 trillion which was already lower than the industry estimates of $2 trillion.

The 'Dean of Valuation' in a long blogpost said his earlier valuation estimate which was lower than the overall market view received strong reactions. Some of them were solely based on emotion, he said, as they held strong conviction in the company. Some of it was based on cost of capital, which the analyst believes reflects a fundamental disconnect with market history, current market pricing and basic business sense.

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His latest $1.45 trillion valuation accounts for the trailing 12-month revenue and operating income numbers to include the just-leaked third quarter numbers. “The equity value that I obtain for Anthropic is close to the lower end of the offering price estimates, but as I noted at the time that I posted it, and will reinforce again now, it is a function of not just my upbeat story about the company, but also one about how the AI products and services market will evolve over time,” he wrote.

Aswath Damodaran’s worries for Anthropic

Damodaran estimates Anthropic’s target revenues will reach a trillion dollars in ten years. Not only would this put them at or close to the top of all companies, in terms of total annual revenues, but they will also be sharing that grouping with companies like Amazon and Walmart that deliver on scale, but at the expense of margins, he said, adding that Anthropic emerges as a winner in the premium portion of the AI market, capturing a dominant market share, with pricing power.

In his previous post valuing Anthropic, Damodaran had raised the alarm over the company’s governance structure, stating that its structure as a public benefit corporation and a voting share concoction that leaves founders in control, no matter how much capital the company raises in equity markets. He said he received feedback that this may not be a negative as these are smart people who know AI better than the rest. The analyst is however not convinced as he believes concentration of power in the hands of founders is a bad idea.

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“While much of the focus on Anthropic has been on their compute commitments, disclosed (loosely) in their prospectus, my valuation of Anthropic is driven by expectations of what those commitments will look like over time, and especially if my growth story for the company comes into fruition. Delivering a trillion dollars of revenues will require Anthropic to not just maintain and replenish the compute power that it has already locked down, but add to that power over time,” Damodaran said, warning that building new data centers is getting more difficult, as local communities push back, and politicians realize that opposing them is a net vote winner

Regulatory risks are also one of the key worries for Anthropic. “Put simply, Anthropic will become riskier, if revenues do not measure up to expectations and the pathway to profitability becomes rockier, making it more an output than an input variable,” the valuation expert said.

How investors should react to Anthropic’s IPO?

While Damodaran remains cautious about Anthropic’s IPO, he noted that uncertainty is a feature of investing, no matter what one invests in, with the differences across investments lying in how much uncertainty one face, rather than whether she faces.

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He listed out four responses to such uncertainties.

1) Ignore it: Damodaran pointed out that there are investors who are capable of ignoring uncertainty and going in fully even on the most uncertain investments. They are able to do so because they are far less risk averse than the rest and are willing to live with the consequences of investments (and their portfolios) blowing up. “They are more gamblers than investors, but with good instincts and timing, gamblers can get wealthy too,” he said.

2) Avoid it: If an investor completely wants to avoid uncertainty, she cannot invest in equities, corporate bonds, which have risk of default, and even treasury bonds, which have price risk from shifting interest rates, Damodaran noted. Unless the investor simply wants to just hold cash, she has to therefore decide what her threshold for risk is, and stay within that threshold.

3) Margin of Safety: The third approach to dealing with uncertainty also borrows from conventional value investing and imposing a margin of safety, where you will buy a stock only if its price is less than your value estimate by a margin (20%, 30%, 40%) that you specify.

4) Law of large numbers: “If I had a million dollars in investable funds, would I invest that entire amount in Anthropic, even if it trades at well below my assessed value? The answer would be no, given the uncertainties associated with the future of the company, but that answer would change if my portfolio became less concentrated, since its performance would be less a function of any individual company's performance (good or bad),” Damodaran said. In effect, he said he is using the law of large numbers as an ally to not only reduce his risk exposure to individual companies, but also as a basis for making investments in far riskier stocks than he would be otherwise inclined to invest in.

Disclaimer: This article has been written by Debaroti Adhikary, who is not a SEBI-registered Research Analyst or an Investment Adviser. Debaroti Adhikary and his/her ‘relative(s)’ (as defined under Section 2(77) of the Companies Act, 2013) do not hold any financial interest in the companies mentioned in this article as of the date of publication. The views/recommendations mentioned in this article, wherever applicable, are those of the respective SEBI-registered Research Analyst/brokerage and have been reproduced/reported with due attribution. They should not be construed as the views or recommendations of The Economic Times Digital or the journalist. Readers are advised to consider the original research report and make their investment decisions based on their own assessment. Brokerage disclaimers here.