AI meets aggressive accounting at Meta’s gigantic new data center

That outcome looks too good to be true, and it probably is.

Indeed, it is quintessential structured finance—the point of which is to help companies try to achieve seemingly irreconcilable financial-reporting goals. Meta wants other people’s money to pay for the data center. Those investors want to know Meta ultimately has their backs. But at the same time, Meta wants to keep its near-pristine credit rating and doesn’t want the extra assets and debt on its books.

Construction on the project was well under way when Meta announced a new financing deal last month. Meta moved the project, called Hyperion, off its books into a new joint venture with investment manager Blue Owl Capital. Meta owns 20%, and funds managed by Blue Owl own the other 80%. Last month, a holding company called Beignet Investor, which owns the Blue Owl portion, sold a then-record $27.3 billion of bonds to investors, mostly to Pimco.

Meta said it won’t be consolidating the joint venture, meaning the venture’s assets and liabilities will remain off Meta’s balance sheet. Instead Meta will rent the data center for as long as 20 years, beginning in 2029. But it will start with a four-year lease term, with options to renew every four years.

This lease structure minimizes the lease liabilities and related assets Meta will recognize, and enables Meta to use “operating lease," rather than “finance lease," treatment. If Meta used the latter, it would look more like Meta owns the asset and is financing it with debt.

The favorable accounting outcome hinges on some convenient assumptions. Some appear implausible, while others are in tension with one another, making the off-balance-sheet treatment look questionable.

The joint venture is what is known in accounting parlance as a variable interest entity, or VIE for short. That term means the ownership doesn’t necessarily reflect which company controls it or has the most economic exposure. If Meta is the venture’s “primary beneficiary"—which is another accounting term of art—Meta is required to consolidate it.

Under the accounting rules, Meta is the primary beneficiary if two things are true. First, it must have “the power to direct the activities that most significantly impact the VIE’s economic performance." Second, it must have the obligation to absorb significant losses of the VIE, or the right to receive significant benefits from it.

On the first point, consider this: If Meta doesn’t have the power, who does? Meta is a hyperscaler. It knows how to run data centers. Blue Owl is a financier. Whether the venture succeeds economically will come down to Meta’s decisions, expertise and skill.

Blue Owl has control over the venture’s board. But voting rights and legal form aren’t determinative for these purposes. What counts under the accounting rules is Meta’s substantive power and economic influence. Meta in its disclosures said “we do not direct the activities that most significantly impact the venture’s economic performance." But the test under the accounting rules is whether Meta has the power to do so.

The second test—whether Meta has skin in the game economically—has an even clearer answer. Meta has operational control over the data center and its construction. It bears the risks of cost overruns and construction delays. Meta also has provided what is called a residual-value guarantee to cover bondholders for the full amount owed if Meta doesn’t renew its lease or terminates early.

That guarantee complicates the lease accounting as well. Under the accounting rules, Meta’s lease liabilities would have to include any renewals that are “reasonably certain." That is a high threshold and a judgment call. But there are factors that favor counting more than four years.

The guarantee mitigates the risk for bondholders, and provides an incentive for Meta to renew. If Meta walked away, and there wasn’t a new tenant to take over, the guarantee by Meta is supposed to be sufficient to cover the outstanding debt.

Another judgment call: Under the accounting rules, Meta would have to include the residual-value guarantee in its lease liabilities if the payments owed are “probable." That could be in tension with Meta’s assumption that the lease renewal isn’t “reasonably certain."

If renewal is uncertain, the guarantee is more likely to be triggered. But if the guarantee is triggered, Meta would have to recognize the liability.

Ultimately, the fact pattern Meta relies on to meet its conflicting objectives strains credibility. To believe Meta’s books, one must accept that Meta lacks the power to call the shots that matter most, that there’s reasonable doubt it will stay beyond four years, and that it probably won’t have to honor its guarantee—all at the same time.

Artificial intelligence, meet artificial accounting.

Write to Jonathan Weil at jonathan.weil@wsj.com