😬 AI's awkward earnings season

Last week was a rough one for the AI trade. 

Going into this earnings season, investors were looking for signs that Big Tech would either bring AI costs down or prove that its AI products are generating enough revenue to justify the price tag. For the most part, they’re still waiting. 

Here is a rundown of the updates we got from Big Tech this earnings season: 

• Meta will spend more than expected but its core business is still strong. The company, which was the first of its peers to report earnings, told investors it would spend even more aggressively on AI and created a new class of nonvoting stock that could ultimately be used to help pay for it. The good news: advertising revenue came in right above Wall Street estimates. 

• Google’s core search business showed some signs of cracking, leading to the stocks’ worst day ever. The company's AI search summaries may be cannibalizing its main advertising business as users interact with fewer traditional search ads. The company missed revenue estimates and posted negative free cash flow for the second consecutive quarter, after doing so for the first time in its history earlier this year. The good news: its cloud business is booming and capex came in below estimates.

• Google’s AI overviews are also losing money for other companies that depend on traffic. Reddit, for one, said that traffic from Google fell significantly in the quarter due to the “shift to AI mode and AI overviews.”

• How Google will manage to fix this is a mystery, as it’s a nuanced problem that requires balancing the needs of the AI rollout with the — oh, wait, spoke too soon, as early as Friday people were reporting that they were no longer seeing AI Mode turned on by default. It’s one thing to be expensive, we suppose, but quite another to be both expensive and costing the company revenue too.  

• Amazon’s core e-commerce business is also slowing, while its spending accelerates. The company's quarterly revenue and earnings missed estimates, while its capex and negative free cash flow came in above expectations — a deadly combo for the stock in this environment. 

• Microsoft ended the week relatively scot-free. The company reported soaring cloud revenue and capex below expectations, exactly the combination investors were looking for going into the week. Separately, the company said it would offer buyouts to 60,000 employees, about a quarter of its workforce, in a cost-cutting campaign.

• A lot of this capex spending is going toward memory chips, which has driven up the price of the critical component to personal computers. Intel’s sales took a hit this past quarter because PC-makers, its largest customer base, are cutting production as memory costs soar. While Intel has benefited from AI demand for its data center chips, it appears the customers for its side-gig are interfering with the supply chain for its main revenue driver. 

The Takeaway: 

Meta, Google, Microsoft and Amazon have spent a combined $1.28 trillion dollars on capex since ChatGPT was made public in Q4 2022. 

At first, these companies were applauded by the stock market when that metric went up, seeing it as both proof that they were staying on the cutting edge and as a promise of future demand. But as that number keeps swelling, cash-flows go negative, and AI revenue underwhelms, investors are rethinking the massive valuations they’ve given these companies in recent years. 

And there may not be any going back from here. With billions already sunk into AI infrastructure and competitors racing to build even more, cutting back could mean falling behind. Spending too little could risk losing the AI race, though it's increasingly unclear if there’s a prize at the finish line. 

— J. Edward Moreno

– Thomas Jones

• 🏈 NFL: Tonight the Chicago Bears face the Seattle Seahawks in a major NFC faceoff, with Seattle the 63% favorite to win. 

• 📊 Senate Check In: On the eve of election day, Democrats are now a 70% chance to win the Senate. Democrats must flip four seats and hold all their current ones to take the Senate. Current state-by-state chances of a Dem flip: North Carolina (95%), Alaska (71%), Texas (72%), Maine (69%), Ohio (72%) and Iowa (43%).  

*Event contracts are offered through Robinhood Derivatives, LLC — probabilities referenced or sourced from KalshiEx LLC, ForecastEX, LLC or Rothera Exchange and Clearing LLC.

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