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

The Investor's Podcast (We Study Billionaires) - The Investor’s Podcast Network

The episode provides a deep dive into Meta's current investment thesis, weighing its massive capital expenditures against significant legal and

Key takeaways

• Meta's 2026 CapEx guidance is set between $130–$145 billion, with analysts projecting $200 billion for 2027.
• A major legal settlement involving 29 states and Meta reached approximately $18 billion to resolve child safety and privacy concerns.

Main topics

• Meta's AI infrastructure CapEx
• Legal liabilities and child safety lawsuits

Notable quotes

The biggest risk is not taking any risk.

Conclusion

Investors face a high-stakes gamble on whether Meta's massive AI inves

Transcript preview

Speaker 1 (0:00) You're listening to TIP. Speaker 2 (0:02) Welcome back to the Investors Podcast, episode 848. And the last stock I pitched to you, Sean, was Copart, which is a company that we looked at last year. And today, we will have yet another company that we covered before and that deserves another look. And that company is Metto. And I can't really spoil that. I started building a position in it in my personal account not too long ago. Speaker 4 (0:27) It's only been nine months since we first covered Meta, but it does somehow feel like an eternity ago with all the news that's come out from the hyperscalers this year. And just a couple of months pass and you already feel like you need to discuss the opportunity again and provide an update. And that's what we're doing today. Speaker 2 (0:42) I'm not sure if you remember, but last time in the episode, you said that you would like to wait for the stock to drop further and perhaps see sort of an advertising downturn before you would actually go out and buy Meta. We didn't really see an advertising downturn, but the stock still declined about 25 % from yearly highs on some other news that I'm quite sure we will get into today. Speaker 4 (1:03) Let's get into it. Speaker 1 (1:08) Since 2014, with more than 200 million downloads, we have interviewed the world's best investors, studied deeply the principles of value investing, and uncovered many compelling investment opportunities. We focus on understanding businesses and intrinsic value, investing accordingly, and sharing everything we learn with you. This show is not investment advice. It's intended for informational and entertainment purposes only. All opinions expressed by hosts and guests are solely their own. and they may have investments in the securities discussed. Now for your hosts, Sean O'Malley and Daniel Manka. Speaker 4 (1:54) There's so much going on that it's difficult to even know where to start today, Daniel. Perhaps we go with what has changed since our first episode in January on Meta. And some of the most notable things have probably been Meta announcing that it would build a cloud business, more or less, and that there is, or better said, was a major lawsuit hanging over Meta's head. Speaker 2 (2:16) Yeah, I think it was safe to say there was no shortage of news, unsurprisingly, whenever it comes to Meta. And just for context, In January of this year, Mark Zuckerberg announced on Threads, which is sort of the equivalent to Twitter or X, that Meta wants to build out AI infrastructure at scale. And he talked about building tens of gigawatts of data center capacity this decade, which means hundreds of gigawatts or more over time. So thinking the next couple of decades. And just for context, a single gigawatt is roughly the output of a nuclear reactor. So we're talking about quite a lot of energy here. And for that project, He even brought in Dina Powell McCormick, who is a former government official, and she's sort of working as a president and vice chairman on that project, explicitly there for just working on government partnerships and to finance the build out of these data centers. Speaker 4 (3:07) It's Speaker 2 (3:08) a Speaker 4 (3:08) fascinating hire, I think, in itself. When your CapEx plans are so big that you need someone whose sole job is essentially to diplomacy with the federal government, then you know you're making some serious capital allocations. Having that political support at this moment, though, is pretty important optically. Virginia is the data center capital of the country, if not the world, probably. And so I have been seeing data centers popping up my entire life since I was a kid, but I don't really remember them ever being controversial until recently. And so we actually had a family member with some land that for years, they were going back and forth with the courts to try and win approval for a massive data center to be built on that property. And that deal just fell through recently. So the sentiment changes in AI are creating real obstacles for big tech companies that are manifesting as legal opposition, for example. And so I was looking at a Pew survey on this recently, and about half of all Americans say they're more nervous about AI than excited about it, while 40 % say they're equally excited and concerned. And then only 10 % say they're more excited than concerned. So that is not exactly a ringing endorsement of the national popularity of Speaker 2 (4:22) AI. And all of that in a country that is usually more AI or tech first than any other country on the planet. So I think it says something about just the general thought of people on this matter. And of course, it also comes from the fact that for a long time, AI companies were basically telling you we're coming for your jobs. I think that doesn't help, especially in America. And I recently talked to a member of our mastermind community, and he told me some let's say, fascinating stories. He used to work in the White House, and now he basically runs a consulting business where, among other companies, Meta would go to seek help when it needs connections to politicians for future projects, which is pretty much exactly what's happening right now. And from what I gathered, I think Meta is not very good at, let's say, understanding how Washington works. I definitely hope they will do a better job this time, because considering the CapEx announcements, it would be good if they didn't mess up this project. this new sort of regulation. I think the project that I discussed back then was about a decade ago, Meta trying to position a stablecoin, which didn't work out back then, but has since become a huge thing. So if they would have just played the cards better, this could have been a huge thing for Meta very early on. And I just hope this doesn't become, you know, sort of a theme for them to mess this up, because they have these enormous capital investments right now. Obviously, that's the case for most of the hyperscalers. Right now, it's always looking like you suspect that they put even more money into these projects, and then they even come out on top of what analysts imagine. So for example, Meta's 2026 CapEx guidance has been raised multiple times and is now between $130 and $145 billion. There is no official guidance for 2027 yet, but analysts project that it will be close to $200 billion. An estimate that is also based on Matter's cloud plans, obviously, but there's so much more than just the cloud that I think Zuckerberg basically sees AI and all the opportunities as his third shot, basically, at finally building a platform for Matter and his company. Speaker 4 (6:20) Just quickly, so we get the audience on the same page here. Daniel, to put you on the spot, maybe, how about we just quickly define what a hyperscaler is and what that means? Speaker 2 (6:30) Well, basically, I use this term. maybe wrongly for a very long time, where I just felt like most of the Mac 7 companies are hyperscalers, but that's actually not true. Hyperscalers are all the companies that have cloud businesses, right? So obviously when you talk about companies like Matter, by now it would be one of them, but before that it was primarily Amazon, it was Oracle, you know, a company that I didn't necessarily think about it. And then you have Google, and of course you also have Microsoft. So those are the companies that we talk about when we talk about hyperscalers. It's not the same as a Mac 7, you know, Apple is not a hyperscaler. NVIDIA, I'm not even sure entirely whether they count into that direction or not. But typically, we're talking Amazon, we're talking Google, Microsoft. And by now, we're also talking Matter. Speaker 4 (7:10) It's one of those terms that you hear so much and seems so important that you're almost embarrassed to ask what it means. So there you go. That's a little 101 on hyperscalers. And we talked before the show, going back to your previous point a moment ago, that perhaps it might make sense to quickly give some background on what exactly. we mean when we say that meta is on its third attempt to build a platform. And so younger listeners might not remember this, and it feels funny to say that, but Facebook used to be a desktop-based app in the late 2000s. And back then, it tried to be much more than just a social network. Facebook had third-party apps and games and payments. And if you ever planted crops in Farmville, you were part of Zuckerberg's first attempt to build a platform ecosystem. I don't know about you, Daniel, but I very much remember Farmville and actually wonder if anyone still plays that. At the company's IPO in 2012, games and apps were around 20 % of Facebook's business. So this was no joke. Yeah, it was quite Speaker 2 (8:09) big back then. I gotta say, I don't remember if I played Farmville. I think there was a popular farming game at about the same time, which was basically when I was in elementary school. But I think it wasn't Farmville. Probably just a cheap knockoff of Facebook's original game. But anyway. The problem for Matter, or back then still Facebook, was that the world ended up moving, as we all know today, to mobile. And Apple started to make the rules in that environment. And Apple basically said, you can't have a platform within our own platform, which is the App Store, of course. So Facebook had to double down on its social network business and obviously advertising to monetize that. And I think in hindsight, you can safely say that this has probably been the best thing that ever happened to Matter. But I also believe that... Zuckerberg himself was never really happy with that position. To me, it just seems like he's too much of a visionary and a tech guy for being someone who's happy just running an ads business for the rest of his life, that at least to some extent depends on Apple's moods and of course, the app store. So I think I can remember that he openly said that he always admired Microsoft and the platform that they have built. And I think it was in 2014, so two years after the rise of mobile smartphones. that basically killed his first platform, that he spent $2 billion on Oculus, which probably most of us would still remember. And obviously, AR and VR are still a big thing today at the company. We will talk about them later today, but by far the biggest investment and his attempt on building a platform has been the Metaverse, which is obviously also why the company today is not named Facebook anymore, but Meta. Speaker 4 (9:42) I think it's pretty good context for understanding how something like the Metaverse could even happen. where in hindsight, there's an absolutely mind-numbing amount of cash burned on something that has yet to pan out, if ever, despite the founder of one of the most successful companies in the history of capitalism being so confident in the technology that he renamed the company after it. So I sometimes see memes on social media showing these virtual meetings or boardroom snippets with a caption asking how such a terrible design. It looks like a game on the Wii system from the early 2000s. How that could cost close to $100 billion to develop. And I guess the answer is that Zuckerberg was desperately trying to build a platform that was going to help cut his dependence on Apple. And with that vision in mind, it does make much more sense to spend that amount of money and maybe rename your entire company. But before you change your name, you would think that you would... maybe make sure that the tech was a little further along and had some real evidence that this is something consumers want to pay for. So it is a bit complicating in the context of Meta's massive AI bets today, which to be fair, they're not alone in. We know Zuckerberg though is willing to overspend on things he believes in, and he's desperate to diversify Meta's core business beyond advertising. Speaker 2 (11:04) Well, and I think in this case, it's not only to create a new platform. but also just because he clearly sees AI spend as a defense mechanism. So he has publicly said that he would much rather invest too much money than just wake up in a couple of years time realizing that he underinvested and got disrupted, which I think is generally a healthy perspective for a company and a CEO to have. And I'm not exactly sure which side I'm on in this case. I mean, on the one hand, I believe Meta has one of the strongest ad engines ever built with network effects that make it nearly impossible to disrupt. But on the other hand, and I know that's a take that not too many people share, and we discussed it before our call here, I actually buy into the AR glasses story, which of course, there are also some caveats. But generally, I do think this could become a sort of platform in the future. Speaker 4 (11:52) I feel a little betrayed. I thought we were on the same page, you know, Daniel. We were both really tough on Snapchat for their AR glasses. So I have to say, this is a little surprising to me. I know we were both unified and mocking those things, at least from Snapchat, where they were. really a debacle. But something else we should get into though, now that we're mentioning the core business, is that Meta just faced lawsuits that threatened exactly this business and its moat. And so for the longest time, Meta has been an annuity-like business in which you could count on tens of billions of dollars and advertising cashflow to consistently be coming in. And so that's really the only reason why Zuckerberg has been able to afford spending so much money on all these other things that he's wanted to bet on. And so If that is threatened, we would need to look even more critically at the commitments Meta is currently making. Speaker 2 (12:43) If you say it like that, we might actually want to start there, I would say. So just for context, in case you missed it, which was quite difficult to do, there was a lawsuit in New Mexico in 2023, so about three years ago, in which Meta was accused of basically endangering children. And that case went to trial earlier this year, and Meta was found liable. So it was ordered to pay... $375 million. And that was only the first phase of this entire lawsuit debate. So then the second phase came. And the question was basically whether Matter had created a so-called public nuisance, which is a legal concept, which was historically used against polluters and opioid distributors. And just a few weeks ago in August, the judge ruled that it did actually commit this sort of public nuisance. And it found the company or the platform were, quote, insignificant. contributing cause of the state's teen mental health crisis. And it also ordered Meta to pay another $570 million in an abatement fund, which is basically a fund that pays for prevention, screening, and treatment of the harms. So the total damages were close to a billion dollars. And I should say that Meta is appealing, but this is where we currently stand. Speaker 4 (13:55) And the real problem here is not the billion dollars in damages, right? It takes Meta less than a week to generate. that much in profit, which is absurd to say. But the fact that Meta also had to change how its product works in New Mexico, and that this obviously opened the floodgates for more lawsuits, that's sort of the bigger story. And Meta was actually ordered to hide like counts for users under 18, unless a parent approved otherwise. They were forced to pause notifications sent to miners between 10 p.m. and 7 a.m., and they had to cap miners' usage at 90 hours a month. Roughly three hours a day. And Speaker 2 (14:33) the recommendation of the state attorney general was that other states and even other countries should use this as a blueprint whenever they go out against META. So this was actually just the beginning because of that. Because, you know, the one thing that everyone was actually talking about in the last couple of weeks was the massive Oakland trial where 29 states went to court against META. And the trial was actually expected to run for about six to eight weeks, which... would have meant that a verdict would be there sometime around October. And Zuckerberg, Instagram chief Adam Mosseri, and former COO Sheryl Sandberg were all expected to testify. But things came a bit differently. I mean, I think back then we still talked about a headline figure for potential fines in this trial that was worth $1.4 trillion. That's trillion, not with a B, billion dollars, which is pretty much exactly the market cap that Meta is trading at today. Speaker 4 (15:24) Yeah, that... $1.4 trillion number was great for headlines and for screenshotting, but it never actually was a realistic outcome in the case, as I'm sure you know. If I'm not mistaken, I think this was actually calculated by Meta in an attempt to effectively scare people and maybe get the public opinion on their side, since it is not in most people's interest to completely wipe out an American social media platform where it's... pretty much assured that a Chinese one is just going to take its place and probably has many of the same mechanics in place as well. Speaker 2 (15:58) Yeah. I think the way the number came up is by basically stacking up all the individual violations. So part of the case is brought under what is called COPPA, C-O-P-P-A, and that's the Children's Online Privacy Protection Act. And that's basically a federal law that prohibits collecting data on kids under the age of 13 years old without parental consent. COPPA carries what is called a civil penalty per violation. So if you treat every under 13 account over the years, and you stack up all of them as individual violations, and then you multiply that by the maximum penalty per violations, which is what Meta did, then you would arrive at this theoretical ceiling of $1.4 trillion. And as you said, that figure came from Meta's own legal filings. Nobody involved actually thought this would be a realistic outcome. I think the amount actually argued in the courtroom was close to $200 billion. And even those $200 billion would have been a pretty massive hit to Meta, obviously. And although these fines usually don't come at once, they're basically paid over many decades. And historically, US courts have usually awarded around 2 % of the statutory maximum, so $1.4 trillion in this case, or 20 % of the ask, which is sort of the $200 billion rate. And that's an absolute maximum. So if Meta would have lost the case, I personally would have expected payments to be between $20 and $30 billion. But we're talking in the past tense here because Meta managed to settle very early on. And this, I would say, really came as a surprise to me. I still remember like starting my research and thinking, gosh, when this episode comes out, we likely won't know how this turns out. And then only a day later, we had a settlement. So I don't know. To me, it seems like the states knew they didn't really have a chance in court. So they... probably just decided to take the money and settle this way. Speaker 4 (17:46) Settlement ended up being less than $18 billion. And that is not shabby by any means, even if it was below what your bottom estimate was for what might've happened in court. And most importantly, there weren't any major changes to how Meta needs to operate its apps either. And so similar to what happened in New Mexico, Instagram basically just goes ahead with hiding likes for teens. They added a time cap. And then maybe you have some nighttime and school time blocks, but really nothing major that's fundamental to the functioning of the business. And Speaker 2 (18:18) there are actually a couple of interesting things when you look into the details of what they came up with. So the first thing is that certain parts of the apps are not included here. So DMs, for example, you can still even at night, for example, open DMs. And I think it was a couple of years ago where the Instagram management team was basically saying that a huge part of the growth for the app. is coming from the DM section. So I could even see how this sort of turns into an advantage over time because all the other social media apps that don't have this DM, direct message, I should say, section might have to block their apps just like Meta did, but people can still visit Meta just on the DM section. But that was only one of the interesting facts. The other one is that Meta only pays $18 billion under two conditions. So the first would be that YouTube and TikTok also agree. to implement similar measures as Meta. And this is sort of why I'm saying, if you don't have a DM function, like YouTube, for example, this would hit you much harder compared to Meta. And then the second thing, or the second condition, is that YouTube and TikTok both match half of the $5.3 billion payment each. So for now, Meta only has to pay $12 billion, and that's also over a 10-year time window, I should say. And they manage to sort of pressure. their competitors into similar rules, and to some extent, also similar payments. And I think this is quite important, because if Meta needs to restrict its app for minors, while competitors don't, then Meta 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 Meta's apps, then you know, 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. Because even if the trial would have been over after six weeks, if META had been found guilty or liable, there would have been many more lawsuits over the next couple of years, where the chances for META 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, you know, setting this precedent of settling instead of losing in court is a good one. All that said, I could still imagine, you know, 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. 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. Speaker 4 (21:17) Let's take a quick break and hear from today's sponsors. 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. 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