Meta Q2 result-- AI in execution, not a top 10 holding but interesting nonetheless

 META 2Q 25 RESULTS

If I had to identify the biggest mistakes in my investing career, one would surely be underestimating operational momentum. The thinking here is that the exhaustion of operational improvements is uncertain, and maybe they end soon, maybe just after you have put a position in. The reality is that in most cases, operational improvements last well beyond an arbitrary reporting period and beyond my concerns. If the starting point for investment is a reasonable (although not cheap) valuation, investing and seeing how far operational improvement stakes us can be a very profitable exercise. That is the overarching approach with my Meta investment.

The benefits of AI spent by Meta in the digital advertising world have been prolific. Meta stands as perhaps the largest beneficiary of the large caps in AI operational usage. Digital advertising perhaps opens itself as one of the most pliant businesses to engage AI. That is probably true, but it may also be an indication of what is possible for many industries over time. Certainly, the results encourage companies to invest in AI. That helps to explain the huge capex that Meta and the others are undertaking. Secondly, it helps explain Meta’s enthusiasm to aggressively expand its so-called Superintelligence efforts to develop a personalised AI assistant and capture that market, maybe ahead of GOOG and OpenAI. That depends on LLM progress. Meta doesn’t have to be the best; their access to over 3 billion active users will help here, but they have to be competitive.

Meta has lagged the others recently, but has identified and seen the potential of AI and is aggressively attempting to catch up and hopefully pass their rivals here. Therefore, the aggressive acquisition of personnel, Meta thinks that a small, highly focused and talented team will outperform a larger, unfocused team.

Last quarter numbers of interest are User growth 6%, Pricing +9% and ad impressions +11%, Revenues +22% and costs +12%. Operating margin is 43% with Reality Labs losses, 53% without these losses. Much better run rate than my numbers for the FY25, revenues by about 3% better, and NPAT may be +10% higher. The benefits of the AI spend on ad targeting and ad marketing support are reaping large benefits.

Note the strong ad impression growth along with strong price growth (graph below), which was explained in detail by Meta and is counterintuitive, as more supply (impressions) usually leads to lower prices or lower price growth. Both were strong. The explanation was that AI is improving the content available, adding to dwell time for FB and IG, while concurrently, AI is improving ad selection, making them more relevant, and that is leading to more views and more conversions to sales for advertisers. Execution rarely gets any better than that.

The next question is, can the ongoing capex continue to generate these types of returns? Capex was upped, like GOOG. Meta plans to attack the universal agent market and simultaneously develop the AI glasses as a potential new platform. These are two huge areas, but the outcome of both is uncertain.

Capex is both long-term, glasses and a personal assistant, and short-term, including AI-targeted ads and AI marketing assistance tools for advertisers. The last one is paying off well, and the LT is in development and uncertain.

Longer term investing in Meta is most likely to be tied to the success of glasses and the universal assistant, shorter term the ability to keep the revenue growing above expenses as AI is embedded further into the business, which is likely to have a shorter duration. That dictates the investing strategy.

The bulk of improvements (unit growth, dwell time, conversions) are in the big platforms, FB and IG, but Threads and WhatsApp are potentially in the firing line at some point for the same treatment. Note: The Threads data was not disclosed, showing probably some slowing for the Twitter competitor.

Risks to me are that Meta is fighting a war on each front, usually not a good thing and highlights management's aggressiveness and its financial muscle. The first war is AI and the push for a universal assistant; the second war is Reality Labs and a platform to potentially replace the Apple iPhone with AI glasses. Both huge risk/reward endeavours. If Meta proves successful in either, it is a big payoff. Reality Labs continues at about $18b losses pa. Meta has the resources to continue this fight, and results like we have just had add more ammunition. See FCF margin below. While the markets remain supportive of this strategy, anyway.

The next risk is regulatory, which is a theme amongst the large US behemoths. The EU has suggested limited personalisation of ads, which would directly impact profitability. Long way to play out here.

Valuation I see value at $650, which includes 5Y 14% eps cagr and 22X exit PE. Not stretched assumptions IMO if no neg macro issues eventuate. Success or failure on its large ventures will move this valuation around.

 

 

 

Mark Zuckerberg CEO

We had another strong quarter with more than 3.4 billion people using at least one of our apps each day and strong engagement across the board. Our business continues to perform very well, which enables us to invest heavily in our AI efforts.

Over the last few months, we've begun to see glimpses of our AI systems improving themselves. And the improvement is slow for now, but undeniable and developing superintelligence, which we define as AI that surpasses human intelligence in every way, we think, is now in sight. Meta's vision is to bring personal superintelligence to everyone, so that people can direct it towards what they value in their own lives.

To build this future, we've established Meta Superintelligence Labs, which includes our foundations, product and FAIR teams as well as a new lab that is focused on developing the next generation of our models. We're making good progress towards Llama 4.1 and 4.2, and in parallel, we are also working on our next generation of models that will push the frontier in the next year or so.

We are building an elite, talent-dense team Alexandr Wang is leading the overall team, Nat Friedman is leading our AI Products and Applied Research, and Shengjia Zhao is Chief Scientist for the new effort. I've spent a lot of time building this team this quarter. And the reason that so many people are excited to join is because Meta has all of the ingredients that are required to build leading models and deliver them to billions of people. The people who are joining us are going to have access to unparalleled compute as we build out several multi-gigawatt clusters. We are making all these investments because we have conviction that superintelligence is going to improve every aspect of what we do.

From a business perspective, I mentioned last quarter that there are five basic opportunities that we are pursuing, improved advertising, more engaging experiences, business messaging, Meta AI and AI devices.

On advertising, the strong performance this quarter is largely thanks to AI unlocking greater efficiency and gains across our ad system. This quarter, we expanded our new AI-powered recommendation model for ads to new surfaces and improved its performance by using more signals and longer context. It's driven roughly 5% more ad conversions on Instagram and 3% on Facebook.

We're also seeing good progress with AI for ad creative with a meaningful percent of our ad revenue now coming from campaigns using one of our generative AI features. This is going to be especially valuable for smaller advertisers with limited budgets. While agencies will continue the important work to help larger brands apply these tools strategically.

The second opportunity is more engaging experiences. AI is significantly improving our ability to show people content that they're going to find interesting and useful. Advancements in our recommendation systems have improved quality so much that it has led to a 5% increase in time spent on Facebook and 6% on Instagram, just this quarter.

The fourth opportunity is Meta AI. Its reach is already quite impressive with more than 1 billion monthly actives. Our focus is now deepening the experience and making Meta AI the leading personal AI. As we continue improving our models, we see engagement grow. So our next generation of models is going to continue to really help here.

And the fifth opportunity is AI devices. We continue to see strong momentum with our Ray-Ban Meta glasses with sales accelerating. The percent of people using Meta AI is growing, and we are seeing new users AI retention increase too, which is a good sign for that continued use.

I think that AI glasses are going to be the main way that we integrate superintelligence into our day-to-day lives. So it's important to have all of these different styles and products that appeal to different people in different settings.

Finally, we're seeing people continue to spend more time with our Quest ecosystem and the community continues to grow steadily.

Susan J. S. Li CFO

Q2 total revenue was $47.5 billion, up 22% on both a reported and constant currency basis. Q2 total expenses were $27.1 billion, up 12% compared to last year. In terms of the specific line items, cost of revenue increased 16%, driven mostly by higher infrastructure costs and payments to partners, partially offset by a benefit from the previously announced extension of sever useful lives.

R&D increased 23%, mostly due to higher employee compensation and infrastructure costs. Marketing and sales increased 9% primarily due to an increase in professional services related to our ongoing platform integrity efforts as well as marketing costs, partially offset by lower employee compensation. G&A decreased 27%, driven mostly by lower legal-related costs.

We ended Q2 with over 75,900 employees, down 1% quarter-over-quarter, as the vast majority of the employees impacted by performance-related reductions earlier this year were no longer captured in our head count.

Second quarter operating income was $20.4 billion, representing a 43% operating margin. Free cash flow was $8.5 billion. We also made $15.1 billion in nonmarketable equity investments in the second quarter which includes our minority investment in Scale AI, along with other investment activities.

On a user geography basis, ad revenue growth was strongest in Europe and Rest of World at 24% and 23%, respectively. North America and Asia Pacific grew 21% and 18%.

In Q2, the total number of ad impressions served across our services increased 11%, with growth mainly driven by Asia Pacific. The average price per ad increased 9%, benefiting from increased advertiser demand, largely driven by improved ad performance. Pricing growth slowed modestly from the first quarter due to the accelerated impression growth in Q2.

Family of Apps operating income was $25 billion, representing a 53% operating margin.

Within our Reality Labs segment, Q2 revenue was $370 million up 5% year-over-year due to increased sales of AI glasses, partially offset by lower Quest sales. Reality Labs operating loss was $4.5 billion.

Engagement

On the first, daily actives continue to grow across Facebook, Instagram and WhatsApp as we make additional improvements to our recommendation systems and product experiences. We continue to see momentum with video engagement, in particular. In Q2, Instagram video time was up more than 20% year-over-year globally. We're seeing strong traction on Facebook as well, particularly in the U.S., where video time spent similarly expanded more than 20% year-over-year. These gains have been enabled by ongoing optimizations to our ranking systems to better identify the most relevant content to show.

Another emphasis of our recommendations work is promoting original content. On Instagram, over 2/3 of recommended content in the U.S. now comes from original posts. In the second half, we'll be focused on further increasing the freshness of original posts, so the right audiences can discover original content from creators soon after it is posted.

WhatsApp continues to be the largest driver of queries as people message Meta AI directly for tasks such as information gathering, homework assistance and generating images. Outside of WhatsApp, we're seeing Meta AI become an increasingly valuable complement to our content discovery engines. Meta AI usage on Facebook is expanding as people use it to ask about posts they see in Feed and find content across our platform in Search.

Moving to Reality Labs. The growth of Ray-Ban Meta sales accelerated in Q2, with demand still outstripping supply for the most popular SKUs despite increases to our production earlier this year. We're working to ramp supply to better meet consumer demand later this year.

Monetization

The first part of this work is optimizing the level of ads within organic engagement. We continue to optimize ad supply across each surface to better deliver ads at the time and place they are most relevant to people. In Q2, we also began introducing ads within Feed on Threads and the Updates tab of WhatsApp, which is a separate space away from people's chats.

While ad supply remains low and Threads is not expected to be a meaningful contributor to overall impression growth in the near term, we are optimistic about the longer-term opportunity with Threads as the community and engagement grow and monetisation scales.

On WhatsApp, we expect the introduction of ads and status will be gradual over the course of this year and next, with low levels of expected ad supply initially. We also expect WhatsApp ads and status to earn a lower average price than Facebook or Instagram ads for the foreseeable future, due in part towards WhatsApp skew toward lower monetizing markets, and more limited information that can be used for targeting. Given this, we do not expect ads and status to be a meaningful contributor to total impressions or revenue growth for the next few years.

The second part of increasing monetization efficiency is improving marketing performance. There are three areas of this work that I'll focus on today, improving our ad systems, advancing our ads products, including by building tools that assist in ads creation and evolving our ads platform to drive results that are optimized for each business' objectives.

First is our ad systems, where we're innovating in both the ad retrieval and ranking stages to serve more relevant ads to people. A lot of this work involves us continuing to advance the modelling innovations we've introduced previously while expanding their adoption across our platform.These improvements have driven nearly 4% higher conversions on Facebook Mobile Feed and Reels.

Our new Generative Ads Recommendation system, or GEM, powers the ranking stage of our ad system, which is the part of the process after ads retrieval where we determine which ads to show someone from candidates suggested by our retrieval engine. The combination of these improvements increased ad conversions by approximately 5% on Instagram and 3% on Facebook Feed and Reels in Q2.

Lattice deployments are driving a nearly 4% increase in ad conversions across Facebook Feed and Reels in Q2.

Next, ad products. Here, we've seen lifts in advertiser adoption of sales and app campaigns since we've expanded availability and are working to complete the rollout for lead campaigns in the coming months. Within our Advantage+ Creative suite, adoption of genAI ad creative tools continues to broaden. Nearly 2 million advertisers are now using our video generation features, image animation and video expansion, and we're seeing strong results with our text generation tools as we continue to add new features.

Outside of Advantage+, we're seeing good momentum in business messaging, particularly in the U.S., where click to message revenue grew more than 40% year-over-year in Q2. The strong U.S. growth is benefiting from a ramp in adoption of our website to message ads, which drive people to a business's website for more information before choosing to launch a chat with the business in one of our messaging apps.

Finally, we continue to evolve our ads platform to drive results that are optimized for each business' objectives and the way they measure results. In Q2, we completed the global rollout of our incremental attribution feature, which is the only product on the market that optimizes for and reports on incremental conversions, which are conversions that would not have happened without a person seeing the ad.

We also launched omnichannel ads globally in Q2 and which enable advertisers to optimize for incremental sales, both in-store and online with just one campaign. In tests, advertisers using omnichannel ads have seen a median 15% reduction in total cost per purchase compared to website-only optimization.

Opex

Next, infrastructure. We expect having sufficient compute capacity will be central to realizing many of the largest opportunities in front of us over the coming years. We continue to see very compelling returns from our AI capacity investments in our core ads and organic engagement initiatives and expect to continue investing significantly there in 2026.

Outlook

We expect third quarter 2025 total revenue to be in the range of $47.5 billion to $50.5 billion. While we are not providing an outlook for fourth quarter revenue, we would expect our year-over-year growth rate in the fourth quarter of 2025 to be slower than the third quarter as we lap a period of stronger growth in the fourth quarter of 2024.

Turning now to the expense outlook. We expect full year 2025 total expenses to be in the range of $114 billion to $118 billion, narrowed from our prior outlook of $113 billion to $118 billion and reflecting a growth rate of 20% to 24% year-over-year.

While we're still very early in planning for next year, there are a few factors we expect will provide meaningful upward pressure on our 2026 total expense growth rate. The largest single driver of growth will be infrastructure costs, driven by a sharp acceleration in depreciation expense growth and higher operating costs as we continue to scale up our infrastructure fleet.

Turning now to the CapEx outlook. We currently expect 2025 capital expenditures, to be in the range of $66 billion to $72 billion, narrowed from our prior outlook of $64 billion to $72 billion and up approximately $30 billion year-over-year at the midpoint. While the infrastructure planning process remains highly dynamic, we currently expect another year of similarly significant CapEx dollar growth in 2026 as we continue aggressively pursuing opportunities to bring additional capacity online to meet the needs of our AI efforts and business operations.

In addition, we continue to monitor an active regulatory landscape, including the increasing legal and regulatory headwinds in the EU that could significantly impact our business and our financial results. For example, we continue to engage with the European Commission on our Less Personalized Ads offering or LPA, which we introduced in November 2024 and based on feedback from the European Commission in connection with the DMA.

As the commission provides further feedback on LPA, we cannot rule out that it may seek to impose further modifications to it that would result in a materially worse user and advertiser experience. This could have a significant negative impact on our European revenue as early as later this quarter. We have appealed the European Commission's DMA decision, but any modifications to our model may be imposed during the appeal process.

Question-and-Answer Session

AI strategy

And I think it's one of the interesting challenges in running a business like this now is there's just a very high chance it seems like the world is going to look pretty different in a few years from now. And on the one hand, there are all these things that we can do, there are improvements to our core products that exist.

And then I think we have this principle that we believe in across the company, which we tell people take superintelligence seriously. And the basic principle is this idea that we think that this is going to really shape all of our systems sooner rather than later, not necessarily on the trajectory of a quarter or 2, but on the trajectory of a few years. And I think that that's just going to change a lot of the assumptions around how different things work across the company.

So anyway, I think it's basically just what we're continually observing, how this works and what the trajectory or the pace of AI progress has been. I think it continues to be on the faster end. And that I think informs a lot of the decisions from everything from the importance and value of having the absolute best and most elite talent-dense team at the company to making sure that we have a leading compute fleet so that the people here can do, the researchers here have more compute per person to be able to lead their research and then roll it out to billions of people across our products, making sure that we build and drive these products through all of the different things that we do, which I think is one of the things that our company is the best in the world at is basically when we take a technology, we're good at driving that through all of our apps and our ad systems and all that stuff, it's not just going to kind of sit on the vine.

I think that there's no other company, I think that is as good as us at kind of taking something and kind of getting it in front of billions of people. So yes, I mean, we're just going to push very aggressively on all of that. But at some level, yes, this is -- there's sort of a bet in the trajectory that we're seeing and those are the signals that we're seeing. But we're just trying to read it.

Opex Capex

So thinking about next year, there are clearly many, many moving pieces in a very dynamic operating environment. But there are certain aspects that we have some visibility into today, including the rough shape of our 2026 infrastructure plans. And that flows through into our expense expectations next year. And we also have some visibility into the compensation expense growth that we'll recognize from the AI talent that we're hiring this year. And so those two things are part of why we gave a little bit of an early preview into the expectations for growth for 2026 total expenses as well as for 2026 CapEx.

We also expect a greater mix of our CapEx to be in shorter-lived assets in 2025 and '26 than it has been in prior years.

On the CapEx side, the big driver of our increased CapEx in '26 will be scaling genAI capacity as we build out training capacity that's going to drive higher spend across servers, networking, data centres next year. We also expect that we're going to continue investing significantly in core AI in 2026.

AI research effort

In terms of the shape of the effort overall, I guess I've just gotten a little bit more convinced around the ability for small talent-dense teams to be the optimal configuration for driving frontier research. And it's a bit of a different setup than we have on our other world- class machine learning system.

So if you look at like what we do in Instagram or Facebook or our ad system, we can very productively have many hundreds or thousands of people basically working on improving those systems, and we have very well-developed systems for kind of individuals to run tests and be able to test a bunch of different things. You don't need every researcher there to have the whole system in their head. But I think for this -- for the leading research on superintelligence, you really want the smallest group that can hold the whole thing in their head, which drives, I think, some of the physics around the team size and how -- and the dynamics around how that works.

Core systems improvements

One is we're focused on making recommendations even more adaptive to what a person is engaging with during their session so that the recommendations we surface are the most relevant to what they're interested in at that moment. And we're making optimisations to help the best content from smaller creators break out by matching it to the right audiences sooner after it gets posted.

And we're also working on improving the ability for our systems to discover more diversified and niche interests for each person through interest exploration and learning explicit user preferences.

But we also have a lot of long-term bets in the hopper around areas like developing foundational models that will support recommendations across multiple services. Incorporating LLMs more deeply into our recommendation systems. And a big focus of this work is going to be on optimising the systems to make them more efficient. So that we can continue to scale up the capacity that we use for our recommendation systems without eroding the ROI that we deliver.

Open source

We've always open sourced some of our models and not open sourced everything that we've done. So I would expect that we will continue to produce and share leading open source models.

I also think that there are a couple of trends that are playing out. One is that we're getting models that are so big that they're just not practical for a lot of other people to use. So it's -- we would kind of wrestle with whether it's productive or helpful to share that or if that's really just primarily helping competitors or something like that. So I think that there's that concern. And then obviously, as you approach real superintelligence, I think there is a whole different set of safety concerns that I think we need to take very seriously.

ROI on Capex

So at present, we're not really thinking about external use cases on the infrastructure, but it's a good question.

On your second question, which is really around the sort of ROI on CapEx, there are a couple of things. So again, on the core AI side, we continue to see strong ROI. Our ability to measure that is quite good, and we feel sort of very good about the rigorous measurement and returns that we see there.

On the genAI side, we are clearly much, much earlier on the return curve and we don't expect that the genAI work is going to be a meaningful driver of revenue this year or next year. But we remain generally very optimistic about the monetization opportunities that will open up, and Mark spoke to them in his script, the sort of five pillars, so I won't repeat them here. And we think that over the medium- to long-term time frame, those are opportunities that are very adjacent and intuitive in terms of where our business is today, why they would be big opportunities for us and that there will be sort of big markets attached to each of them.

KPIs on AI evolution

Yes, in terms of what to look at, I mean, what I'm going to look at internally, the quality of the people on the teams, the quality of the models that we're producing, the rate of improvement of our other AI systems across the company and the extent to which the leading kind of foundation models that we're building contribute to improving all of the other AI systems and kind of everything that we're doing around the company.

Then I think you just get into our standard product and business playbook, which is translating that technology into new products, which will first scale to billions of people and then over time, we will monetize. But I think that there's going to be some lag in that, right? And that, I think, is kind of always the way that we work is, whether we're building some new social product or this, something like Meta AI or a new product around this, we're going to work on getting to leading scale, building the highest quality product, focused on that for a few years. And then once we're really confident in that position, then we'll focus on ramping up the business around it.

So it's -- I mean, going back to the last question a little bit, it's sort of when you compare this business to some of the cloud businesses, it's like we do have this delay where we focus on building research and then doing research and then ramping consumer products, and it often does take some period of time before we really are ramping up the business around it. I think that's kind of a known property of our business and the cycle around it.

But I guess, on the flip side, we believe that if you are building superintelligence, you should use all of your GPUs to make it so that you're serving your customers really well with that. And we think that there's going to be a much higher return than we can do by generating that directly, rather than just kind of renting or leasing out the infrastructure at other companies.

Glasses as Platform

I mean, I continue to think that glasses are basically going to be the ideal form factor for AI because you can let an AI see what you see throughout the day, hear what you hear, talk to you. Once you get a display in there, whether it's the kind of wide holographic field of view like we showed with Orion or just a smaller display that might be good for displaying some information, and that's also going to unlock a lot of value where you can just interact with an AI system throughout the day in this multimodal way. It can see the content around you, it can generate a UI for you, show you information and be helpful.

So I think that this is a pretty fundamental form factor. There are a lot of different versions of it. Right now, we're building ones that I think are stylish, but aren't focused on the display. I think there's a whole set of different things to explore with displays. This is kind of what we've been maxing out with Reality Labs over the last 5 to 10 years is basically doing the research on all of these different things.The other thing that's awesome about glasses is, they are going to be the ideal way to blend the physical and digital worlds together. So the whole metaverse vision, I think, is going to end up being extremely important, too, and AI is going to accelerate that, too.

It -- just that if you'd asked me 5 years ago, whether we'd have kind of holograms that created immersive experiences or superintelligence first, I think most people would have thought that you'd get the holograms first. And it's this interesting kind of quirk of the tech industry that I think we're going to end up having really strong AI first. But because we've been investing in this, I think we're just several years ahead on building out glasses. And I think that that's something that we're excited to keep on investing in heavily because I think it's going to be a really important part of the future.