Meta Platform’s shares look like a stock-market steal. But their bargain price is more a warning about its uncertain prospects than an opportunity for investors.
Meta’s stock has weakened recently as concerns have grown over its spending on AI, making it unusually cheap. The company is trading near its lowest price-to-earnings multiple in three years. At around 18 times forward earnings, its valuation also represents a discount to other big tech companies. The premium for Google-parent Alphabet’s shares over Meta is the highest since 2022.
That attractive price comes with an underlying business that is growing rapidly. Revenue grew 33% in the first quarter – a shocking figure for a company as big as Meta.
Meta has arguably been the most successful big tech company ever in terms of using AI in ad sales, which account for almost all of its revenue. It is using AI to show users posts and videos that motivate them to view and click on ads more often. AI is also helping to improve conversions—getting users to take actions like buying the things they see ads for. The company said conversion rates following clicks on ads increased 6% in the first quarter. Advertisement prices have also increased. All of this is giving huge momentum to the meta at a time when tech companies are under greater pressure than ever to show returns on big AI investments.
But there are reasons to be skeptical about whether Meta’s AI party will last.
The potential for user growth in the long term is strong. The company has a large base of users – more than 3.5 billion people used Meta’s Facebook, Instagram, WhatsApp and Messenger daily in the first quarter. However, the growth isn’t impressive: Users increased 4% year-over-year in the quarter, but declined sequentially, something that had never happened since it began reporting its active-user metric in 2019.
Meta executives believe their AI-infused advertising strategy provides them with enough runway to increase revenue. However, without better user growth, it is only a matter of time when Meta may reach the natural limit for the advertising business on which it depends.
And Meta, unlike its big tech competitors, has little to fall back on if the advertising business reaches its limits. Meta doesn’t have a cloud-computing business like Amazon, Microsoft or Google that could provide another way to generate returns from AI or increase sales during a soft patch for ads. It also doesn’t have Amazon’s e-commerce operations or Microsoft’s corporate-software franchise.
Meta has built a small but fast-growing business out of its AI-infused smartglasses; But despite the company’s grand ambitions for them, those glasses have little chance of replacing people’s smartphones or driving a surge in revenue any time soon. CEO Mark Zuckerberg’s other non-advertising ventures, including video-calling devices and virtual-reality headsets, have largely flopped.
Given the narrowness of Meta’s business and its extensive track record, there are legitimate concerns about its spending in the race for AI model development, especially since it lags rivals. Meta last month released a new AI model called Muse Spark, which puts it in tough competition with Google, Anthropic and OpenAI – at a huge cost and after several changes to its AI strategy.
Investors are losing patience due to huge expenses and limited prospects of returns. Meta’s stock fell last week after an earnings report that included increasing planned capital spending this year by $10 billion to about $135 billion.
And the company is increasing its debt burden to continue that expenditure, which is weakening its balance sheet. Meta had more than $57 billion of long-term debt at the end of the first quarter, up from about $10 billion when the AI trend began in late 2022. This total also does not include the $25 billion in bonds sold by Metra last week or the off-balance-sheet vehicle it is using to build a $27 billion data center in Louisiana.
Despite Meta’s strong revenue growth, expense growth continues to look shaky. According to an analysis by Pierre Ferragu of New Street Research, the growth in Meta’s projected cash costs this year – the amount of money going out the door for AI and other expenses – is significantly higher than its projected revenue growth. As he said in a recent report: “The meta spends more than it can afford.”
As it tries to make its way into the AI race, Meta also faces a number of legal challenges that are hard to quantify, but could impact its business and user growth. Australia in December banned children under 16 from using social media, and recent court defeats in the US in cases involving social-media addiction and harm to children are likely to increase the number of further lawsuits.
Markets can be volatile. But there are good reasons to be skeptical of Meta’s prospects – even if its shares look historically cheap.
Write to Asa Fitch at asa.fitch@wsj.com