🧵 Meta: Threading the Needle
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🧵 Meta: Threading the Needle
AI accelerates growth, while Reality Labs gets a reality check
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Meta Platforms (META), the artist formerly known as Facebook, reported its Q2 FY23 earnings report with an impressive revenue growth acceleration.
META stock has now surged over +254% from its November 2022 lows. 👀
Founder-CEO Mark Zuckerberg discussed the various ways the company could benefit from AI with its Llama model and shared how he thinks about Reality Labs for the long term.
Today at a glance:
Meta Q2 FY23.
Recent business highlights.
Key quotes from the earnings call.
What to watch looking forward.
You've likely heard of Meta's new venture into microblogging with Instagram Threads. Meta's answer to Twitter reflects the company's unending pursuit of expansion in the social media landscape.
For a detailed exploration, check out our YouTube Channel, where we dissect Threads and its potential impact on Meta's financials and the broader industry. The real Zuck vs. Musk fight is already happening in the battle for our attention.
Before we begin, I know the numerous acronyms and metrics associated with Meta's business can be confusing. As a helpful reminder, here's a quick rundown of the key metrics and their meanings.
Meta has two business segments:
Family of Apps (FoA): Facebook, Instagram, Messenger, and Whatsapp.
Reality Labs (RL): Virtual reality hardware and supporting software.
About 99% of Meta’s revenue comes from FoA and advertising.
Meta’s advertising revenue comes from two elements:
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.
Let’s dive in!
1. Meta Q2 FY23
From user growth to revenue breakdowns, here's a look at the Q2 performance.
Key metrics:
Family DAP grew +7% Y/Y to 3.07 billion (+0.05B Q/Q).
Family MAP grew +6% Y/Y to 3.88 billion (+0.07B Q/Q).
Facebook DAUs grew +5% Y/Y to 2.06 billion (+0.02B Q/Q).
Facebook MAUs grew +3% Y/Y to 3.03 billion (+0.04B Q/Q).
Ad impressions grew +34% Y/Y (an acceleration from +26% Y/Y in Q1).
Average price per ad declined -16% Y/Y (vs. -17% Y/Y in Q1).
Income statement:
Here is a bird’s-eye view of the income statement.
Revenue grew +11% Y/Y to $32.0 billion ($1.2 billion beat).
FoA revenue grew +12% Y/Y to $31.7 billion.
RL revenue declined -39% Y/Y to $0.3 billion.
Gross margin was 81% (-1pp Y/Y).
Operating margin was 29% (+0pp Y/Y, +4pp Q/Q).
FoA operating profit was $13.1 billion (41% margin, +2pp Y/Y).
RL operating loss was $3.7 billion (vs. a $4.0 billion loss in Q1 FY23).
EPS grew +21% Y/Y to $2.98 ($0.05 beat).
Expenses included non-recurring items such as:
Legal expenses of $1.9 billion
Restructuring charges were $0.8 billion.
Cash flow:
Operating cash flow was $17.3 billion (54% margin, +12pp Y/Y).
Free cash flow was $11.0 billion (34% margin, +19pp Y/Y).
Balance sheet:
Cash, cash equivalent, and marketable securities: $53.5 billion.
Long-term debt: $18.4 billion.
Guidance:
Q3 FY23 revenue is forecasted to be $32-$34.5 billion ($2 billion ahead of consensus), or about +20% Y/Y in the mid-range, a significant acceleration.
Total expenses in FY23 are expected to be $88-$91 billion (vs. $86-90 billion previously) due to unexpected legal-related expenses recorded in Q2.
So what to make of all this?
User metrics were once again healthy. All metrics saw accelerating growth in users for a second consecutive quarter. Facebook added 27 million DAUs sequentially to its existing 2-billion-user base, indicating that user exodus has yet to materialize. Facebook is still adding more users than some of its competitors. For comparison, during the same quarter:
Snap reached 397 million DAUs (+14 million Q/Q).
Pinterest had 465 million MAUs (+2 million Q/Q).
Reels drove strong engagement, with ad impressions growing by +32% across FoA (compared to +26% Y/Y in Q1 FY23 and the fourth consecutive quarter of acceleration). Despite TikTok and other platforms gaining popularity, users spend more time on average using Meta's apps (and view more ads as a result).
The overall revenue per person grew +5% Y/Y to $8.32. So incremental engagement is leading to more revenue per user. This is particularly noteworthy when looking at other public companies in this space. For comparison in the same quarter:
Snap (SNAP) ARPU declined by 16% Y/Y to $2.69.
Pinterest (PINS) ARPU declined by 1% Y/Y to $1.53.
Reality Labs lost $7.7 billion in H1 FY23 and $13.7 billion in FY22. Management already forecasted these losses would expand in FY23 and FY24 (more on that in a minute).
The operating margin was flat despite non-recurring legal expenses ($1.9 billion) and restructuring charges ($0.8 billion). Excluding them, the operating margin would have increased by 8 percentage points.
Q3 FY23 Guidance was well ahead of expectations. The high-end of guidance is $34.5 billion in Q3 FY23, implying an +25% growth Y/Y. It’s partially explained by a weaker comp (Q3 FY22 saw revenue decline by 4.5% Y/Y with factors such as the first full quarter impacted by the war in Ukraine) and 3 percentage points of currency tailwinds. But the big driver is the success of Reels monetization.
Headcounts declined by 14% Y/Y and by 7% Q/Q to 71,469 in the “year of efficiency” with a leaner organization.
Stock buybacks were only $0.9 billion in Q2, compared to $9.22 billion in Q1, showing that META shares are not deemed as attractive now by management.
Is the business sustainable?
User growth and engagement are critical to Meta's ongoing success. The company has adapted to major shifts, from mobile transition to implementing Stories and now short video formats.
Despite predictions of Facebook's demise, the platform continues to add tens of millions of new users and could benefit from a potential TikTok ban in the US.
Meta has a robust balance sheet with nearly $54 billion in cash and $18 billion in long-term debt. Free cash flow was $18 billion in the first half of FY23 (+4% Y/Y). As a result, Zuckerberg can invest in initiatives like Reality Labs without jeopardizing the business.
The bear case is that revenue will collapse if network effects start working against the company (the more users leave Meta’s ecosystem, the less valuable it will become).
The challenge lies in maintaining relevance and engagement for nearly 3 billion daily users. With many moving parts, the road ahead is not as straightforward as past financial metrics might imply.
2. Recent business highlights.
Llama 2
In July, Meta released a commercial version of its open-source AI model Llama (short for Large Language Model Meta AI). The new version of the model is called Llama 2.
On open models, Zuckerberg explained:
“We view the model that we're building, sort of the foundation for building products. So by sharing it we can improve the quality of the model and improve the quality of the team that we have that is working on that. That’s a win for our business of basically building better products.”
Open-Source nature: Llama is an open-source project with the intent of building an ecosystem around it.
Community & recruitment: Open-source projects like Llama contribute to community standardization and recruitment appeal.
Community contributions: The community can add value in various ways:
Safety and security: More scrutiny in open-source leads to improved security.
Efficiency: Community contributions can make AI models more cost-efficient.
Partnership with Microsoft: Meta has partnered with Microsoft as it does not have a public-cloud offering.
Availability: The model will also be available through AWS, Hugging Face, and other providers.
Business arrangements: Large companies reselling services based on Llama will need to make a business arrangement with Meta.
Revenue potential: Business arrangements may not bring short-term revenue but have long-term revenue generation potential.
Overall strategy: The approach combines creating an open ecosystem with potential revenue from major tech companies that utilize open-source developments commercially.
Instagram Threads
We previously discussed the launch of Instagram Threads here. 👇
Threads reached 100 million downloads in the first five days, a success that caught Meta by surprise. Zuck explained:
“Thread is not a massive project. I thought for a while that the opportunity around public conversations and kind of a text-based product was bigger than what had been executed yet in the markets, so we had a relatively small team work on that.[…] Threads has been dramatically more than we expected. […] It really kind of blew up and created a big opportunity immediately.”
Zuckerberg acknowledged Threads’ promising start but emphasized there's still much work to do. He plans to build an engaging experience, fine-tune it for user retention, and then focus on growth.
“I'm quite optimistic about our trajectory here. We saw unprecedented growth out-of-the-gate. And more importantly, we're seeing more people coming back daily than I'd expected. And now we're focused on retention and improving the basics. And then after that, we'll focus on growing the community to the scale that we think is going to be possible. Only after that we are going to focus on monetization. We've run this playbook many times before with Facebook, Instagram, WhatsApp, Stories, Reels and more. And this is as good of a start as we could have hoped for. So I'm really happy with the path that we're on here.”
Threads needs enough functionality and hundreds of millions of users before monetization may be considered.
Meta Quest 3
The Quest 2 was initially released in October 2020 at $299 and $399, depending on the model. According to a report from The Verge earlier this year, Meta sold nearly 20 million Quest headsets to date (the vast majority being the Quest 2).
So the release of the Meta Quest 3 mixed reality headset at the end of September will be critical to watch. It’s 40% thinner and offers twice the graphics performance. While it will launch at a higher price ($499), it’s still far cheaper than the future Apple Vision Pro and its shocking $3,499 price tag.
We previously covered the release of the Apple Vision Pro and its positioning in the VR market. In short, Apple entering the VR category (or “spatial computing”) is more evidence that the market Meta is going after is meaningful.
Expect RL losses to expand in Q3 as the costs of bringing the Meta Quest 3 to market hit the P&L.
Check our YouTube Channel for our coverage of how Apple Vision Pro could disrupt the mixed reality market.
3. Key quotes from the earnings call
Zuckerberg on the “Year of Efficiency:”
“We've already seen a number of examples of how our leaner organization and some of the cultural changes that we've made can build higher-quality products faster and (Threads) is probably the biggest example so far. […] I'm going to be focused on continuing to run the company as lean as possible for these cultural reasons, even though our financial results have improved. I expect that we're still going to hire in key areas, but newly budgeted headcount growth is going to be relatively low.”
In the last call, Zuck touched on two main areas for AI: 1) recommendations and ranking in existing products and 2) new use cases.
On recommendations and ranking:
“AI recommended content from accounts you don't follow is now the fastest-growing category of content on Facebook's feed. Now, since introducing these recommendations, they've driven a 7% increase in overall time spent on the platform. This improves the experience because you can now discover things that you might not have otherwise followed or come across.”
The algorithmic feed has propelled TikTok’s success, and Meta is using this formula to drive similar engagement on Instagram and Facebook. Elon Musk is trying to replicate this formula with the “For You” tab on X/Twitter.
Facebook is performing well on recommended content from accounts you don’t follow, essentially turning into a TikTok clone.
On Reels specifically:
“Reels is a key part of this discovery engine and Reels plays exceed 200 billion per day across Facebook and Instagram. We're seeing good progress on Reels monetization as well with the annual revenue run-rate across our apps now exceeding $10 billion, up from $3 billion last fall.”
For context, $10 billion is 8% of Meta’s trailing-12-month revenue.
On improving monetization through AI:
“AI is driving results across our monetization tools, through our automated ads products, which we call Meta Advantage. Almost all our advertisers are using at least one of our AI driven products. We've also deployed Meta Lattice, a new model architecture that learns to predict an ads performance across a variety of datasets and optimization goals. And we introduced AI Sandbox, a testing playground for generative AI powered tools like automatic text variation, background generation and image outcropping.”
Zuckerberg touched on three categories of products ahead with Gen AI involved:
AI Agents (creativity, interaction with businesses).
AI-powered features for Ads (creative help, performance).
Productivity and efficiency internally (write code faster, knowledge base).
On the AI Agents opportunity:
“We're debating heavily when thinking through the amount of AI CapEx to bring online. Because the reality is, we just don't know how quickly these will scale and we want to have the capacity in place in case they scale very quickly, but because they're kind of brand new things and there aren't that many precedents for things like this, it's actually quite hard to forecast.”
On investments in Reality Labs:
“A lot of investors might want to see us spending less here in the near term. My view is that, we are leading in these areas. I believe that they're going to be big over time. We're -- I think we've shown that we can deliver good business results in the near-term while investing ambitiously in the long-term. So I'm planning on continuing to do that. And I do continue to believe that over-time we will be happy that we did that. […] We think that we're going to be the leaders in it and nothing that we're seeing from the market makes us rethink that in a fundamental way.”
On the long-term way to think about the losses from Reality Labs:
“We're here to build awesome experiences that help people connect. I think helping to shape the next platform is going to unlock that in a profound way for decades to come.”
It’s no secret that Apple’s App Tracking Transparency has made it a priority for Meta not to depend on someone else’s platform, unencumbered by the rules defined by another company. In the process, by building and owning the underlying platform, Zuckerberg aims for a more efficient monetization for the entire ecosystem.
CFO Susan Li on expenses:
“We expect higher infrastructure-related costs next year. Given our increased capital investments in recent years, we expect depreciation expenses in 2024 to increase by a larger amount than in 2023. We also expect to incur higher operating costs from running a larger infrastructure footprint.”
On RL losses:
“For Reality Labs, we expect operating losses to increase meaningfully year-over-year (in 2024) due to our ongoing product development efforts in AR, VR, and our investments to further scale our ecosystem.”
On Messaging:
“In terms of driving on-site conversions, we continue to see strong results with click-to-messaging ads and are well positioned given our suite of messaging applications. Daily click-to-WhatsApp ads revenue continues to grow very quickly at over 80% year-over-year. We also recently started testing the ability to buy click-to-WhatsApp ads directly from the WhatsApp Business app, which now has more than 200 million monthly users.”
4. What to watch looking forward
Here is the Q2 update on the things I’m watching closely:
🥽 Reality Labs’ losses are expected to expand in FY24. And we are still looking at a multi-year strategy. So don’t hold your breath. The release of the Meta Quest 3 will be critical because it’s the first big release in three years, and it will have a critical head start on Apple.
👨👩👧👦 Can Family DAP and MAP continue to grow? So far, so good.
🎬 Will engagement and monetization continue to improve via Reels?
🧵 Can Threads steadily grow its daily active user base? And more importantly, can it deliver features to delight users and keep them engaged?
💬 Can click-to-messaging continue its rapid growth? With WhatsApp ads revenue growing +80% Y/Y, the answer was “yes” in Q2.
🔓 Could Meta’s differentiation come from its open-source models? It sounds like a savvy move, but the jury is still out. We’ll learn more at Connect in September.
What company should we cover first in our report next Friday?
That’s it for today!
Stay healthy and invest on!
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Author's Note (Bertrand here 👋🏼): The views and opinions expressed in this newsletter are solely my own and should not be considered financial advice or any other organization's views.
Disclosure: I am long META in the App Economy Portfolio. I share my ratings (BUY, SELL, or HOLD) with App Economy Portfolio members here.
🧵 Meta: Threading the Needle
Do you think they will turn around the user retention issue on Threads?
Some of my clients are shifting to threads and I wrote a piece on it recently but the landscape is shifting rapidly. I think it still looks like a good bet at the moment, but I would be interested to know what you think
I think rumors of Facebook's untimely demise have been very, very wrong more times than any other big tech company.