♾ Meta: AI now, Metaverse later
♾ Meta: AI now, Metaverse later
AI boosted engagement ahead of the "Year of Efficiency"
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Meta Platforms (META), the artist formerly known as Facebook, reported its Q4 FY22 earnings report.
Despite declining revenue and margins, the stock soared 25%. So let’s review what’s happening here.
Today, we’ll cover the following:
Meta Q4 FY22.
Recent business highlights.
Key quotes from the earnings call.
What to watch looking forward.
“The reports of my death are greatly exaggerated.” ~ Mark Twain
It’s hard not to think about this quote while listening to Meta’s Q4 FY22 earnings call and reviewing the numbers.
CEO Mark Zuckerberge’s explained in his prepared remarks:
“I said last quarter that I thought our product trends look better than most of the commentary out there suggests. I think that's even more the case now.”
Users are still growing, but the core advertising business has slowed down in a challenging macro environment. Since Apple (AAPL) allowed users to block the IDFA (identifier for advertisers), Meta has lost billion in ad monetization.
Meanwhile, the company continues to invest heavily in its Metaverse initiative.
Three months ago, Altimeter Capital CEO Brad Gerstner (whose fund owns 2 million META shares) wrote an open letter urging Meta to:
Cut headcount expenses by 20%.
Reduce annual capex (currently $30B) by at least $5 billion.
Keep Metaverse / Reality Labs spending under $5 billion per year.
While Reality Labs will expand its losses in FY23, it appears management took note of the first two requests with an extensive restructuring plan affecting its workforce and capital expenditures.
Before we start, here is a reminder of the key metrics and their meaning.
Meta has two business segments:
Family of Apps (FoA): Facebook, Instagram, Messenger, and Whatsapp.
Reality Labs (RL): Virtual reality hardware and supporting software.
About 97% of Meta’s revenue comes from advertising.
You get the revenue by multiplying two things:
The number of users.
The average revenue per user.
Revenue increases when more users see more ads (or ads at a higher price).
Simple, right?
It gets a bit technical if we look at the detailed metrics.
Facebook metrics include only Facebook and Messenger:
Daily active users (DAUs).
Monthly active users (MAUs).
Average revenue per user (ARPU).
Family metrics include users who visited at least one of the apps in the Family segment:
Daily active people (DAPs).
Monthly active people (MAPs).
Average revenue per person (ARPP).
Family metrics represent the company’s estimate of the number of unique people using at least one of the apps without double-counting.
1. Meta Q4 FY22
Key metrics:
Family DAP grew +5% Y/Y to 2.96 billion (+0.03B Q/Q).
Family MAP grew +4% Y/Y to 3.74 billion (+0.03B Q/Q).
Facebook DAUs grew +4% Y/Y to 2.00 billion (+0.02B Q/Q).
Facebook MAUs grew +2% Y/Y to 2.96 billion (+0.00B Q/Q).
Ad impressions grew +23% Y/Y (an acceleration from +17% in Q3).
Average price per ad declined -22% Y/Y.
Income statement:
Here is a bird’s-eye view of the income statement.
Revenue declined -4% Y/Y to $32.2 billion ($480 million beat).
FoA revenue declined -4% Y/Y to $31.4 billion.
RL revenue declined -17% Y/Y to $0.7 billion.
Gross margin was 74% (-6pp Y/Y).
Operating margin was 20% (-17pp Y/Y, flat Q/Q).
FoA operating profit was $10.7 billion (34% margin, -14pp Y/Y).
RL operating loss was $4.3 billion (vs. a $3.7 billion loss in Q3 FY22).
EPS declined -52% Y/Y to $1.76 ($0.48 miss).
Meta announced it would lay off approximately 11,000 employees and canceled multiple data center projects. As a result, restructuring charges were $4.2 billion in Q4 FY22.
Cash flow:
Operating cash flow was $14.5 billion (45% margin, -9pp Y/Y).
Free cash flow was $5.3 billion (16% margin, -21pp Y/Y).
Balance sheet:
Cash, cash equivalent, and marketable securities: $40.7 billion.
Long-term debt: $9.9 billion (plus $15.3 billion in operating lease liabilities).
Guidance:
Q1 FY23 revenue from $26-$28.5 billion (in line with the $27.3 billion expected). That’s -2% Y/Y in the mid-range, or flat on a constant currency basis.
Total expenses in FY23 are expected to be $89-$95 billion (vs. $94-$100 billion previously) thanks to the restructuring.
So what to make of all this?
User metrics were healthy. Even the legacy Facebook app saw an uptick in users sequentially and reached 2 billion DAU for the first time.
The macro environment is challenging for advertisers. So headwinds on monetization were not surprising. Average price per ad dropped by 22% Y/Y. For comparison, Snap (SNAP) saw its Average Revenue per User decline by 15% Y/Y.
Engagement remains strong, with ad impressions growing by +23% across FoA (compared to +17% Y/Y in Q3 FY22). Despite the rise of TikTok and other platforms, users spend more time on Meta’s apps on average and see more ads.
The strong dollar generated a 6 percentage point headwind, making the growth number artificially muted. The growth in constant currency was +2% Y/Y and is a better representation of the business performance.
Reality Labs lost $4.3 billion in Q4 and $13.7 billion in FY22. These losses will expand in FY23.
Restructuring charges ($4.2 billion) were the main reason behind the margin compression. Excluding them:
The gross margin would have been 5% higher.
The operating margin would have been 13% higher.
Q1 FY23 Guidance was flat Y/Y fx neutral and in line with expectations. Revenue could reach as high as $28.5 billion in Q1 FY23, an improvement to Q1 FY21’s $26.2 billion (before Apple’s new privacy measures significantly diminished Meta’s ad revenue per impression).
Is the business sustainable?
Wall Street analysts have been predicting the death of Facebook for many years now, with the rise of new social apps. And maybe they’ll eventually be right.
But not today.
The balance sheet has $41 billion in cash and less than $10 billion in long-term debt.
Meta is printing money, but the margin of safety has dwindled. The company generated $18.4 billion in free cash flow in FY22 (-52% Y/Y).
The bear case is that revenue will collapse if network effects start working against the company (with users leaving Meta’s ecosystem for new shiny social platforms).
So the question is whether the company can maintain relevancy and keep engaging its nearly 3 billion daily users.
Meanwhile, Mark Zuckerberg can afford to push on his Metaverse bet without putting the company's future at risk. But even if successful, Reality Labs could need years before the segment becomes cash-flow accretive.
There are many moving pieces, and the path forward is not as easy as the trailing financial metrics suggest.
2. Recent business highlights.
There are two primary areas of focus for management:
AI today:
AI discovery: Meta wants to serve highly relevant ads to its users. The AI powering Reels (short videos) is one of the main priorities. Facebook and Instagram are shifting toward recommended content a la TikTok.
Ad monetization: Reels plays have more than doubled in the past year. Zuckerberg highlighted the challenge of improving the monetization efficiency of Reels (which is less than feed). Reels are a relatively new feature, and their monetization hasn’t reached its full potential. The format is less suitable for ad conversion. The paradox of Reels is that their success takes some time away from feed and lowers the ad revenue per impression as a result. AI plays a crucial role in boosting conversion for advertisers, which improves returns on ad spend and should benefit the ecosystem over time.
Messaging apps (Messenger, WhatsApp) are still under-monetized:
Click-to-message ads are online ads where users can directly message a business through an ad instead of being redirected to a website or landing page. These ads have a $10 billion run rate (about 9% of overall revenue).
Paid messaging refers to a business paying to send messages directly to users through a messaging platform. It is often used as a form of customer engagement, providing customer support, or selling directly in chat.
Generative AI: A natural evolution of the recommendation AI will be for Meta to generate content rather than simply recognizing or classifying content. The goal? Making creators more productive and creative across the apps. Generative AI is expensive, so the company must find a scalable model.
The Metaverse tomorrow:
Hardware: Virtual Reality headset Meta Quest Pro launched at the end of 2022 and was well received despite its $1,499 price. A next-generation headset will launch later in 2023. And it’s not only about VR. Meta wants to deliver first-class Mixed Reality (MR), where you can move around and interact with people and objects in your physical space while enjoying virtual content. The company announced the Meta Reality system, with applications beyond gaming, such as 3D modeling, drug development, architecture, or interior design. AR glasses are also on the horizon.
Ecosystem: Over 200 apps on Meta’s VR devices generated over $1 million. It remains to be seen if users will embrace this vision of the future of work and play. Apple is rumored to join the fray with a mixed-reality headset later this year, which could be another iPhone moment for MR. But going back to Meta, Reality Labs remains a long shot that could be many years away from turning a profit.
3. Key quotes from the earnings call
During the earnings call, AI and Efficiency were said 33 times. 👀
CEO Mark Zuckerberg commented on the all-time high reach of FoA:
“We reach more than 3.7 billion people monthly across our family of apps. On Facebook, we now reach 2 billion daily actives and almost 3 billion monthly. The number of people daily using Facebook, Instagram and WhatsApp is the highest it's ever been.”
On the theme of 2023:
“I want to discuss my management theme for 2023, which is the "year of efficiency". We closed last year with some difficult layoffs and restructuring some teams. When we did this, I said clearly that this was the beginning of our focus on efficiency and not the end. Since then, we've taken some additional steps like working with our infrastructure team on how to deliver our roadmap while spending less on capex. Next, we're working on flattening our org structure and removing some layers of middle management to make decisions faster, as well as deploying AI tools to help our engineers be more productive. As part of this, we’re going to be more proactive about cutting projects that aren't performing or may no longer be as crucial, but my main focus is on increasing the efficiency of how we execute our top priorities.”
At a recent all-hands meeting, he said: “I don’t think you want a management structure that’s just managers managing managers, managing managers, managing managers, managing the people who are doing the work,” according to The Verge. So this new org structure fits the bill.
On ad performance:
“In the last quarter, advertisers saw over 20% more conversions than in the year before. And combined with a declining cost per acquisition, this has resulted in higher returns on ad spend.”
This is critical in the bull case. Since Apple's changes to its Identifier for Advertisers (IDFA) system in April 2021, Meta lives in a world where advertisers have less data available, and users have more control over their data and privacy. So the company needs to demonstrate it can still create high returns on ad spend.
CFO Susan Li on stock buybacks:
“In the fourth quarter we repurchased $6.9 billion of our Class A common stock, bringing our total share repurchases for the full year to $27.9 billion. We had $10.9 billion remaining on our prior authorization as of December 31st and today we announced a $40 billion increase in our stock repurchase authorization.”
So far, the stock buybacks have not been the best capital allocation, but time will tell.
On the expense outlook for 2023:
“We anticipate our full-year 2023 total expenses will be in the range of $89-95 billion, lowered from our prior outlook of $94-100 billion due to slower anticipated growth in payroll expenses and cost of revenue. […] We expect capital expenditures to be in the range of $30-33 billion, lowered from our prior estimate of $34-37 billion. The reduced outlook reflects our updated plans for lower data center construction spend in 2023 as we shift to a new data center architecture that is more cost efficient and can support both AI and non-AI workloads.”
So that’s $10 billion of expenses ($5 billion of opex and $5 billion of capex) that vanished from the FY23 outlook. As a result, free cash flow is about to get a boost.
On the gap between Reels and feed monetization:
“We are still roughly on track to bring the overall Reels revenue headwind to a neutral place by the end of this year or early next year, and we're planning to do that through both improving Reels monetization efficiency and growing incremental engagement from Reels.”
So the missed revenue opportunity due to Reels taking away from the feed should be net neutral by the end of FY23.
Zuckerberg on future investment in Reality Labs over time:
“None of the signals that I've seen so far suggests that we should shift the Reality Labs strategy long term.”
So continue to expect investments in RL for the foreseeable future, starting with increasing losses in FY23.
4. What to watch looking forward
Here are a few things I’ll be watching:
Reality Labs’ losses will expand next year, but could we see a strategic shift?
Can Family DAP and MAP continue to grow?
Will ad revenue per impression stabilize in FY23 as expected?
Can click-to-messaging continue its rapid growth?
M&A could be back into play after a federal judge ruled Meta can buy virtual reality startup Within Unlimited. More to come?
Will we see more streamlining with additional layoffs?
Brad Gerstner provided an interview update last night where he said:
“When you compress the layers in an organization, you get to more productivity and that’s what this is about. The next five to ten years they are one of the best-positioned companies to capitalize on this move to AI.”
It’s hard to believe sentiment has moved so swiftly, but here we are.
META (the stock) has more than doubled since November.
What a difference a quarter makes.
That’s it for today!
Stay healthy and invest on!
Disclosure: I am long AAPL and META in the App Economy Portfolio. I share my META rating with App Economy Portfolio members here.
Can you share Samsung and Xiaomi income statement
First off, great breakdown as always. i love the visuals you use to illustrate each business segment and how they all make up the total. I have been a verbal opponent of Facebook (legacy platform) since its inception. I never ascribed to its model, so I never gave them my personal information, or pictures of myself (willingly - other people posted them and Facebook refused to even consider my privacy request of having them taken down).
Meta's billions invested into the "metaverse" is burned money. I have not seen a single viable model for a Metaverse that does not solely sell space to advertising from corporations. It makes sense why Meta wants in on this opportunity, but their Horizon worlds and latest example of their virtual conference room software is...crude to say the least and isn't serious in my opinion.