Meta Platforms just reported great earnings -- and, in the process, put the entire bull market in jeopardy.
The questions that investors are asking go back to the 2022 launch of ChatGPT. Immediately sensing the power and potential of the technology, investors wondered who would ultimately make money from artificial intelligence. Four years later, we're not much closer to an answer.
On Wednesday, Meta reported earnings and revenue that, while noisy due to legal expenses, generally showed strong growth. Importantly, the company announced that its personal AI agent, Muse, is off to a blazing start, with more than 10 million people in the U.S. and Canada setting up Muse agents in the month and a half since launch. Wall Street was impressed, and many analysts raised price targets in reaction to the report, with the average one-year target jumping from $819 to $838 (implying a gain of about 20%), per Bloomberg data. The stock zoomed 7% higher in after-hours trading.
But then those bad old fears about spending cropped up again. At the beginning of the call, Meta quickly said it was adding a new class of nonvoting shares, and when Goldman Sachs analyst Eric Sheridan had the temerity to ask for the rationale, Chief Financial Officer Susan Li explained that the move "will expand our funding tools and give us flexibility to invest behind the unprecedented momentum we're seeing across every part of our business driven by AI."
A filing from the company put a finer point on it. "Recent significant capital raises at other notable companies, and others soon anticipated to take place, to fund the same AI growth -- for example, Alphabet, SpaceX, Anthropic, and OpenAI -- have resulted in an increasingly challenging environment for raising capital." Therefore, it was introducing the shares so it could "act with speed and flexibility when capital needs or strategic opportunities arise."
Muse, for all its success, is also horribly expensive to operate, which ironically means the product's growth has proven painful. "Muse's compute intensity means that expanding its user base will require significant investment," Li said. Indeed, despite the strong earnings, the company's free cash flow turned negative in the quarter.
Meta shares not only gave back their post-market gains, but they were down 7% on Thursday. Meanwhile, the price of insurance on Meta's bonds rose to fresh record highs, indicating that real credit worries are cropping up.
This is much more than a Meta problem. Muse was expected to provide a mere example of how companies can build massively profitable products by leveraging AI technology. Instead, the product is now yet another illustration of how much companies stand to lose when they roll out products that are costly to operate and provide amorphous benefits to customers. Anthropic and OpenAI, the leading AI houses, are enjoying massive growth in users and revenue. And they're both losing billions of dollars.
Muse is a personal product, but the picture is murky at the enterprise level as well. A recent KPMG survey found that 89% of businesses "report measurable value from AI," but we might doubt how much value, given that only 12% consistently assess whether their AI investments are profitable. Troublingly, the percentage of companies reporting productivity gains from AI actually fell from 42% in the first quarter to 37% in the third quarter.
If investors have collectively made one bet over the past two years, it is that tech companies' massive spending on AI will pay off, and tech giants' free cash flows will rise phoenixlike from their current depressed levels to wuthering heights. Meta's report didn't make that look any more likely. Not in the 2020s, at least.
"Because there's just so much demand across so many sectors of AI, there's a scarcity of capital," Nvidia CEO Jensen Huang told CNBC on Thursday, adding: "The demand of the capital is much greater than the availability of the capital. That's going to get solved." It's a framing that makes capital availability sound like a puzzle that investors have to work out. If they balk, then smaller, more leveraged players could be in trouble.
It may be harder for AI companies to access credit, but not so the U.S. Treasury. The yield on the 10-year Treasury note fell 0.193 percentage point on Thursday, its largest single-day decline in more than three years. The move reflects investors' rush to safety, but it also underlines just how systemic AI has become. When investors buy bonds at that kind of clip, it implies that worries about the economy are taking over.
This week's selloff isn't apocalyptic. At Thursday's close, the Nasdaq Composite was down just 0.5% for the week, while the S&P 500 was little changed and the Dow Jones Industrial Average was up 1.7%. But what we just heard from Meta would be deeply troubling if it's evidence that America's most important companies are sinking ever more billions into a money-losing technology.
Microsoft, Alphabet, and Amazon.com all report earnings next week, and they could put the tech trade back on track. The risk, however, is growing. Big Tech has been saying that the AI spending is worth it because the opportunity ahead is so great. Maybe it is.
Investors are now daring to ask: OK, and what if it isn't?
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