The Tell

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A poker tell is any physical, verbal, or behavioral cue that a player gives away, often unconsciously, which hints at the strength of their hand or their intended actions. Tells can be obvious or subtle, and players might try to fake them to deceive opponents, making it a skill for experienced players to distinguish real from false signals. Examples include changes in body language like posture or eye contact, the way a player handles their chips, or even the time it takes them to act. 

Now, let's see how this applies to Nvidia, the poster child of AI, the tech powering AI 24/7.

While the report and guidance were strong, the one red flag with Nvidia's report was that the company continues to see its accounts receivable balloon. During the quarter, this metric climbed 89% year over year to $33.4 billion, outpacing its sales growth. Accounts receivable is how much money is owed to the company for products that have been shipped. Continued big jumps in this metric can be a sign of channel stuffing or collection problems. Given that Nvidia has started to make investments in its customers, like OpenAI and Anthropic, this makes it even more notable, as the chipmaker is essentially providing the cash these companies need to help buy its chips. This type of circular financing likely isn't sustainable over the long run.

Channeling Enron?

In reality, when you dig into the details, Enron’s downfall is the predictable mixture of human greed, poorly structured incentives, and lack of sanity checks when everyone has their fingers in the pie. 

You might be surprised to learn that most of Enron’s accounting tactics were not technically illegal at the time – they were actually publicly celebrated for being financial innovations. Shareholders, employees, investment bankers, and accountants all benefited from the situation and enabled Enron for years. They only stopped when it became untenable. This is a big part of the question “Why did Enron fail?”

The most important takeaway from The Smartest Guys in the Room is to understand the key enabling conditions for Enron’s deception. When multiple conditions mutually reinforce each other and create positive feedback loops, a massively outsized result – a lollapalooza – can happen.

These are also the warning signs you can use to detect unstable situations and desist from bad behavior.

1. Accounting practices that disguised the fundamentals

The root of the Enron collapse has to be the accounting tactics that enabled deception. They let Enron book more revenue than they actually earned; keep losses and debt off balance sheets. If these were disallowed, the money-losing state of Enron would have been apparent far sooner.

Mark-to-market accounting allowed booking the total value of a deal immediately, rather than spaced out over time.

Complicated SPE deals allowed Enron to borrow money while keeping it off their balance sheet

One-time asset sales were booked as recurring revenue

Deals that were actually dead were fictitiously kept alive to avoid a writedown that quarter

All this structure became so convoluted that no one totaled up the big picture. No one pieced together the dependencies between Enron’s deals, and how the dominoes would fall if Enron’s stock price fell.

Lesson: Resist the temptation of clever accounting tricks that mislead on fundamentals, even if they’re technically legal. You may eventually deceive even yourself on the true fundamental strength of the situation. 

AKA Stuffing the Channel ...

Channel stuffing is the practice of flooding a distribution channel with excess inventory to artificially inflate sales figures, often done to meet short-term sales quotas or inflate performance. This can lead to negative consequences like high return rates, bloated inventory, fluctuating demand, and reduced profits. It is a fraudulent accounting practice that can result in significant legal trouble for companies, notes KPMG International and MoloLamken. 

Question, what does this really mean for AI. No one knows, do one? - Fats Waller