Free cash flow plummets 91%, how expensive is Meta's AI bet?

Original Author: Li Hailun

Original Editor: Xu Qingyang

Original Source: Tencent Technology

Meta's second-quarter revenue surged thanks to AI-driven advertising, but profit declined due to litigation costs, layoffs, and computing power expenses.

On July 29, US local time, Facebook parent company Meta Platforms released its Q2 2026 financial report for the period ending June 30, after the US stock market closed.

The financial report shows that Meta's total revenue for the quarter reached $60.801 billion, a year-over-year increase of 28%. However, dragged down by one-time expenses such as legal litigation provisions, organizational restructuring severance costs, and surging computing power expenditures, net profit fell 14% year-over-year to $15.848 billion, with diluted earnings per share of $6.18.

Market sentiment quickly turned cold after Meta's earnings release. As earnings per share fell short of Wall Street expectations and the midpoint of Q3 revenue guidance was $62.5 billion, slightly below the average Wall Street estimate of $63.1 billion, Meta's stock price fell over 6.37% in after-hours trading, dropping to $548.30. Prior to the earnings release, Meta's stock had already declined for 10 consecutive trading days, erasing about 13% of its market value since July 15.

As tech giants compete fiercely in the AI endgame, with open-source large models, agent ecosystems, and computing power infrastructure construction entering deep waters, Wall Street's scrutiny of "AI return on investment (ROI)" is becoming unprecedentedly direct and stringent.

The strong revenue growth and cold market reaction reveal investors' deeper concerns about underlying business growth: against the backdrop of surging AI infrastructure investment, can Meta's robust digital advertising base support the pressure from trillion-dollar computing power expenditures and the sharp decline in free cash flow?

AI Drives Ad Growth, Reality Labs Still Bleeding Cash

Looking at specific business segments, Meta's core business in this quarter presented a pattern of "a strong advertising base providing support, and Reality Labs seeing revenue recovery but expanding losses."

The "Family of Apps" segment, which is the core cash flow source for the group and includes social platforms like Facebook, Instagram, WhatsApp, and Threads, performed stably. In June 2026, the Daily Active People (DAP) across the family of apps averaged 3.60 billion, a 3% increase year-over-year. Among them, Instagram's daily active users officially surpassed the 2 billion mark in Q2, and Threads reached 500 million monthly active users (MAU).

In Q2, Meta's advertising business saw both volume and price increase: ad impressions grew 14% year-over-year, while the average price per ad rose 12% year-over-year. Commenting on this performance, Meta founder and CEO Mark Zuckerberg stated in the earnings release, "AI is accelerating our core business today, driving our next-generation products, and opening up entirely new enterprise opportunities. The financial results are starting to show, and I'm optimistic about the potential ahead."

CNBC analysis suggests that despite macroeconomic uncertainties, the AI-algorithm-refined ad targeting system (such as Advantage+) is continuously improving conversion efficiency, providing Meta with a stable cash flow foundation.

For the Reality Labs division, responsible for the metaverse and smart hardware, Q2 revenue reached $431 million, higher than $370 million in the same period last year and exceeding analyst expectations of $423.4 million. The quarterly operating loss was $4.620 billion, widening from $4.53 billion in the same period last year but better than the analyst estimate of a $5.07 billion loss.

Since 2021, Reality Labs has accumulated approximately $85.6 billion in operating losses. Currently, the division's business focus is primarily on the Ray-Ban Meta smart glasses developed in partnership with EssilorLuxottica. With new frame styles and AI features, Meta is attempting to turn this product into a hardware terminal for its personal AI assistant.

Surge in Computing Power Investment, Meta's Free Cash Flow Plummets 91%

Analyzing the total costs and expenses of $42.026 billion in Q2 (up 55% year-over-year), the increase is primarily driven by two main lines: rigid investment in infrastructure and the provision of non-operating one-time expenses.

In terms of R&D and hardware construction, Meta's R&D expenditure in Q2 increased by 67% year-over-year, reaching $21.7 billion. Meta is accelerating its data center deployment globally.

Meta also announced a joint venture with BlackRock to build a data center in El Paso, Texas, with a total development cost of approximately $14 billion. The investment scale for the data center expansion in Louisiana could exceed $50 billion. The company also plans to invest over C$13 billion to build its first data center in Alberta, Canada.

In addition to computing power investment, the Q2 income statement also included $3.58 billion in one-time non-operating expenses, which was the main reason dragging down earnings per share below expectations. Of this, $2.40 billion was related to legal litigation costs arising from regulatory scrutiny regarding the use of social media platforms by teenagers and its impact on mental health. The Wall Street Journal noted that since multiple lawsuits are scheduled to go to trial in the US this year, ongoing losses may follow.

Another $1.18 billion was for employee severance costs related to the restructuring of approximately 8,000 people initiated in May 2026. As of June 30, Meta had 75,472 employees globally, a 1% decrease year-over-year.

Meta's Chief Financial Officer Susan Li explained during the conference call that excluding the $2.4 billion litigation provision and the $1.18 billion severance costs, Meta's Q2 operating profit would have achieved approximately 9% year-over-year growth, instead of the reported 8% decline.

However, the indicator that most alarmed the capital market was the shrinking free cash flow. Operating cash flow for Q2 was $31.86 billion, but after deducting a massive $31.08 billion in quarterly capital expenditures, free cash flow plummeted from $8.55 billion in the same period last year to $784 million, a year-over-year decline of 91%.

The pressure on free cash flow is not unique to Meta but is a common reality for the entire tech giant group amidst the AI arms race. For instance, Google's parent company Alphabet saw its quarterly capital expenditures surge to $44.9 billion, directly causing its free cash flow to turn negative for the first time in history.

Ryan Lee, Senior Vice President of Products and Strategy at Direxion, pointed out in an interview that while Meta did not slip into negative free cash flow, the drop below $1 billion in free cash flow is still noteworthy, reflecting the company's current massive cash consumption rate.

Zuckerberg Seeks New AI Outlets: Personal Agents and Enterprise Services

In the view of analysts, Meta's business model differs from its competitors who have cloud service systems. Microsoft has Azure, Google has Google Cloud, Amazon has AWS—all can use their cloud computing businesses to sell computing power directly to external enterprises. Meta, lacking a large-scale native cloud business, relies primarily on revenue from its advertising business to support its AI capital expenditure.

To address this, Meta is attempting to adjust its AI layout and commercialization strategy.

In early July, Meta launched the Muse Spark 1.1 model. This is a significant product following Meta's $14.3 billion investment in June 2025 and bringing in Scale AI founder Alexandr Wang to lead the technical team. It focuses on agents and code generation, with pricing lower than comparable products from OpenAI and Anthropic. However, the Muse Image feature launched during this period faced scrutiny for generating images using Instagram public accounts and has since been suspended.

Regarding the subsequent application of the massive infrastructure, Zuckerberg outlined his clear vision to analysts during the earnings call. He explicitly stated that the vast majority of computing power the company acquires will be prioritized for training next-generation large models, optimizing core advertising business drivers, and delivering personal agents and new products to users, while also anticipating building the capability to serve large enterprise customers.

Just one day before the earnings release, Zuckerberg also published an op-ed in the Wall Street Journal and gave an exclusive interview. He explicitly stated that powerful AI tools should be widely available and benefit the entire society, opposing the monopolization of AI power by a few closed-source institutions. He re-emphasized Meta's core vision: striving to deliver "Personal Superintelligence" to every ordinary user, thereby seeking broader technological and commercial justification for its high capital expenditure.

Capital Expenditure Guidance Raised, Q3 Growth to Slow

Regarding future performance outlook, Meta's financial guidance was cautious, which was also the main reason for the pressure on its stock price after hours.

For Q3 2026, the company expects total revenue to be between $61.0 billion and $64.0 billion (assuming approximately 1% negative impact from foreign exchange). The midpoint of this guidance is $62.5 billion, lower than the average analyst estimate of $63.15 billion to $63.24 billion. Some foreign media analysis suggests that this implies the Q3 revenue growth rate will slow down from 28% in Q2 to a range of 19% to 25%, raising market concerns about slowing ad revenue growth and the cycle for realizing AI returns.

In terms of expenditure guidance, Meta further raised its investment baseline. The company adjusted its full-year 2026 capital expenditure guidance range from the previous $125 billion to $145 billion to $130 billion to $145 billion, raising the lower limit of the full-year capex guidance by $5 billion.

Considering the $2.4 billion legal litigation costs confirmed in Q2, the lower limit of the full-year total expense guidance was raised to $165 billion to $169 billion. The effective tax rate for the second half of the year is estimated to be between 15% and 17%. However, the company explicitly stated that it continues to expect operating income for the current year to surpass the 2025 level.

Meta's Q2 financial report reflects the realities the company faces during its AI transformation: the core advertising business base remains solid, providing cash flow for cutting-edge exploration. However, on the other hand, the extremely high capital requirements for AI infrastructure like data centers and GPU procurement significantly squeeze free cash flow, while one-off legal and restructuring costs dragged down current profits.

For the capital market and investors, the key to observing Meta going forward lies in whether its annual, hundred-billion-dollar hardware infrastructure investment can penetrate the enterprise service segment through the Muse series of large models, achieve high-rent computing power, and quickly translate into commercializable output.

On the Q2 earnings call, Zuckerberg emphasized that although earnings per share were below expectations due to legal-related costs and significant investment in AI computing power and talent this quarter, the company's revenue surged 28% year-over-year to $60.8 billion, demonstrating strong underlying business vitality.

Zuckerberg stated that AI technology has fully accelerated its core advertising and recommendation algorithm systems and driven the launch of new product lines like personal and enterprise AI agents. Addressing market concerns about capital expenditure growth, he reiterated Meta's goal is "to put superintelligence directly into everyone's hands" and emphasized that against the backdrop of AI computing power shortage, its full-stack self-development and forward-looking infrastructure construction plan will create irreplaceable long-term competitive barriers and high returns for the company.

Special thanks to contract translator Wuji for contributing to this article.