Monumental task: This photo illustration shows an image of Zuckerberg and Meta’s logo. The CEO’s move to recruit a secretive AI brain trust of researchers and engineers to achieve “artificial general intelligence” will require a vast investment of capital. — AFP
SAN FRANCISCO: Some investors are questioning the amount of cash Big Tech is throwing at artificial intelligence (AI), fuelling concerns for profit margins and the risk that depreciation expenses will drag stocks down before companies can see investments pay off.
“On a cash-flow basis, they’ve all stagnated because they’re all collectively making massive bets on the future with all their capital,” said Jim Morrow, founder and CEO at Callodine Capital Management.
“We focus a lot on balance sheets and cash flows, and so for us they have lost their historical attractive cash flow dynamics. They’re just not there anymore.”
Alphabet Inc, Amazon.com Inc, Meta Platforms Inc and Microsoft Corp are projected to spend US$311bil on capital expenses in their current fiscal years and US$337bil in 2026, according to data compiled by Bloomberg.
That includes a more than 60% increase during the first quarter (1Q) from the same period a year ago. Free cash flow, meanwhile, tumbled 23% in the same period.
“There is a tsunami of depreciation coming,” said Morrow, who is steering clear of the stocks because he sees profits deteriorating without a corresponding jump in revenue.
Much of the money is going toward things like semiconductors, servers and networking equipment that are critical for AI computing.
However, this gear loses its value much faster than other depreciating assets like real estate.
Microsoft, Alphabet and Meta posted combined depreciation expenses of US$15.6bil in 1Q, up from US$11.4bil a year ago. Add in Amazon, which has pumped more of its cash into capital spending in lieu of buybacks or dividends, and the number nearly doubles.
“People thought AI would be a monetisation machine early on, but that hasn’t been the case,” said Rob Almeida, global investment strategist at MFS Investment Management. “There’s not as fast of AI uptake as people thought.”
Of course, investors still have a hearty appetite for the technology giants given their dominant market positions, strong balance sheets and profit growth that, while slowing, is still beating the rest of the S&P 500.
This explains the strong performance of AI stocks recently.
Since April 8, the day before President Donald Trump paused his global tariffs and turned a stock market swoon into a boom, the biggest AI exchange-traded fund, the Global X AI & Technology ETF, is up 34%, while AI chipmaker Nvidia Corp has soared 49%.
Meta has gained 37%, and Microsoft has climbed 33% – all topping the S&P 500’s 21% advance and the tech-heavy Nasdaq 100 Index’s 29% bounce.
Just Tuesday, Bloomberg News reported that Meta leader Mark Zuckerberg is recruiting a secretive AI brain trust of researchers and engineers to help the company achieve “artificial general intelligence,” meaning creating a machine that can perform as well as humans at many tasks.
It’s a monumental undertaking that will require a vast investment of capital. And in response, Meta shares reversed Monday’s decline and rose 1.2%.
But with more and more depreciating assets being loaded on the balance sheet, the drag on the bottom line will put increased pressure on the companies to show bigger returns on the investments.
This is why depreciation was a frequent theme in 1Q earnings calls.
Alphabet chief financial officer (CFO) Anat Ashkenazi warned that the expenses would rise throughout the year, and said management is trying to offset the non-cash costs by streamlining its businesses.
“We’re focusing on continuing to moderate the pace of compensation growth, looking at our real estate footprint, and again, the build-out and utilisation of our technical infrastructure across the business,” she said on Alphabet’s April 24 earnings call.
Other companies are taking similar steps. Earlier this year, Meta Platforms extended the useful life period of certain servers and networking assets to five and a half years, from the four-to-five years it previously used.
The change resulted in a roughly US$695mil increase in net income, or 27 cents a share, in 1Q, Meta said in a filing.
Amazon, however, has taken the opposite approach.
In February, the eCommerce and cloud computing company said the lifespan of similar equipment is growing shorter rather than longer and reduced useful life to five years from six.
To Callodine’s Morrow, the big risk is what happens if AI investments don’t lead to a dramatic growth in revenue and profitability.
That kind of market shock occurred in 2022, when a contraction in profits and rising interest rates sent technology stocks plummeting and dragged the S&P 500 lower.
“If it works out it will be fine,” said Morrow. “If it doesn’t work out there’s a big earnings headwind coming.” — Bloomberg
