Meta makes a big move into defense. Here's how it could start to matter for investors

CNBC

2 days ago

Meta's expensive bet on virtual and augmented reality technology is making its way to the Pentagon. Investors who have been worried about when all that spending will pay off should feel a little bit better now. Meta announced Thursday that it is partnering with defense-technology company Anduril to create VR and AR devices such as headsets for the U.S. Army — and the news piqued our interest for a few reasons. For starters, the privately held Anduril was started by none other than Palmer Luckey, the founder of Oculus, which Meta acquired in 2014 for $2 billion to kickstart its ambitions in the world of VR technology. Luckey had an acrimonious split with the company then known as Facebook in 2017, but now they're back on working terms. But, as investors, the main reason to care is that working with Anduril could be a boon for Meta's Reality Labs division — home to its VR and AR teams, along with CEO Mark Zuckerberg's "metaverse" ambitions more broadly. Reality Labs has racked up cumulative operating losses north of $60 billion since late 2020, including a hefty $4.2 billion loss in the company's first quarter. In recent years, Wall Street has generally given Meta a pass on the Reality Labs losses — the stock is up more than 430% since the start of 2023. To be sure, that follows a brutal 2022 in which Meta shares lost nearly two-thirds of their value, driven in part by investor concerns about Zuckerberg's aggressive spending. But since then, the market has largely glossed over the Reality Labs losses thanks to Zuckerberg's intense focus on efficiency across the entire company, including steep job cuts, and the strong performance of its core Facebook and Instagram businesses. At the same time, investors also have gained an improved understanding on where Zuckerberg's controversial metaverse vision fits into the grand scheme of things. While Zuckerberg's north star may still be some form of the metaverse — a virtual world where people hang out, play, and shop — there is a recognition that the technology needed to get us there is artificial intelligence. AI, of course, has very real-world applications today, and Meta is investing heavily in it. AI is already delivering improvements to its bread-and-butter advertising business through improved ad targeting. Meta's Reality Labs has picked up some smaller successes along the way, most notably the AI-infused smart glasses made in collaboration with Ray-Ban. But, as the first-quarter results showed, the glasses haven't led to a materially improved financial picture for that division. And because we've seen Wall Street grow anxious before over the Reality Labs losses, we wouldn't be surprised to see it happen again without a better understanding of its future. That's where teaming up with Anduril comes into play. The partnership revolves around the U.S. government's Integrated Visual Augmentation System (IVAS) contract. This 10-year, $22 billion contract was initially awarded to Club name Microsoft in 2021. In late 2024, Microsoft partnered with Anduril to incorporate the latter's "Lattice" operating system onto Microsoft's mixed reality HoloLens platform. Then, earlier this year, Microsoft opted to hand control of the contract over to Anduril, giving it "oversight of production, future development of hardware and software, and delivery timelines," according to a press release. In exchange, Microsoft's Azure became Anduril's preferred cloud-computing destination for all IVAS-related workloads and Anduril's AI technologies. Anduril has named its next-generation IVAS product EagleEye. We're not arguing that the Anduril partnership will be a financial needle mover in the near term. However, if the effort proves successful — and betting against either Zuckerberg or Luckey has never proven a good bet — it provides a pathway to generate a stable source of Reality Labs sales from the U.S. government, and that means operating losses in the division should improve, assuming expenses remain under control. The move should also help further diversify the company's overall revenue stream, which is almost entirely reliant on social media ads, in the years to come. While Meta has proven to still be a fantastic outlet for advertisers, revenue diversification in the era of AI is a good thing to see. Consumer behaviors are already evolving — consider the way hundreds of millions of people are turning to AI chatbots, threatening online ad competitor Alphabet's core internet search business — and who knows what other changes could be in store. At a higher level, Meta's work with Anduril points to a continued shift in the private company/government partnerships. Some Silicon Valley tech giants have historically been hesitant to contract with the U.S. military out of fear of retaliation from consumers, employees, or both. However, we are now seeing top U.S. tech companies become more open to government partnerships. Indeed, late last year, Meta said it made its Llama AI model " available to U.S. government agencies and contractors working on national security applications." Zuckerberg also has taken steps to improve his relationship with President Donald Trump. In an interview on the Core Memory podcast released shortly after Thursday's news became public, Luckey shared some interesting thoughts on how Anduril can leverage all the money that Meta has so far invested to build products like the Ray-Ban glasses and Quest headsets: "What we're doing is working with Meta to take the building blocks that they've invested enormous amounts of money and expertise in, and we're able to use those building blocks in EagleEye without having to recreate them ourselves. There's things that Anduril probably could do if we were willing to put billions of dollars of taxpayer money into it. I think we could convince the Army to give us a lot of money to recreate these things, but why would you do that when they've already been made? Why spend five years doing something when it's already been done in the consumer sector? ... They do have a lot of intellectual property and building blocks that they've built that are just as useful on the battlefield as they are on the head of any consumer." That's not to say that Meta is going to start developing military-grade hardware, but this does offer up an opportunity to further monetize its massive investment in research and development (R & D) by licensing out whatever consumer-grade hardware and software may be useful to Anduril as it looks to build out the final product. On the same podcast, Luckey said Anduril and Meta have already been working closely together for the better part of a year, relying entirely on private funding for the initiative during that time. This is particularly notable because it suggests that Meta does not need to ramp up hiring overnight to handle the work with Anduril, potentially adding expenses to Reality Labs. It's already been ongoing. Bottom line Meta's partnership with Anduril represents an encouraging — albeit incremental — move in addressing the large Reality Labs losses, which could fuel additional earnings growth for the company. Just how significant a contribution this effort becomes, of course, depends on Anduril's ability to make EagleEye a success with widespread U.S. military adoption. On the podcast, Luckey said Anduril's intent is to deliver first prototypes to the Army this year, "if all goes according to plan the way that I hope." So, as with the Ray-Ban glasses, we may not see the fruits of this effort on Meta's next earnings report or even the next few after that. But there is now a more clear path for Reality Labs to start pleasing skeptical investors. (Jim Cramer's Charitable Trust is long META and MSFT. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. 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