Meta’s move into cloud excites Wall Street despite falling margins

meta CEO Mark Zuckerberg appears willing to make big bets on a potentially large market that is far less profitable than the company’s dominant online advertising business.

Cloud infrastructure is proving very lucrative for hyperscalers Amazon, microsoft and googleAnd Zuckerberg has hinted recently that the meta could be headed in that direction. On Wednesday, CNBC’s Jim Cramer confirmed that Meta will sell excess computing power to outside customers. According to Bloomberg, the company is considering whether to offer access to AI models hosted on its infrastructure or sell access to raw computing power.

Wall Street welcomed the news. After the slump of the past year, meta The stock started the third quarter strong, rising 9% on Wednesday, its steepest rise in more than five months. Investors have been exploring whether Meta can diversify its business and monetize hundreds of billions of dollars in investments in advanced data centers and artificial intelligence infrastructure.

“It’s part of the company’s roadmap to turn this into a revenue stream,” said Karan Ramchandani, managing director at advisory firm Post Oak Group. “It seems like a no-brainer to compete in the market and sell computing power to other B2B players.”

At Meta’s annual shareholder meeting in May, Zuckerberg said a potential cloud computing business was “definitely on the table.” And on an earnings call seven months ago, Zuckerberg said companies routinely “ask us, is there any computing we can buy at some premium over what we’re buying it for?”

Just before Wednesday’s rally, Meta’s stock ended four consecutive quarters of decline, losing nearly a quarter of its value over that period. In April, Meta increased the cap on its 2026 capital spending outlook by $10 billion to $145 billion. Part of that is financed with debt, with the company raising $25 billion in bond sales just as it reported first-quarter results.

“I think this is a response to complaints that the company is spending too much and skepticism about whether Meta can get a return on its capital investment,” said Paul Meeks, head of technology research at Freedom Capital Markets, about Meta’s move into the cloud. “The problem with this company is that they’re only building their capabilities, or only building their capabilities right now, and they’re not actually monetizing their AI apps yet.”

Nearly all of Meta’s financial benefits from its AI spending to date have been realized in its core advertising business, which has dramatically improved targeting capabilities and provided marketers with a wider range of creative tools. Meta still derives 98% of its revenue from digital advertising.

Zuckerberg has been trying to change the narrative, with cloud perhaps his most ambitious new initiative. Meta shares rose nearly 4% in May when it announced two subscription services: the Meta AI app and website, as well as a variety of paid subscription plans for Instagram, Facebook, and WhatsApp.

Mehta declined to comment for this story.

As the generative AI boom approaches its fourth anniversary, cloud infrastructure has become an especially valuable commodity that few companies can afford to offer at scale. U.S. leaders are Amazon web services, microsoft with azure google The cloud has built massive business by allowing companies to offload their computing requirements.

Evercore analyst Mark Mahaney said Meta is unlikely to try to challenge these hyperscalers. Rather, Mahaney sees Meta following in the footsteps of the so-called neo-cloud: core weave and Neviusprovides access to AI-specific computing products such as: Nvidia chips and systems.

Shares of Coreweave and Nevius both fell by double digits on Wednesday following the meta report.

Mahaney said Mehta may have been motivated in part by the influence of Elon Musk. space x. The company that owns xAI recently signed deals to provide capacity to Google and Anthropic worth more than $2 billion in combined monthly revenue, as well as startup Reflection AI.

Brian Schechter, partner at Primary Venture Partners, also draws comparisons to SpaceX. He said the two companies are similar in that they have spent billions of dollars training large-scale AI models on their own infrastructure.

Schechter said both companies “failed to bring AI models to market that would have significant customer traction.” “Being able to monetize compute after not being able to perform training shows how compute acts like a commodity.”

What worries some investors is the potential hit to Meta’s profitability. Selling cloud services typically requires building a large enterprise sales and support team, and the profits cannot match the profits that Meta generates from advertising.

Meta’s gross margin of 82% is among the highest in the tech industry, and its operating margin was 41% in its most recent quarter. Google is giving us a glimpse of what’s to come.

Google’s services business, which makes most of its money from advertising, had an operating margin of 42% in the first quarter, while its cloud business had an 18% operating margin. It took years just to get there. The company started its cloud infrastructure business in 2008 and became generally available in 2011. In 2020, Google began disclosing financial information, but was unable to record a profit until the first quarter of 2023.

Meeks said that while Meta “probably has one of the brightest business models in the tech industry,” any move beyond online advertising “will dilute the business and make it less profitable than it was in its glory days.”

“As Meta shareholders, we would like to see Meta continue with its open model and monetize its AI through products and services at much higher margins than to get into a heated battle to build data centers in places like North Dakota,” Meeks said.

WATCH: The meta of building a cloud business is “a very smart pivot,” says Evercore ISI’s Mark Mahaney.