TIP848: Meta (META): What the Market Misses? w/ Daniel Mahncke & Shawn O'Malley

19:39Shawn O’Malley:And I think this is quite important because if Matter needs to restrict its app for minors while competitors don't, then Matter obviously has a competitive disadvantage, right? I mean, this doesn't really matter financially because these teens account only account for about 1 % of revenue. But if today's teens don't use Matter's apps, then, the 20 and 30-year-olds of the next decade might not use them either, or at least not to the same extent. I think the biggest advantage of the settlement is obviously that a lot of uncertainty that could have been there for years, basically, is now more or less resolved.

20:14Shawn O’Malley:Because even if the trial would have been over after six weeks, if Metta had been found guilty or liable, there would have been many more lawsuits over the next couple of years where the chances for Metta winning would have been significantly worse. In fact, there likely will still be many more lawsuits anyway. I mean, Meta is still facing hundreds of pending lawsuits from individuals and from families and even school districts and others. But I do believe that setting this precedent of settling instead of losing in court is a good one. All that said, I could still imagine I live in the EU and knowing the EU, I would be surprised if there aren't more lawsuits coming from here because it seems like it has become a business model of just suing the big tech in the US to get back what you don't get in tax revenue.

20:59Shawn O’Malley:But again, even if I assume that they will end up with a lot more lawsuits and perhaps something like $2 billion in annual costs for these lawsuits over the next decade, I think it's more or less negligible if, on the other hand, the fear of further regulation that actually goes into the algorithm is gone. Let's take a quick break and hear from today's sponsors.

21:20Daniel Mahncke:For most of my 20s, my money story was simple. Earn more and the rest takes care of itself. My income did go up. My spending went up right alongside it, though. I just didn't notice. My savings rate had quietly slipped from 30 % down to 20%, and I didn't catch it until Monarch put every account on one screen and showed me the trend, which sings a little for a guy who spends all day pulling apart someone else's balance sheet. And now the investment view shows me my whole portfolio in one place and how it's actually doing against the S &P 500. And when a big purchase is coming, I map it out first and see whether I'm on track before it's too late to adjust.

22:03Daniel Mahncke:Write your own money story with Monarch. Use code WSB at monarch.com to get your first year of Monarch Core half off at just$50. That's 50 % off your first year at Monarch.com with code WSB. Curious about online trading, but haven't taken the first step yet? You're not alone. And Plus 500 Futures is a great place to start. The futures markets are moving fast. And with Plus 500, you can explore popular assets like oil, gold, S &P 500, Bitcoin, and more. From crypto to commodities, there's always something happening. The platform is super easy to use, so you can trade on the go right from your phone.

22:45Daniel Mahncke:You can get started with just$100 and jump into the action. See something interesting? Once your account is open, you can trade it in just a couple of clicks. And if you're not quite ready yet, you can practice with a free demo account. No risk, no pressure. With 20 years of experience, Plus500 makes trading more accessible than ever. check it out at plus500.com. Trading and futures involves risks of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500. It's trading with a plus. Every week we analyze companies on this show and ask the same question, is management actually running this business efficiently?

23:22Daniel Mahncke:Here's the honest answer for most companies right now. The ones pulling ahead are the ones putting AI to work on the everyday stuff. That's exactly what NetSuite Next was built for. NetSuite Next surfaces insights exactly when you need them. It puts agents to work on routine tasks and problems, and it lets you ask complex questions in plain language, like talking to a knowledgeable colleague. But technology is only part of the story. AI is also reshaping how people and teams work together, and that shift is already underway. Expert created business guide in your hands today. It's called Aligning for the Agentic Era, How AI is Changing Everyday Work.

23:55Daniel Mahncke:And right now, it's yours absolutely free. Inside, you'll discover how AI could reshape work across your entire organization and how to position your business to prosper from it. I use this and you should too. If your revenues are at least in the seven figures, get our free business guide aligning for the agentic era, how AI is changing everyday work at netsuite.com slash TIP. The guide is free to you at netsuite.com slash TIP. netsuite.com slash tip. All right, back to the show. I think it's really interesting to think about the competitive dynamics here, because on the one hand, you could probably argue that for meta to be restricted in its ability to target and resonate with the next generation of users, that would be a competitive disadvantage.

24:45Daniel Mahncke:On the flip side, though, and this seems hard to imagine with meta, but if they're the only ones with these really strict enforcements, then they get to wear this veil of, hey, we are pioneering child protection on the internet. And that could actually be a tremendous rebranding opportunity for them to earn back credibility and basically make all their competitors look bad. So I don't know, there's different ways to look at how this will all unfold. And for me in the past, I have actually opted not to personally invest in Meta because I felt like the impact they've had on society has been particularly damaging, and they really have pioneered many of the worst tactics that we've seen be adopted by other social media companies.

25:30Daniel Mahncke:I also recognize that that can be a really costly perspective to have as an investor in terms of missing out on great returns. So I would say I could probably get more comfortable with an investment in Meta if the price was right. And I felt good about these new protections being put in place, but I definitely come with my own biases. And personally, I'm pretty happy to see these rulings go into effect, but I'm also skeptical that kids will find a way around them. And if not, they'll find other platforms to use. And so it's probably as good of a time as ever to launch a social media app targeting folks under 18 or to be a Chinese competitor that can come in and try and grab market share for social media in the US.

26:13Daniel Mahncke:And I remember when TikTok was banned, for example, Overnight, it seemed like everyone immediately downloaded an app called Little Red Book that I'm not even sure. I don't even think like half the app was in English or barely any of it was in English. People were downloading it and using it. It was the number one on the app store for like a week because it was scratching the itch of TikTok while TikTok was gone. So what's your take though on these rulings?

26:38Shawn O’Malley:Yeah, first I got to say, I've never heard of that app. So that has just gone completely by me. Also, TikTok was never not allowed here. so maybe that's why, but yeah, I think it's difficult. I've certainly seen takes online that I disagree with. So for example, some people say that Meta was being sued for basically being too addictive. And I think that's a misframing of what actually happened in my opinion. Obviously, if that were the case, you could argue that many things are too addictive. I mean, should video games be illegal if they keep kids on the screen for four hours, maybe movies or even books?

27:09Shawn O’Malley:I mean, for example, I just thought about the app or the game Roblox, which I think is the number one thing for young people nowadays to play. And I've heard that the average time they play it per day is three hours. That's the average. So you'll probably have a lot more, you know, young kids that play that game for many more hours. And then you have to think about how would you regulate that? So I don't believe Meta was sued for being too addictive. I think it was sued for the intentional design of products to induce what you could probably call compulsive or addictive behavior in kids and teens.

27:41Shawn O’Malley:And I think the difference here that it's about strategically focusing on young people and exploiting their weaknesses, then hiding that this is even happening. And I think that's different than, for example, a good movie or a good game that ties you to the screen for a couple of hours, or saying that, you know, something is clearly designed for kids in the first place, because at that point, you know, they are subject to special regulation, which meta has not been, although you could argue they tailor the product for kids and young teens. And of course, this would also mean that, you know, YouTube Shorts would need to face similar lawsuits and maybe just YouTube as a whole, which is again, as you said, what Meta is kind of now saying out publicly.

28:21Shawn O’Malley:They had this sort of open letter to TikTok and YouTube portraying themselves as, you know, the white knight standing there protecting kids and that these competitors are not doing that. And of course, there's something to it. I think most social media has these problems, which is also why I'm not biased against Meta, maybe in the same way that you are, because I told you earlier, I personally probably spent much more time on YouTube. So to me, what's more addictive is YouTube Shorts when I compare that to, for example, Instagram. And I also think, and this might be an unpopular take or opinion, that many parents who grew up without using a smartphone or social media for that sake, simply are a bit over their heads when it comes to knowing how to control their kids' usage, but also sort of understand why they would need to do that in the first place.

29:07Shawn O’Malley:I mean, looking at the New Mexico case, where they basically decided to pause push notifications to miners between, as you said, 10 p.m. and 7 a.m. And to cap miners' usage at, I think it was 90 hours a month. That's all stuff that I believe parents should be able to control by themselves. But obviously, that also doesn't change the fact that there is a problem with how Meta built its products for kids. And that's why they got sued.

29:31Daniel Mahncke:Robert Leonard There's definitely a fundamental question about the relationship people want to have with the government here and what types of things you want to be regulated and what falls to personal autonomy and parenting and what should fall to government or large corporations to dictate. I don't know if we want to get into all that, but I would say generally, even though this trial quickly ended with a settlement and should give Meta some breathing room in the future for some of these pressures. I think Meta will continue to have problems with trials as most Mag7 companies have and will. But since Meta's business is more concentrated than Google's, Apple's, or Microsoft's, it'll always be a bigger problem for Meta.

30:15Daniel Mahncke:And as soon as something could threaten their ad algorithm, that really makes it an existential question for Meta and their existence, which is why Zuckerberg can't let go of the platform idea we've talked about today and expanding his business beyond advertising, even though advertising has done him very well. So let's get back to Zuckerberg's AI vision for Meta, because I think it's pretty unique compared to some of the other hyperscalers and how it could change the company's future. And so a year ago, Meta's AI story was really just centered on its LLM llama. Today, though, it seems it's taken on a life of its own, and there are many more layers to this vision now?

30:56Shawn O’Malley:Yeah, I think by now there are many use cases for AI that Zuckerberg continues to talk about. And I think it's actually part of the communications problem for Matter. I think the market is just not buying the entire story. And that's primarily because of what we talked about in the beginning, which is that Zuckerberg has this major vision of becoming a platform that simply hasn't worked out a single time that he tried doing it. And in fact, there wasn't a single self-created product after Facebook, if you actually think about it, that Zuckerberg has successfully built and then also shipped to a larger audience.

31:28Shawn O’Malley:And I got to say, he did some great acquisitions. So for example, if you look at Instagram, that might be one of the best acquisitions in corporate history, perhaps after YouTube, I'm open for that argument. But he basically bought an app for less than a billion dollars, I think it was about 700 million back then, because the stock price after the announcement sort of dropped. And now you could make an argument that this app alone is worth about$100 billion. So you have a CEO that, in my opinion, also gets a bit too much of a bad reputation right now or whenever things are not going that well for Meta.

32:00Shawn O’Malley:But still, if we talk about AI CapEx, I'm not sure if you remember, but there was a brief moment where Meta was the only Max7 company that already saw a tangible AI monetization. It was about the time that we covered the company for the first time. So it was early this year. And the stock back then traded about$700 per share. So AI was improving the ad algorithm, just as you said. And then what you can look at, which is quite a good metric, is you look both at ad impressions as well as ad prices. And whenever those go up at the same time, you know their business is going quite well. And that's exactly what you saw in Q1 of this year.

32:36Daniel Mahncke:Yeah, we covered that dynamic in our first episode on Meta, which we'll have linked to in the show notes for anybody who wants to go back and listen, but Meta does not set ad prices. Ads are sold in an auction. So the price is whatever advertisers bid. And so that means price and volume are connected like supply and demand. When Meta opens up a lot of new ad inventory, for example, through a new format like Stories back in 2018 or adding reels in 2022, supply of ad inventory jumps and then auctions become a little less competitive. And then the average price per ad falls. It's just a supply and demand basic story there.

33:15Daniel Mahncke:And that always looks scary when it happens in the quarterly numbers, but it's actually usually a bullish moment in the cycle because this cheaper inventory attracts more advertisers. Then the targeting improves over time as Meta works on its underlying algorithms. And then you see the bids rise, what advertisers are willing to pay increase. And then a few quarters later, you have both impressions and pricing growing at the same time. And that creates really an incredible twin engine for growth. And so the scarier version actually is the opposite, where you have impressions stalling out and price increases alone carrying revenue.

33:52Daniel Mahncke:That's really not something we talked about before. Pricing power is a great thing to have. But any business that relies too much on just raising prices to drive earnings growth, That can become problematic over time. And it's the same in advertising. Effectively means that the auction is being squeezed rather than expanded. And that hampers their earnings power longer term.

34:15Shawn O’Malley:There's a slight catch to that, though, which I think is worth mentioning. So the two most important factors, as we talked about, are ad impressions and also ad prices. In the best case, as you said, both of them grow simultaneously. But due to the auction dynamic that you just described, that's not often the case. There are two ways though that ad impressions can grow. So either Instagram is simply showing you more ads. So for an example, let's say you spend 20 minutes on the platform and then you go through, let's say 20 posts and you get four ads shown on those 20 posts. That could be increased to five ads, right?

34:48Shawn O’Malley:The other way for impression growth is when users spend more time on the app. So if you spend 30 minutes instead of 20 minutes and you go through 30 posts instead of 20, you might be shown ads at the similar frequency, but instead of just being shown five ads, you're now being shown seven ads. So that's the other way. And according to Meta, time spent on Instagram and Facebook grew about 10 % in Q1 and Q2 of this year. So that was the major reason for impression growth.

35:16Daniel Mahncke:In theory, that is more sustainable growth, since the general assumption is that you don't want to shove down even more ads into a user's feed. Although we will still talk about how Meta managed to actually increase ad loads without anyone being annoyed and how they might eventually end up turning every pixel into an ad through the use of AI, which is sort of an incredible thing to consider. And I know that you talk about visiting Instagram only. You like to go there and actually use it as a way for almost product discovery. You like to see the ads there to help you find new stuff. So you could probably speak to that.

35:54Shawn O’Malley:Yeah, that's actually true. And I'm not quite sure what that says about me, but I actually just booked a golf session for my family and I got the idea and the offer through an Instagram ad. I got to say that. So I don't know, I think it's just generally astonishing how Meadow turned ads into content to some extent. I mean, ads used to be these highly annoying banners that only cover, let's say like 5 % of the online screen or maybe videos that you couldn't click away, but it was always something that you wanted to avoid, right? You wanted to prevent seeing ads. Now, Meta's ads take up the entire screen, basically, if you're going on Reels, for example, and nobody's really bothered by that.

36:32Shawn O’Malley:It sort of feels like ads have just become a part of the content. And of course, it helps that, for example, influencers who create most of the content on these platforms are constantly posting ads too. So the line between what is actually content and what are ads. It's just increasingly blurred. So that helps. But anyway, back to the pricing dynamics, because there's one more thing that I wanted to add. The healthier way to increase ad impressions is obviously to spend more time on Mattis apps. But the other way to increase ad revenue is to play with the pricing. And here again, it might seem like higher prices are generally a negative thing or perhaps a less sustainable way to grow.

37:11Shawn O’Malley:But that's only the case because you would say, well, Meta's advertisers are return driven. So they're not brand advertisers. They don't pay just to get into more eyeballs. For them, it's important to make a profit on their ads immediately. So just an example, if they spend$1 ,000, they want to make, let's say$1 ,500. So this would be a 50 % return on the price that they paid or basically the ads that they had. And if ad prices go up, you would think that return goes down, but that doesn't necessarily has to be true. So prices going up is only bad if everything else is equal. So if the ad isn't getting more targeted and isn't getting more effective, well, then you don't want to pay a higher price for the ad.

37:53Shawn O’Malley:But if the ads become more effective and increase in ad prices, it doesn't have to reduce the return on ad spend. So again, for example, if the cost per lead goes from a dollar to let's say a dollar and 10 cents, but the lead spends on average 10 % more on the advertised product, then nothing actually changes.

38:11Daniel Mahncke:And AI models actually help to make Meta's ads more effective. They have systems called Andromeda, Gym, and Lattice. And those are the models that rank and target to find the best ads for every user. They're also the ones that rebuilt Meta's ad targeting after Apple's privacy changes some years ago. And since AI improves their probabilistic prediction abilities, Meta was able to drive up both prices and impressions in Q1 of this year. And unfortunately, though, we don't see that trend continuing into Q2.

38:42Shawn O’Malley:Yeah, I think that's actually a big part of meta story. So what I like to do is try to ignore the headlines and sort of the obvious reasons for why stock is down and just try to figure out what else could also cause it. So I'm sort of assuming here that the market is actually smarter than we as value investors sometimes give it credit for and kind of know something that I would miss just by looking at, let's say, the front page of the New York Times. Because if I do that, the lawsuits seem to be the reason for why the stock is out and potentially also the CapEx, which the sentiment about that changes every single time or every single week in the markets.

39:18Shawn O’Malley:But I think there's something else. Because again, I think Meta reached$700 per share earlier this year, even though everyone knew that CapEx would likely be higher than expected. And I think what changed was the AI ad algorithm narrative. So as you said, in Q1, it looked like Meta was the only company with an actual, real, tangible payout. So you have this$200 billion ads business, and apparently AI makes it much more efficient. That was the narrative. But that narrative, as you just said, was a bit harder to support in Q2, where ad pricing has driven much of the growth and impressions in the most important markets actually lag.

39:54Shawn O’Malley:So worldwide, if we look at the numbers, impressions actually grew 14 % and prices grew 12%, which looks pretty good. However, if you split that up a region, the US and Canada saw only 9 % growth in impressions and prices jumped 20%. And then in Asia, impressions were up 17 % and prices were up just 1%. So I know that's a lot of numbers, but to me, that discrepancy suggests that pricing growth in the US is likely not going to be because the ads are actually becoming more effective, but rather that meta is sort of reducing advertisers' returns, sort of the dynamic that we just discussed. Otherwise, I think why wouldn't prices also grow faster in Asia?

40:35Shawn O’Malley:Assuming that there are no changes to the ad algorithms or the regulation in just one geography, I didn't hear any of that. So I have to assume that Meta's sort of turning the dial in North America to get growth there right now.

40:49Daniel Mahncke:And we should also say that this is not the most sustainable way to grow, as we've mentioned. It's generally an advantage, though, that Meta can turn these dials when they need to, right? When organic growth is a little bit slower, which can perhaps be simply due to just economic cyclicality, the ad load dial can be turned. And for a quarter, you get an additional ad shown and voila, you're back to 20 % plus growth again. And many companies would love to have a dial like that, that they can tap into so easily at their disposal. And going to another topic, how about we discuss WhatsApp? And last time we talked about the vision for AI agents within WhatsApp as being this prolific business opportunity where the agents could help small businesses all over the world become much more efficient.

41:38Daniel Mahncke:And it's because a lot of folks communicate with businesses over WhatsApp in different parts of the world, which is sort of a foreign concept to me here in the US. But I've certainly learned to understand how different people use WhatsApp. And this seems to be sort of the preferred way to monetize WhatsApp is by doing some sort of B2B service as opposed to advertising.

42:00Shawn O’Malley:Yes. And I think I've become more bullish on WhatsApp's outlook because just as As you said, the entire concept last time was a bit foreign to me. I use WhatsApp a lot, but I never use it to talk to businesses. So it was sort of difficult for me to understand this sort of monetization layer, because despite, again, being a WhatsApp power user, if that even exists, there are very few business accounts here in Germany. And I think last time I talked about that there's just a cultural difference where I wouldn't want any business account between my personal messages. And I just couldn't imagine how that works out.

42:31Shawn O’Malley:But I don't know. I mean, it's just not popular to use them. And I think many American analysts or investors just look at the overall user number of WhatsApp because they don't use the app at all. And then assume you can scale the success of some countries to all others. And because of my experience, I'm just not sure whether you can actually do that. That said, though, I think WhatsApp has been very successful in India and some other Southeast Asian countries. And Zuckerberg has actually pointed out in an interview, and I found it quite astonishing, that Thailand and Vietnam rank about sixth and seventh among Meta's countries by revenue, while by GDP, they are somewhere in the 30s range.

43:09Shawn O’Malley:So the reason is that business messaging apparently is a huge part of those countries. And something like 2 % of Thailand's GDP flows through commerce on Meta's messaging apps, which is just an insane fact to me. In those markets, businesses basically run their entire sales and customer service through chat, which could be WhatsApp, but it could also be Facebook. And it works there. And that's something that we discussed last time. Labor is cheap enough to have actual humans answering the messages all day.

43:40Daniel Mahncke:That's where AI agents can potentially help remove some of the frictions that make the economics work better in countries like Germany and the rest of Europe and maybe the US. even though there is a much smaller user base in the US. And so the plan would be to give every one of those 100 million small and medium businesses that already work with Meta, give them an AI agent that handles sales and support questions. And the way this would be monetized is likely through a cut of the incremental conversions that they're able to drive. And so the advantage of expanding into developed markets, obviously, is that there's higher ARPUs.

44:16Daniel Mahncke:The average of revenue per user is much higher because median incomes in those countries are much higher. And so even at a lower level of penetration, Meta could make the same amount of money or more in the US or Europe as it does in emerging markets where there's certainly much more usage of WhatsApp in this way.

44:35Shawn O’Malley:Zuckerberg also personally gave an update in the latest earnings call on the progress of WhatsApp and sort of its future importance to Meta. And I think the best thing that we can do is just listen to what he said.

44:46Daniel Mahncke:I'm also very excited about our progress with business agents. We made meta business agents available globally this quarter on WhatsApp and Messenger. And there are already more than 1 million businesses using them to talk to their customers or complete sales every week. We're rolling business agents out on Instagram now too. One interesting thing about having an agent talk to your customers every day is that it learns over time and can bring all of those insights back to you. So we're building more agentic capabilities to summarize all these conversations, digest what happened overnight, and surface what customers are asking for.

45:22Daniel Mahncke:And soon it'll go further, including suggesting ways to grow your business, giving you competitive intelligence and real-time insights into what's working and what's not. And over time, we'd like to build this into a business-in-a-box service that can help you start and run a whole business using Meta's platforms.

45:39Shawn O’Malley:And just for the sake of completeness, And Meta is also integrating ads into WhatsApp, but only in the status feature. And while Meta claims that the status feature has about 1.5 billion users, I think it's definitely not a big thing here in Germany. And I think it's also a trend where mostly old people are using it. And I don't want to put an age range on it, but probably people over the age of 50. So the majority of ad revenue there is once again coming from lower up your markets, or at least the sort of people that don't use the app too often. Let's take a quick break and hear from today's sponsors.

46:40Daniel Mahncke:and captures the conversation and hands me back a clean, searchable recap. And so the key points, the follow-ups, the things I usually want to act on, it has all of that. And that allows me to stay present in the room instead of scribbling notes that I won't be able to read back later. And I notoriously have very bad handwriting. And so it's changed how I prep and how I follow up with investors. It's also built for people who take conversations seriously. Enterprise-grade security. So if you're recording calls with clients or industry contacts, that's covered too. So if you live in meetings, calls, and interviews, well, give it a look.

47:14Daniel Mahncke:Go to plod.ai slash WSB and use code WSB for 10 % off. That's plod.ai slash WSB, code WSB. And always get consent before you record a conversation. Curious about online trading, but haven't taken the first step yet? You're not alone. and plus 500 futures is a great place to start. The futures markets are moving fast. And with plus 500, you can explore popular assets like oil, gold, S &P 500, Bitcoin, and more. From crypto to commodities, there's always something happening. The platform is super easy to use. So you can trade on the go right from your phone. You can get started with just $100 and jump into the action.

47:57Daniel Mahncke:See something interesting? Once your account is open, you can trade it in just a couple of clicks. And if you're not quite ready yet, you can practice with a free demo account. No risk, no pressure. With 20 years of experience, Plus 500 makes trading more accessible than ever. Check it out at plus500.com. Trading and futures involves risks of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500. It's trading with a plus. Every week we analyze companies on this show and ask the same question, is management actually running this business efficiently? Here's the honest answer for most companies right now.

48:32Daniel Mahncke:The ones pulling ahead are the ones putting AI to work on the everyday stuff. That's exactly what NetSuite Next was built for. NetSuite Next surfaces insights exactly when you need them. It puts agents to work on routine tasks and problems, and it lets you ask complex questions in plain language, like talking to a knowledgeable colleague. But technology is only part of the story. AI is also reshaping how people and teams work together, and that shift is already underway. Expert created business guide in your hands today. It's called Aligning for the Agentic Era, How AI is Changing Everyday Work.

49:03Daniel Mahncke:And right now it's yours absolutely free. Inside, you'll discover how AI could reshape work across your entire organization and how to position your business to prosper from it. I use this and you should too. If your revenues are at least in the seven figures, get our free business guide, Aligning for the Agentic Era, How AI is Changing everyday work at netsuite.com slash tip. The guide is free to you at netsuite.com slash tip. netsuite.com slash tip. All right, back to the show. I think this goes back to an earlier point that Zuckerberg is sort of bored by the ads business personally. And then he wants to get more involved in his users' lives, as well as the enterprise business world.

49:47Daniel Mahncke:And if that's what it takes, then this is what they have to do because you wouldn't need to spend$150 billion on CapEx for simply improving ad algorithms with AI, right? Meta could likely spend 20 % of that and remain this incredible cash printing machine with actually improving economics on their advertising business. And then maybe the stock could trade at double today's prices. That's the way Apple has approached things without exactly wanting to bet big on investing in LLMs. But the reason Meta needs this CapEx is for Zuckerberg's personal super intelligence idea, if we want to call it that.

50:26Daniel Mahncke:And so he envisions everyone having a continuous personalized AI assistant that understands their specific goals, health, relationships, career, and finances. But that level of AI would also give him the opportunity to play in the enterprise space, which is why the entire cloud business debate came up in the first place.

50:46Shawn O’Malley:There's a pretty interesting article that Zuckerberg wrote, and I linked to it in the show notes. So everybody who is just interested in how he thinks about it should likely check that out. And I think one of the most important things for this vision is basically the new model, the new LLM that Meta has built, and that is called MuseSpark. And they have no chance of expanding into the enterprise space if they can't offer what is a frontier model, or at least one that is almost as good as the frontier models. And that's just because you need a suit of AI power tools that sort of support the cloud.

51:18Shawn O’Malley:But it's not only about the enterprise space, right? You have super intelligence as basically this personal assistant, and you also need the right hardware to do that because Zuckerberg thinks of these agents, as you just mentioned, as something basically that understands you very well, and that can help you on a highly personalized level with everything that you do. And as we talked about in the last episodes, it seems that the most important thing by now for all LMs is the harness that is working. and so basically the context that you give it. So if you control the hardware plus the LLM, that's incredibly valuable to a company.

51:51Shawn O’Malley:And what better hardware for that vision than I'll actually let you take a guess what it could be. Oh boy, I think we're back to talking glasses, huh? We are back to talking glasses, that's right. And I recently listened to the Sam Altman interview on David Zanra's show, and I think I talked to you about it. And he basically said that he expected AI to have a much larger impact by now than it actually had. And he said that GPT-4 was already capable of basically replacing most SaaS companies, but that inertia was just too strong. And there wasn't really this iPhone moment yet that AI needs. And the last part is sort of where I bring it up here, because I think that Zuckerberg believes that AR glasses are the iPhone moment for personalized AI.

52:37Shawn O’Malley:And while I would definitely not classify myself as a visionary, I just can't shake the feeling that he might be eventually right with that sort of vision in his head. I do think glasses are the best fit for at least everyday hardware, at least if the product is well thought out. And obviously that could take a long time. That said, I believe we discussed this last time. I could totally see a future in which Meta is spending tens, even hundreds of billions of dollars on that vision. And then in 10 years time, when the technology might actually be there, Apple, for example, takes over and does what it does best, which is to build hardware for consumers.

53:16Shawn O’Malley:And I think that Meta has some powerful patterns. We talked about this before the call. For example, they have this wristband that we also talked about when we first covered Meta. So if you want to understand how it works, I would advise you to go back to that episode after listening to this. then basically to give you a summary apple's vision pro works with cameras at the bottom that basically track your hands so that's not a great solution because as soon as it is dark or you might just have your hands in your pockets you basically can't use the vision pro anymore with meta's wristband you are controlling the glasses much easier and you know the glasses don't need to see your hands all the time so this is by many experts considered to be the way to go for AR glasses.

53:58Shawn O’Malley:And Meta has a patent on that. It's not just something that any other company could copy.

54:03Daniel Mahncke:I think this is more or less just Apple being Apple, right? The iPod was not the first MP3 player. The iPhone was not the first smartphone. The Apple Watch was not the first smartwatch. And AirPods were certainly not the first wireless earbuds. And so Apple has never really once pioneered a category, right? Their entire playbook is to let others prove the market exists, let them make the early mistakes, and then show up years later with the polished version and the strongest brand and consumer tech. So that's why it was so interesting that they really did try to pioneer the category with these Vision Pro goggles.

54:39Daniel Mahncke:And so right now, the interesting dynamic is that Apple is taking the exact opposite approach to meta. They're not spending anywhere near as much on AI as Meta or any of the other tech giants, and they stopped any of their plans for AR or VR glasses. The Vision Pro was a flop, unfortunately, and almost as if they gave it a try and sort of figured it out, you know, hey, no, the world is not there yet with these glasses. Let's let other people figure out AR and VR.

55:10Shawn O’Malley:And it's quite interesting because, you know, the two of us, we talked about this vision with Snapchat and then also the first time with Meta. And one thing that we just don't know and we have to figure out over time is what exactly and who exactly are the glasses for, right? I mean, you, for example, you don't see yourself wearing any glasses. I wear them, you know, since I was born, basically. So I could certainly see myself wear glasses. But then the question is, what could the glasses do that you can't do easier just using your iPhone, right? I think it's sort of about the incremental value that these glasses can give to you.

55:43Shawn O’Malley:And that's something that you still have to figure out. I mean, AI could change a lot of things, but there's certainly a debate about who actually needs these glasses. I mean, obviously, you know, people are into tech. They just like the idea of that existing. But is there actually a mass market where you can actually, you know, sell this to a billion people or more? That's still to figure out. But I would say on a positive note, it could also be that Apple is wrong and glasses will be the next generation of hardware. And the technology advancement that Meta is making today will give them enough of a lead to win over that category.

56:12Shawn O’Malley:And I initially thought that meta might have a hard time dominating this hardware because they can't offer a larger ecosystem with it. For example, I mean, Google Android's XR glasses would launch with an entire app store and the whole Google ecosystem behind them. So we're talking Google Maps in your field of view, you're talking Gmail, Gemini, all that sort of stuff. But I don't think that meta would even need that. I'm also quite unsure whether you need that in AR glasses anyway. way. I think in VR, that's very helpful. But in an AR experience, you don't want to go through apps anyway. I think there are only a couple of very important features that you want integrated into your AR glasses.

56:52Shawn O’Malley:And I think Meta can create all of those. And I think they just need to work without opening an app. I mean, if I just think about opening an app in my eyesight, and it just takes half a second, I think that would be way too long. So it has to be a smooth experience that doesn't rip you out of what you're currently doing.

57:09Daniel Mahncke:Another problem that I think very much only got bigger for Meta's reputation, and we worried last time that consumers might just not trust Meta enough to want to put their glasses on their noses. And after all the lawsuits and bad publicity that Meta has seen, basically really every couple of years, even after the rebrand, it feels all the more likely for this to be a valid concern. And beyond that, when I think about what a platform does, it does strike me as sort of being the complete opposite of what Meta is good at. A platform features third parties and takes a toll. So an advertising business's job is to fill the screen with content, capture the user's content and sell it.

57:51Daniel Mahncke:So I do wonder, you sound quite bullish on the combination of AI and glasses for Meta, and maybe now not so much anymore. So I'm curious about that. I mean, I have wanted to personally try out the Meta Ray-Bans glasses, at least. Oh, wow.

58:06Shawn O’Malley:So maybe we'll actually see you with glasses in 10 years time that are Meta branded. But to your point, I mean, I go back and forth on it. I think my vision for why they could work is just a bit different. So for example, what if AI doesn't give Zuckerberg his platform that he so desperately wants, But instead, it just sort of transforms the ad business into something that is even greater than it is today. And it wouldn't be the first time that Zuckerberg is sort of forced into his luck. And I don't know, let's say you see a photo, for example, you know, it could be an influencer, it could be a friend or whoever, and there's a sweater in that photo that you like.

58:42Shawn O’Malley:Now, today, that sweater is just part of the photo, but it basically generates no revenue for matter, obviously. Now, imagine you can just ask the AI right there in the app where that sweater is from. And it doesn't just tell you, it also links to the shop. And if you want it, you can just buy it. It's two tabs, costs you a couple of seconds. And then the seller basically pays Meta for the conversion to that product. And potentially, brands just generally pay Meta for the right and the option to be named and come up in these, at least AI generated photos where Meta has the right to own the content.

59:15Shawn O’Malley:And I'm sure there are many ways to monetize that. But the point is that sweater was never uploaded as an ad. So nobody tagged it. There was no advertiser paying anyone, an influencer, for example, for a placement. But still, AI sort of turned this into ad space. And I think that would turn pretty much every object in every photo and in every video on the platform into potential ad inventory. And that's arguably the last step to just completely blur the line between content and ads that we discussed earlier.

59:46Daniel Mahncke:And that doesn't only apply to AI-generated content, right? I mean, this basically would apply to every single photo that's posted.

59:54Shawn O’Malley:Yeah, there's probably more of a problem with the rights and everything, but that can be figured out and potentially, and that goes back to the glasses, I could see that also sort of be a product for the meta glasses. Everything you see in real life is technically only one ask and a click away from becoming a product to some extent. And I know this sounds quite dystopian. We talked about it before, but I think it's more of a question of how do you do it? Whether should you do it in general? And I think Zuckerberg always talks about that, you know, the most important thing for the glasses is that they are good glasses first and that they don't seem intrusive in daily life.

1:00:29Shawn O’Malley:And that's very much the point here. And I don't know, I would love to have a feature like that, you know, of course, only for like five to 10 % of the day, but the rest of the time, I don't want any buttons spammed into my little eyesight. And we could argue that maybe the incentive of an ad platform is not perfect to push out these glasses.

1:00:48Daniel Mahncke:It just feels very black mirror adjacent. I think there's an argument to make, and you mentioned it earlier when we were chatting, that the iPhone is perfect because even if you use it 10 hours a day, you can just put it away. And it feels, in the best case, like a very conscious decision to pull it out and go on Instagram. And glasses are different though, right? There are 2 billion people in the world who wear them every day. And you said yourself that the first thing you do in the morning is reach your glasses. And the last thing you do in the evening is take them off. And so it's sort of a personal space that might just not be made for a product like AR glasses.

1:01:26Daniel Mahncke:You don't want ads being literally shoved into your face as you're laying in bed at night.

1:01:31Shawn O’Malley:And one good point that you made at some point, which is still sucking in my head, is that out of those 2 billion people that wear glasses, obviously a lot of them are prescription glasses and some of them are quite complex. So you also got to ask yourself, who's the customer? There are people who just don't want to wear glasses at all. So they are not your customer. Then out of those 2 billion people who are potential customers, a lot of them were just not able to wear those glasses because of the prescription. So obviously that's just a matter of time to figure it out. But that's sort of the point.

1:02:01Shawn O’Malley:If you spend tens of billions of dollars on it, and I just can't see it happening in the next 10 or 20 years, that's sort of a problem. And obviously, I don't want to go back to the lawsuits, but the big difference between Meta and other big tech is the fact that they are an ad company, right? And every advertiser's most important incentive or currency is engagement. And that's why, you know, algos feed you a lot of negative stuff. And that's why every Meta product focused on consumers comes with at least some sort of questionable incentives. And if we just forget about the glasses and sort of go back to the idea that AI can turn every pixel of your screen into an ad, I think that makes me quite excited as a shareholder.

1:02:39Shawn O’Malley:The feed was more or less saturated years ago. Then you had stories, and that's also to some extent saturated. And then obviously Reels were coming, but also maturing to some extent. And those new AI ads, and I think that's important to understand, they would not only be new inventory for meta, they would be a huge jump because it's basically infinite content. And I talked about it before. If you think that ads is a good business to be in, and there's more and more of that in the future, you sort of want to own the aggregator of that, right? It's similar to the Uber argument. If you think AVs will become a bigger and bigger thing, but it's commoditized, what you want to own is the aggregator of AVs.

1:03:13Shawn O’Malley:And I sort of think about this in the same way. So the most bullish thing about this is that there's an immediate payoff from AI in what meta is doing best. And that still is ads. And you don't need super intelligence or the next computing platform or cloud business and all of that. it's just better algos and more inventory, and that would technically be enough.

1:03:43Daniel Mahncke:Trey Lockerbie

1:04:00Daniel Mahncke:a good thing, and it won't actually be an infinite increase. But still, it's sort of an interesting question to think through of how such a dramatic increase in ad inventory could work against them by really imbalancing supply and demand. So let's get to exactly talking about these broader visions of what Meta wants to do with AI and the CapEx that's going to be involved in that. As you said, CapEx for this year will be$130 to$145 billion, maybe as much as$200 billion next year. And I think what the market is currently scared of is that Meta is trying to justify its AI spend through the platform vision we discussed, but also through Zuckerberg's enterprise vision, meaning new Spark, superintelligence, and gigawatt clusters, which are just mega data centers, basically.

1:04:50Daniel Mahncke:All of that is unproven. And given Meta's track record on expanding outside ads, I would say it's highly uncertain how these will work out. And so in the latest earnings call, Zuckerberg said this when asked about the enterprise vision. I think that the enterprise opportunity is kind of the sum of all of these different things. It's not just the selling compute. Also, the API services, the productivity services, the kind of business agents for other parts of the business beyond marketing are all parts of the overall offering. And I think that there's just a very, very large opportunity there. So we're quite focused on that.

1:05:27Daniel Mahncke:That's going to be somewhat of a new muscle that we build as a company. But I think it's a very important one that we build. So that way, we can make sure that we can maximize the opportunity ahead of us. I think the problem with this is that Zuckerberg has never proved to really be a good go-to-market guy or somebody who knows how to build products that people want. Besides initially what he did with Facebook, and when he is now giving such a vague answer that basically includes everything you can imagine to try and justify hundreds of billions of dollars in capital expenditures. I just don't find that to be a satisfactory answer.

1:06:02Shawn O’Malley:That's also what the market thinks. And I think if Zuckerberg just wanted the stock too early, as you said earlier, he would just cut CapEx in half and frame Matter as this advertising beast that it certainly is. And I think that would be a much better story to tell about using AI for ads, which again, we know they can do that. And in fact, for the longest time, Zuckerberg argued against Matter having a cloud business, saying that the marginal return on a GPU has always been higher when using it internally for Matter's own products than renting it out to a third party, basically. So the question now is, what changed about this?

1:06:38Shawn O’Malley:Because we all heard about them potentially selling computing. I guess there are two ways to look at that. And the first and probably also more bearish take is that Zuckerberg just decided that winning AI is so existential that he spends first and then asks questions later, which I think you could argue this is exactly what happened. And also you have to figure out how to monetize later. And this would fit his argument that, you know, he would rather overspend than wake up being disrupted. And this narrative would also mean that selling access compute is sort of more of a margin of safety scenario than an actual cloud business plan.

1:07:12Shawn O’Malley:And the other option would be that it's sort of a more long-term plan for Meta to turn into an enterprise company. But, and I think this should be mentioned, this would take more than just some access compute, right? To compete with Google, to compete with Amazon, Microsoft, all of those companies, the hyperscalers, as we've now learned, Meta would need an ecosystem that makes it attractive to choose it over all the other cloud providers.

1:07:37Daniel Mahncke:Preston Pysh You could also say that meta needs to defend and justify all the CapEx to the market. And then if their bigger vision is years off, they've got to be able to do something today to provide some returns on capital, hence the move to selling compute as a cloud service. But let me ask you, I mean, what would the enterprise system actually look like? Selling excess compute might work in this environment because you have this massive imbalance between demand outweighing supply, but that is more of a short-term reality. With everyone and their mother building a data center right now, it seems pretty likely that in two years from now or whatever the timeline is, we'll be talking about how there's so much more supply than demand and things will flip the other way.

1:08:19Shawn O’Malley:Which is why you need to build a natural ecosystem right now. And I think the chips and the data centers are sort of the bottom of the enterprise stack. And then these LLM models, so for example, Muse Spark right now, they would be the developer layer. This is where they spin off new apps. And basically, if you follow Meta, they will talk about new apps all the time and how easy it has become through AI to get these new developments out there and to give it to coders and all of that. So that's why I said you need a frontier model to even compete with any of the other clouds. And that's where you build the tools.

1:08:50Shawn O’Malley:And then on top of all that, you also need a Salesforce and support contacts and so on. And in the era of AI, the fastest way to pull customers up to that stack has been the model. This is basically what we've seen in the last one or two years. I think there's an argument to make that by now, people sort of know that this is a more commoditized play. So it is not a huge benefit anymore to be sort of in talks on business with Anthropik or OpenAI. I mean, Microsoft benefited a lot early on from being, you know, using OpenAI as models. And then Google Cloud is currently exploding due to Gemini. You see that in the earnings.

1:09:24Shawn O’Malley:Then Amazon is partnered with Anthropik. And Meta is sort of the only company that is not partnered with OpenAI or Anthropic, which, to be completely honest, might even be an advantage by now. I think there's no circular financing. There are no stakes in trillion-dollar companies that never earned a dime of cash flow. I think currently how the market thinks about it, this might even be a positive. And of course, it's also a difference in where the strength of the model that you have lies. So for example, MuseSpark is supposed to be quite good at orchestrating agents, which is not too surprising, given the entire super intelligence and the sort of personalized agents vision that Mark Zuckerberg has.

1:10:02Shawn O’Malley:And they're also quite good in creating pictures, which is something that we talked about earlier. If you have hundreds of millions of small businesses, if you can just build an LLM that is supporting them and for example, creating ad campaigns, that's a huge thing. But MuseSpark is not necessarily good or strong in coding, at least compared to other frontier models, which of course is especially important for the cloud and the tool building parts. And to be fair, Meta brings more to this than some people assume. I mean, there are features that I don't understand, but some of the software engineers in our mastermind group have talked to me about it.

1:10:36Shawn O’Malley:PyTalk, for example, is sort of the framework that basically the entire AI world builds on, which goes from startups to research labs. And that was also created by Meta. And I think by now it's in a partnership with Linux, if I'm not completely mistaken. So they already own a piece of the developer layer that even companies like Amazon don't own. And they also have their own custom AI chips. And just the fact that they operate on one of the largest computing fleets on the planet for their own apps. So you could at least entertain the idea of all of this and the vision working out.

1:11:09Daniel Mahncke:What doesn't exist are the enterprise connections. Meta has no Salesforce, no support organization, no compliance track record. And that stuff really can take a long time to build. Google, with all of its engineering brilliance, needed more than a decade and tens of billions of dollars in losses before Google Cloud was something that was really even taken seriously and turned profitable.

1:11:31Shawn O’Malley:Which is, to some extent, why I think that if the enterprise vision works at all, I would expect that sort of the entry point would be not the Fortune 500, but maybe the hundreds of millions of small businesses that I mentioned earlier that already live and sort of exist and make business on WhatsApp and Instagram. I think that's a very much meta way to introduce itself to the enterprise world. And I know it's questionable if that will ever work. And if it does, it's almost certainly something that takes you five to 10 years, but at least then you have a vision for where all that CapEx is supposed to go.

1:12:05Daniel Mahncke:What's so scary about this CapEx cycle is that it just seems like there's no way back. We've gone off the cliff. When meta failed with the metaverse, Zuckerberg could just say 2023 would be the year of efficiency. They cut costs and they could account for and make up for some of these losses and relatively return to normal. That is just not the case with the hyperscalers today, given the order of magnitude of liabilities that they're incurring to develop this technology. I recently gave a presentation to members of our mastermind community, which you can find a link to apply for in our show notes below, where I talked about the MAG7 funding these data center build-outs.

1:12:46Daniel Mahncke:And I have to admit, seeing the numbers really makes you pause. Alphabet, for example, has about a trillion dollars in off-balance sheet liabilities alone through leases that haven't started yet and from purchase commitments for things like energy to power those data centers. And this was all coming from a Wall Street Journal reporting deep dive into the topic. And Meta itself is close to$700 billion, which is not so modest. And compared to a year ago, those liabilities have grown about 800 % for both companies. And so a good example of how this financing works is with Meta's mega data center in Louisiana.

1:13:27Daniel Mahncke:The cost for that data center alone will be tens of billions of dollars. But instead of putting it on Meta's balance sheet, its financer was called a special purpose vehicle or SPV. And so it's a fairly complicated concept, but in plain English, Meta and some sort of financing partner will set up a separate company whose only job is to own this one data center. And so the partner in this case is actually a company we covered way back when on the podcast, Blue Owl. They're sort of a private equity and private credit giant. And they're holding the majority of the equity in this SPV. And then Meta keeps a minority stake.

1:14:03Daniel Mahncke:So the reported split is something like 80-20. And that separate company, this SPV, then borrows the financing for the construction itself. So roughly$27 billion of bonds were sold to big institutional investors to help build this data center. And then Meta signs a long-term lease, pays rent, and basically guarantees that the asset will maintain a minimum value at the end. Because in other words, Meta is indirectly guaranteeing the credit of the SPV by saying that they are going to be a long-term customer. And then that dramatically improves the SPV's ability to raise debt at a more reasonable interest rate in the markets.

1:14:48Shawn O’Malley:It's definitely not the least complicated concept that I've ever come across. And in case you ask yourself why they do this, there's an additional benefit to just not having that debt on your balance sheet. One of the most important part of it is that you actually tap into just a completely different pool of money. So you now have insurance companies and you have private credit funds that are desperate for exactly this kind of long-dated bond-like exposure to AI infrastructure. And that's a completely different market than, for example, the equity market. And in a world where Meta might need to finance tens of billions, potentially hundreds of billions of dollars, you can see why they would want more than just one funding channel, especially because if you go to the equity markets and you tell everybody, hey, we will dilute you, that's never a good thing for the markets.

1:15:31Shawn O’Malley:And obviously you will be sold off in the stock market. So that's a huge part of it. And I also learned, this was quite interesting. I didn't know that before that this is sort of the classic infrastructure finance. So this is how pipelines, how power plants and telecom networks have been funded for decades. So I think that's somewhat telling that suddenly you have these hyperscalers, you have companies like Meta that are financed like a utility to some extent. And as you said, I think the scariest part about all of this is that it it appears Meta and Co., all the other hyperscalers, actually tied to contracts that for many, many years, they will pay money, be it in leases, be it in interest payments, but they will pay money and they will do that whether the AI vision is working out or not.

1:16:14Daniel Mahncke:I think this is going to be, well, I think it's a period that will be studied in business and economic textbooks for many generations to come. How about that's one way to put it? And so on one extreme for what you could imagine happening, you might say that the most powerful businesses in the world are all hurling themselves off a cliff simultaneously in one collective mania with all these bets on AI. Or on the other extreme, they're using their financial firepower and global dominance in tech to cement their role in one of the biggest productivity breakthroughs in human history. And obviously that would be quite profitable.

1:16:51Daniel Mahncke:So just a little bit of hyperbole there, but those are sort of truly the two ends of the spectrum that are on people's minds when they're thinking about what's happening. Because all of it really is, I don't want to say unprecedented, but it's at a dramatic, dramatic scale.

1:17:07Shawn O’Malley:It's also just a huge rethinking of these companies. I think I mentioned it to you earlier, but if you think about what Amazon did with AWS in the beginning, a lot of people said, the problem with this is you have a highly profitable company, a high margin business. Now, suddenly you have this huge capex, this huge amount of money that you, for a very long time, basically without a stop, have to invest in the business. And people were saying, this is probably a lower margin business. Why would I want to own a business that has lower margins instead of higher margins? But obviously what you need to compare is the absolute amount of money that you can earn and also deploy.

1:17:40Shawn O’Malley:If you can deploy tens and hundreds of billions of dollars into a certain segment in your company and you can earn a 10 % return on that, there could be much more money than you invest in a capital light business model where you make a higher return, a higher margin generally, but you can deploy significantly fewer capital. So the way I would see this to sound extent is that all of the hyperscalers are now going through what Amazon went through when they sort of pioneered the Google Cloud business, where maybe these businesses will be lower margin going forward, but they can deploy a lot more capital and in absolute terms, make a lot more money than they could five or 10 years ago.

1:18:17Shawn O’Malley:And I guess if we just zoom out a little, the most realistic outcome, especially for Meta, is somewhere in between all of the mentioned scenarios here in this episode. So go for the enterprise cloud, rent out a slice of access compute on short-term contracts, for example, then focus on internal AI and improving the ad engine and sort of the vision of infinite ad loads and then build AI agents for the family of apps to support the SMB customer. So if you ask yourself why I build a position, despite all the doubts that we're sort of mentioning here about Meta, I think to me, it comes down that I believe Meta is just attractively priced because people see AI spend as sort of black and white.

1:18:56Shawn O’Malley:So either Meta, super intelligence and cloud vision all work out and it's a huge success. And that's obviously not what the market is currently having a lot of faith in. Or it's a huge mistake that costs the company's future because they spend too much money. And I might be naive. That is a possibility. But I think the truth is somewhere in the middle. And if that's the case, I think matter is attractively valued today. Although I should say that it's clearly not even close to as much of a bargain as it has been in 2022.

1:19:23Daniel Mahncke:The black and white picture, I think, is a really good analogy for Zuckerberg himself too. I've seen so many comments saying he's one of the worst CEOs in history and that everything he touches fails. And he is probably not the most talented CEO at launching new products, but I'm not sure you can be one of the longest lasting CEOs and founders in the tech industry and build a$1.5 trillion company if you're just completely incompetent, right? That goes without saying. And I should also add that we own another company that was in a similar position a while ago, and that was Google, right? They once sold off by almost 30 % because investors really dislike the idea of Google expanding beyond search and spending money on unrelated things like Gmail, Sheets, Docs, YouTube, and Android.

1:20:07Daniel Mahncke:Beyond that, Google's other bets division is also notorious for burning through money at pretty impressive rates. Yet, I don't think you'll find many people today who would say that this was the wrong decision. I'm not saying it will be the same with Meta, but it is a good example of the market can be nervous about uncertainty around large spending of money, although that might be the best long-term decision in some cases.

1:20:30Shawn O’Malley:And we should say, and this sort of goes back to the defense argument, that meta is vulnerable as long as it is an ads-only business. I mean, I've said somewhat pretentiously that it has an impenetrable mode, but of course, that's never fully true, right? There's an end to everything. And just as much as I love many Instagram ads, it's also a fact that many scammers advertise on Instagram and on Facebook, and you have a lot of AI slop, public resentment towards meta, and so on. So there are a lot of things that don't go right. And I think there's always potential for a new player in town. And if 2022 has shown us anything, then something like an app, you know, like TikTok can just come up and also go out to hundreds of millions of people basically overnight.

1:21:11Shawn O’Malley:And meta won't be able just to buy any of those competitors today. They might have done so 10 or 20 years ago. Today, there would be a lot of regulation around it. So they have to be cautious not to become a victim of the innovator's dilemma.

1:21:24Daniel Mahncke:So when we did a revisit of Uber a couple of weeks ago, I didn't put together an updated valuation primarily because I thought things in some sense hadn't changed too fundamentally. Not that the financial situation hadn't changed, right? Uber has compounded its earnings and retained value a great deal, but more so that We already felt very confident in wanting to own Uber, and we thought only good things had transpired in the last year. So we didn't need a model to tell us whether we should own Uber or not. I have a feeling that things are different here with Meta, and we should maybe think about the modeling side of things a bit because we have split conviction on it.

1:22:03Shawn O’Malley:Yeah, I would say that feeling is quite accurate. So I decided to build a model that's slightly more detailed this time, simply because you have all this depreciation in the schedules there. And the CapEx EG are so enormous that you can't just use averages or perhaps a fixed cash flow conversion. It just wouldn't work for Meta going forward. So in my updated base case, Meta produces basically no free cash flow between 2026 and 2028. We're slightly negative actually in 2026, massively negative in 2027. Then we roughly break even in 2028. Then only in 2030, so the end of the decade or basically the beginning of the new one, we see close to$90 billion of free cash flow again.

1:22:43Shawn O’Malley:And if you want to go through all of the assumptions, please go to our newsletter. You know, if we have too many numbers here, it's quite complicated. Over there, we can explain a bit more about how we get to all of that. So looking at all three scenarios, the bear, the bull, the base case. In the bear case, CapEx has been climbing, in my assumptions, to about$230 billion. Margins are basically staying stuck at around 30%, and then growth is obviously fading over time. The base case is the ad and messaging story working, while CapEx plateaus at around$200 billion and margins recover to the high 30s at the end of the decade.

1:23:19Shawn O’Malley:And then the bull case is what we talked about, every pixel turns into an ad thesis working out. And that would mean that you have growth near, for example, 20 % over the next couple of years. Margins go back about 40%. CapEx reaches 200 billion in 2027, but is then declining about 10 to 20 billion a year. And that's sort of the main setup.

1:23:40Daniel Mahncke:So do you expect CapEx to stay high in all three scenarios? It seems it's hard to imagine otherwise.

1:23:47Shawn O’Malley:Yeah, I think that's just a whole matter in most of the other hyperscalers work now. I don't see them stepping back from the CapEx commitments that they have done. So my basic assumption now is that you will have hundreds of billions that will be paid out. And you now sort of have to see how that impacts the valuation. So in this case, it also means just putting a multiple on the 2030 cashflow per share isn't really accurate because by 2030, depreciation from today's spending is already crushing margins, but 2030 free cashflow is still also reduced by that year's$190 billion of CapEx. So that method would sort of charge for the build-out twice and you wouldn't stop.

1:24:26Shawn O’Malley:You don't get to a normalized level. So I decided to go, and it doesn't get less complex, with three different terminal value approaches this time. So first, we do take my old free cash flow multiple method, which effectively assumes the CapEx never normalizes because of the multiple on depressed margins and cash flows. In the second approach, we also use a multiple, but we do assume sort of a normalized CapEx in 2030 and thus also normalized margins and cash flows. And normalized in this case means that I've just made an assumption on the CapEx to depreciation and amortization ratio that we have seen historically.

1:25:02Shawn O’Malley:Again, more details will follow in the newsletter. But if I expand to this year, it will just get way too boring. And the third version is a plain PE on 2030 earnings. Perhaps the easiest, perhaps also my preferred way because depreciation already runs through the cost of the buildout and through earnings. And when you compare all the fair values of these approaches, you would get to a base case fair value, which is somewhere around$650 to$750 per share.

1:25:30Daniel Mahncke:So from my perspective, is this the most obviously compelling moment to buy Meta? Probably not. And I would say that it was much more so in 2022, as you also mentioned. And one of my issues with Meta is that their CapEx spending just seems so much more speculative than Alphabet and Amazon, where they have at least a more plausible explanation for what they'll do with all this computing power that they're investing in. But like you've said, with meta, they can unlock a lot of value by just embracing what they are and not betting the farm on trying to be some revolutionary AI platform. And that plus the metaverse stuff, the negative impacts on society, especially for young people and the regulatory effects of that.

1:26:12Daniel Mahncke:And all that to say, I'm not sure the margin of safety is so clearly wide that I feel compelled to buy shares in Meta tomorrow. And honestly, I'd be more excited probably to accumulate shares in Alphabet or Amazon with any incremental capital we invest or some of the other great businesses we already own, which is not to say I don't think Meta won't do incredibly well. I'm sure that they probably will do well. It's not a business that I want to bet against. But the question is, relative to our other opportunities, is this the best place to invest an incremental dollar of capital at this exact moment in time?

1:26:47Daniel Mahncke:And I don't know. I don't think I'm sold on it yet, but maybe I'll eventually get there.

1:26:51Shawn O’Malley:I think that skepticism is quite fair. To be honest, I got to say that I might've come out of my research slightly less bullish than when I actually went into it. And I think a common argument right now is that Meta is the max seven with potentially the most optionality, especially given its valuation and everything that Mark Zuckerberg is putting out there that could potentially work out for Meta in the future. And I would generally agree with that. I think there's a lot of stuff that we couldn't even get to today. So for example, Meta just launched a new marketplace app called Seller on Facebook.

1:27:21Shawn O’Malley:And also there's a lot of optionality for Meta's MuseSpark LLM, where I quickly mentioned it today, it comes into ad creation for Meta customers, right? There are immediately millions and millions of customers and a lot of margin to make. However, all of that optionality comes at a high price, not necessarily in terms of the stock price, but primarily because of all the capex and also all the lawsuits that we will still see in the future. And the things Zuckerberg spends the most money on, it kind of seems like they are the most uncertain. I could really see how AR glasses take another decade before they actually become mainstream, if they ever do.

1:27:57Shawn O’Malley:And that can mean tens of billions of dollars in investments until that point. And in the cloud and the super intelligence ambitions, they will probably take even more money and potentially the same amount of time. So I'm not sure. You have a margin of safety there because you can sell access compute, but this is not really an exciting way to invest in the stock. And what I liked about Meta before is that if none of this works out, you are left with the biggest and most profitable advertising business in the world. But looking at all these long-term obligations that especially you pointed out, I think there's risk that the business will be dragged down for a very long time.

1:28:34Shawn O’Malley:And I will definitely not sell any of my shares in my personal account, but I won't push you and Kyle to own it into the intrinsic value portfolio either, because I think you're not fully convinced. And I know that Kyle has a strong opinion on the questionable capital allocation decisions made by Mark Zuckerberg. And to him, that's always a sort of a no-go, as he told us before. All right. And with that, Let me close it for today with a quote by Wilson Mark Zuckerberg that might also explain his constant urge to spend and reinvent matter to some extent. He said, the biggest risk is not taking any risk.

1:29:08Shawn O’Malley:And in a world that is changing really quickly, the only strategy that is guaranteed to fail is not taking risks. And with that and today's episode, see you all in the next one.

1:29:24Shawn O’Malley:app and visit theinvestorspodcast.com for show notes and educational resources. This podcast is for informational and entertainment purposes only and does not provide financial, investment, tax, or legal advice. The content is impersonal and does not consider your objectives, financial situation, or needs. Investing involves risk, including possible loss of principle, and past performance is not a guarantee of future results. Listeners should do their own research and consult a qualified professional before making any financial decisions. Nothing on this show is a recommendation or solicitation to buy or sell any security or other financial product, hosts, guests, and the Investors Podcast Network may hold positions in securities discussed and may change those positions at any time without notice.

1:30:03Shawn O’Malley:References to any third-party products, services, or advertisers do not constitute endorsements, and the Investors Podcast Network is not responsible for any claims made by them. Copyright by the Investors Podcast Network. All rights reserved.