Meta’s woes spur brutal reassessment of Big Tech’s bets
Is this any time to splurge on tech’s Next Big Thing?
As the biggest US tech companies reported earnings this week, the unexpectedly severe drag from the slowing global economy was uppermost in investors’ minds. Growth in digital advertising, ecommerce and cloud computing — three of the main engines behind the secular growth of the digital economy — has slowed more than expected as economic conditions worsen.
The slump in Big Tech’s collective stock market value this week was also a reaction to the companies’ profligate spending. The result has been an unpleasant hit to profit margins for some of the most profitable groups on the planet. Facebook’s operating margin collapsed, falling from 36 per cent to 20 per cent, while Alphabet’s margin dropped 7 percentage points, to 25 per cent. Only a change in depreciation accounting enabled Microsoft to avoid a near-5 point fall.
Along with stubbornly high operating costs, capital spending at some companies has ballooned. At Meta, capex rose 68 per cent in the first nine months of this year to $22.8bn, while at Alphabet it climbed 31 per cent to $23.9bn.
It is tempting to blame all of this on a simple lack of financial discipline. Google executives sounded almost apologetic about the 12,765 new workers their company added in the latest quarter alone, blaming the number partly on an acquisition and promising fewer than half as many new hires in the current quarter.
Much of the spending, however, was entirely purposeful. It reflected a belief that the tech industry stands on the cusp of a new era of growth. If companies such as Alphabet, Meta and Microsoft are to be believed, their willingness to spend heavily now, even in the face of a slipping economy, will determine how much they share in tech’s next decade-long growth cycle.
Two technology platform shifts figured prominently in this discussion. The first is the promised arrival of the metaverse — the name given to a more immersive version of today’s internet. Meta, which has already lost $9.4bn in its metaverse operations in the first nine months of this year, has no intention of taking its foot off the accelerator: instead, it said the losses would increase “significantly” in 2023. Wall Street’s knee-jerk reaction to this and other spending plans was to slash nearly a quarter off Meta’s stock price in the space of a single day.
One way to view this is as a mismatch between the tech industry’s big investment cycles and Wall Street’s hunger for near-term results. If Mark Zuckerberg is right in arguing that Meta has the chance to become as central in the metaverse era of computing as Microsoft was in the PC era, then wasting the odd $10bn will seem inconsequential.
But the Meta chief executive’s inability to lay out a clear and convincing case for how and when large numbers of people will want to enter the metaverse has made it difficult even for the believers to build an investment case. And his attempts instead to focus attention on Meta’s leadership in virtual reality and other metaverse technologies have fallen on deaf ears.
Inventing key technologies has not been a necessary precursor to success in the computing industry’s platform shifts in the past. Microsoft’s dominance in the PC era, like Apple’s leadership in smartphones, owed more to successfully repackaging technologies invented elsewhere than in conducting advanced R&D.
The second platform shift highlighted during this week’s tech earnings is very different. This involves the new technology infrastructure being put in place to support artificial intelligence: the hardware and software needed to collect large volumes of data, train deep learning models and embed AI into all of the most commonly used digital services.
The huge costs of this AI race are becoming increasingly evident. After this year’s surge, Meta indicated that its capital spending in 2023 might jump another 20 per cent, with all the extra costs tied to AI.
One concern this has raised on Wall Street is that the economic model underpinning mass online services is shifting, and that AI requires a new, heightened level of capital intensity. Another worry is that it will be hard to tell if the tech companies ever earn a decent return from this step-change in spending on AI. The companies claim it will enhance the quality of their digital services, increase user engagement and boost the efficiency of advertising — things that are hard to judge from the outside.
Alphabet and Meta both promised to hone their focus on measuring the results of their new AI infrastructure and to adjust their spending based on the effectiveness of the technology. That might give some comfort to investors after this week’s battering. But it was also a warning: Some costs are likely to stay stubbornly high, even if Big Tech’s revenues come under greater pressure in a downturn.