FB: "Planning to Slow the Pace of Our Investments" in the Metaverse
Meta Platforms Q1 2022 (NASDAQ:FB)
Meta Platforms surprised investors in Q1 but not because the quarter was outstanding. Rather, it wasn’t as bad as some had assumed. In an unusual turn of events, Zuckerberg’s earnings call appearance resulted in whispering sweet nothings into investors’ ears. Put differently, he told investors what they wanted to hear. Acknowledging that 2020/21’s period of over-earning was beginning to “back off”, he remarked that with “current business growth levels, we're now planning to slow the pace of some of our investments”.
However great that might be, the quarter provided no conclusive update on the loss of signal from Apple’s iOS updates, with management offering on-platform messaging/commerce as a potential sidestep. Further, when asked about how Meta plans to handle iOS 16, Wehner retorted by saying “I don't think we have anything at this point to share about [iOS] 16”. The future remains murky for Meta’s Family of Apps segment (FOA). Side note, investors tend to dislike uncertainty.
Further Sidenote: Meta Platforms is a gigantic company, with a plethora of more qualified analysts than I covering the name. Nothing I say, nor any insights I may have, will be a net addition to the universe of public knowledge about Meta platforms. With that, here are some tidbits from the Meta Platforms Q1 2022 earnings period.
• Big Blue DAUs Rebound: Facebook’s flagship ‘big blue’ platform gained 31M daily actives following the fanfare in Q4 which saw the platform lose 1M DAUs. Today that stands at 1.96B DAUs with record highs across the US & Canada (196M), Asia (827M), and ROW (629M). Europe lost 2M DAUs in Q1, totalling 307M and is expected to drag Facebook MAUs (+3% YoY, 2.94B) down sequentially next quarter with the loss of service in Russia.
- Aside from big blue, DAP grew 6% to 2.87B, and MAP grew 6% to 3.64B. More people are using Facebook’s family of apps (FOA) than ever before. Wehner would cite that “engagement for both Facebook and Instagram remain above the levels they were at pre-pandemic and that's true both globally and in the U.S” on the call.
• Ad Impressions: In the first quarter of 2022, ad impressions delivered across FOA increased by 15% YoY and the average price per ad decreased by 8% YoY. The decline in pricing was driven primarily by the ongoing mix shift in ad impressions towards regions and services that monetize at lower rates (i.e, Reels).
• Reels Impact Quantified: 20% of time spent on IG is now Reels, launched in late 2020. That’s one-fifth of all activity on Instagram, monetising at lower rates. Like the shift from feed → stories, this is the hurdle Meta must vault.
• iOS Signal Loss: There was no substantial update on the loss of signal from iOS 15, nor were there any useful tidbits on how management expects to navigate further headwinds from iOS 16 (expected in Q2/Q3). Instead, the call was focused on using on-platform messaging and commerce ads as a way to sidestep the loss of visibility. As a reminder, Wehner threw out $10B as a guestimate of iOS impact, and commentary suggests it may be larger. They don’t intend on updating this figure going forward.
• Curtailing Spend: As noted/quoted in the opening remarks. This is a good thing, by all accounts. Perhaps Zuck has realised that stock prices actually do matter when trying to acquire/retain talent. Perhaps he wants to soothe Meta’s poisonous narrative. I am not sure, but even the most vocal Meta bulls expressed a desire for greater control over spend and, given the macro environment, as well as Zuck’s candid acknowledgement that Meta was over earning, it seems like the appropriate move.
• Buyback for Ants: Facebook repurchased just $9.4B in stock this quarter. After the $44.8B allocated through 2021, at considerably higher prices, one would have imagined they act more aggressively with prices having fallen between 30% to 45% from Q4.
Zuck’s Sweet Nothings
The term “sweet nothings” pertains to the words of affection oft exchanged by lovers. For a relationship that has been on the rocks of late, Zuckerberg tried his best to court investors in Q1. Naturally, the focal point of this quarter’s call was headwinds and the team did well in providing clarity on some (Reels, FRL) and not so well on others (iOS).
“Planning to Slow the Pace of Our Investments”
Perhaps the most notable commentary was Zuck’s opening prose on a more conservative approach to spending. For the sake of context, you can read the full passage below.
“I want to share some thoughts on our business trajectory and operating philosophy. First, I think it's useful to level set on our business trajectory over the last few years. After the start of COVID, the acceleration of e-commerce led to outsized revenue growth, but we're now seeing that trend back off. However, based on the strong revenue growth that we saw in 2021, we kicked off a number of multiyear projects to accelerate some of our longer-term investments, especially in our AI infrastructure, business platform and reality labs. These investments are going to be important for our success and growth over time, so I continue to believe that we should see them through. But with our current business growth levels, we are now planning to slow the pace of some of our investments.” - Mark Zuckerberg, Q1’22 Earnings Call
Quantitatively, this translates to a ~$3B reduction in guided total expense for 2022 (now ~$89.5B at the midpoint). CapEx (guided for ~$32B) was unchanged. Qualitatively, the signalling from Zuck is important. Those concerned that Meta is using FOA as a cash cow to fund a decade-long pursuit of whatever VR/AR aspirations Zuck has may still be concerned, as there was no relenting on that reality. But, here Zuck is saying they will be more mindful given the macroeconomic picture. He followed up by acknowledging EBIT margins, currently suffering on account of FRL, would be a priority going forward. Hoping to “generate sufficient operating income growth from Family of Apps to fund the growth of investment in Reality Labs, while still growing our overall profitability” after 2022. This, and Zuck’s apparent willingness to trade-off between short-term financial goals and long-term vision, is a healthy shift of narrative from the one which spooked investors last year.
Reels are 20% of Instagram Activity
Meta Platforms has endured many a pivot, from web→mobile as well as feed→stories and now stories→reels. Each time the latter was growing fast but not optimised for monetisation, and eventually became the core part of Meta’s business. Last week, we were told that Reels equate to 20% of Instagram’s activity. The key difference, as acknowledged by Zuckerberg in the Q4 2021 earnings call is that this time around, they have a sizeable competitor growing just as fast:
“The thing that is somewhat unique here is that TikTok is so big as a competitor already and also continues to grow at quite a fast rate off of a very large base.”
It also takes time for advertisers to become comfortable with new ad formats. Currently, advertisers optimise ads for feed and stories. The honus is on Meta to create intuitive products to allow advertisers to design ads in the Reels format, and for those advertisers to then re-optimise for Reels. Whilst not quite there, I am confident they will figure that out soon. On the creator/influencer side, Meta reinvested $1B in a creator fund to help build out Reels adoption. Asked in the follow-up to the earnings call, Wehner would note that whilst revenue share (popular with YouTube creators) is being experimented with, they “don’t think revenue share will be the predominant model”.
So, adoption is getting there, TikTok still exists, and the fork in the road continues to be; (a) Reels are not optimised for monetisation yet but most importantly; (b) Meta are still hurting from the loss of signal due to Apple’s iOS updates. Sandberg was quick to remind investors that the optimisation for Reels is still a multi-year project before anyone gets too excited. Sheryl Sandbag Sandberg strikes again, but an important comment to manage expectations because not only is monetisation-optimisation a multi-year project, so too is the workaround that Meta must undertake to offset Apple’s iOS updates.
Facebook Reality Labs
Last year, Meta’s Oculus business sold over 8.1M units of VR hardware, surpassed $1B in software revenues, and total revenue for FRL ended the year at $2.27B (+100%) whilst generating $$10.2B in operating losses compared to the FOA business’ $57B in operating income. The fact FRL is heavily dilutive to EBIT margins is not new, so I won’t spend much time on that.
Following the call, we learned that Meta plans to unveil four VR headsets from now until the end of 2024. One, being the high-end version of the existing headset, project “Cambria”, which is set to incorporate eye-tracking, face-tracking, superior ergonomic design, and full-colour pass through (the Quest 2 shows the ‘real’ world as grey/black). Cambria is due in September and will be “more focused on work use cases and eventually replacing your laptop or work setup”. As for the other three, I imagine there will be a “Quest 3” in there somewhere. Similar to Apple’s Pro and Standard models, it is likely we see Meta implement their most superior-tech in high-end models, whilst simultaneously catering to VR adoption through their loss-leading Quest models.
Motion censored gaming existed prior to the launch of the Nintendo Wii, but the console delivered an affordable, home-sized, and intuitive version. Like the Wii, at-home VR setups have existed long before the Quest 2 (Meta’s flagship headset). But also like the Wii, the Quest 2 delivered it in a low cost, wireless, experience. Both consoles took a niche which was previously available to ‘hardcore’ enthusiasts and made it mass-market.
Whilst the Quest business has not yet reached the mania of the Wii console (which peaked at 26M consoles sold in 2009), I am sure we all remember how fun the Wii console was, for the first year or so before it existed to collect dust. To be quite frank, this is the same feedback I hear from many Quest 2 owners, myself included. Currently, the console exhibits more similarities with Wii. A new-fangled “way to play” that quickly becomes redundant. After the Wii days, Nintendo Games have since reverted back to stationary console mechanics, leaving the rearview to make it appear that Wii was a fad.
The key difference this time around is that Quest is not exclusively a gaming device. Whilst known for its fun games, and popular amongst gamers, the majority of Quest’s most popular apps are social. Whatsmore, Zuckerberg touts Horizon Worlds as a “focus” for “building out the Metaverse economy and helping creators make a living, working in the metaverse”.
The immersive nature of VR certainly lends itself more towards gaming, but thinking past the Quest 2, thinking about Meta’s vision for AR and how that could lend itself to communication and social interaction. My perception is that Zuckerberg feels this pursuit is more akin to the time when Apple pioneered to smartphone market’s rapid evolution, as opposed to simply competing against Nintendo, Microsoft, or Sony for gamer attention. The question is not “who creates the next leading gaming experience”, but rather, “what is set to supersede the mobile phone in the coming decades?”.
It seems nigh impossible to consider, but as one S-curve closes, another opens. I am a young man, but a financial history enthusiast. I recall, even in the 90s, reading prose about how internet-enabled mobiles would have a TAM restricted to mostly corporate use. The potential for AR/VR to enhance our 2D forms of communication, and enable richer, more present, connections is scintillating. It could be 10-years away, it could be multiple decades. I don’t know. But I think this is Zuckerberg’s frame of mind when it comes to FRL. I tweeted something of this nature, to which @retaox responded, “I think this is how Zuck sees the opportunity. VR eats into Desktop. AR eats into Mobile”.
I would be inclined to agree. With Meta’s Horizon worlds (their attempt at building the “next” social platform) coming to mobile later this year, and Meta’s “real” AR glasses (not the prototype Ray-Bans) expected in 2024, the scintillating prospect of how these visions will all begin to collide is approaching. With Horizon Worlds allowing mobile, web, and presumably AR, devices to join in, it might give us some signal as to Zuck’s grander vision. But still, this is pie in the sky stuff for now.
Sidenote: If you didn’t catch this edition of Market Talk, I would highly recommend watching the presentation I shared by Meta’s Director of Content Ecosystem, Chris Pruett. There he lays out a great overview of the software ecosystem at Quest and their two marketplaces; Quest Store and AppLabs.
You..You’re…You’re Breaking Up
One thing that wasn’t part of Zuck’s sweet nothings, however, was the loss of signal in relation to Apple’s iOS updates. As repeated every quarter, Meta now struggles to; (a) target users as effectively as they once could due to a reduction in the granularity of data they collect about users and ; (b) measure the performance of said targeting for the above reasons, and due to latency, which is particularly important for advertisers.
There was some commentary about SMBs still being in the trenches, and Meta working with larger entities, as well as workarounds using on-platform messaging ads and commerce, but the fact remains; this is arguably Meta’s largest headwind and there was no further clarity provided in this quarter’s earnings call.
Meta’s revenue in Q1 totalled $27.9B (+7%), with a ~3% headwind from FX. Looking ahead to Q2, management is guiding for ~$29B (with a ~3% FX headwind) at the midpoint, implying a slight decline from the $29.07B they generated in Q2’21. Whilst the aesthetic of a potentially flat or marginally declining YoY revenue number is ugly, this comes after a 56% comp in Q2’21. I personally don’t care all that much, but these are the headlines that move stock prices in the short term, so I expect any weakness there to be paraded around the media as another signal that Meta is dying. I personally find it impressive that Meta managed to grow revenue by 7% in this quarter despite, coming off the back of a 56% comp, with a 3% currency headwind, during a Reels transition which will become increasingly pronounced during the stage at which usage grows before monetisation catches up, macro environments suppressing ad spend, Russia/Ukraine headwinds, and Apple ATT.
Pressure on FOA’s EBIT margin (42.2% in Q1) continues, as the company faces headwinds on the ad-revenue side, as well as increasing R&D and headcount costs. The 10-Q cites “data centres and technical infrastructure” expenditure as a significant component as Meta looks to reinvest aggressively in FOA.
Wehner would tout privacy-enhanced technologies as their path to sidestepping headwinds from iOS. In the medium-term, with on-site conversion (in-platform ads, commerce ads) and a rebuild of Meta’s ad stack (ML/AI) to become more effective with less data. Addressing margins on the call, Zuck would acknowledge that he is ”confident that [Meta] can return to better revenue growth rates over time and sustain high operating margins” for the FOA business, whilst simultaneously funding the FRL arm. Perhaps realising the importance of executing this in a composed manner, some commentary was uttered on the desire to continue growing overall profitability.
“So over the next several years, our goal from a financial perspective is to generate sufficient operating income growth from Family of Apps to fund the growth of investment in Reality Labs, while still growing our overall profitability. Now unfortunately, that's not going to happen in 2022, given the revenue headwinds.” - Mark Zuckerberg, Q1’22 Earnings Call
I believe what Mark is saying here, is that at the segment level, focus will be placed on growing FOA operating margin, which will then be funnelled back into FRL. However, at the business level, operating income should still continue to grow. Essentially, not allowing the investment in FRL to undermine the goal of growing total operating profit over time. I can’t imagine FRL being accretive to EBIT for a number of years given that when asked about the investment/monetisation cycle of FRL, Zuck remarked "this is laying the groundwork for what I expect to be a very exciting 2030s".
Not a great deal of discussion is required as Meta’s balance sheet is pristine. No debt, and enough cash and securities ($44B) to cover the entirety of their obligations ($41B).
Cash Flow Statement
Meta generated $8.6B in free cash flow during Q1 ($6.1B ex-SBC) and conducted a share repurchase, for ants, of $9.4B, after buying at avg prices of $316 (Jan), $225 (Feb) and $211 (Mar). One wonders why they didn’t repurchase more aggressively, given the dwindling share price, but with $29.4B left in the repurchase program, and the share price unlikely to revisit $300 anytime soon, they have plenty of time.
Abdullah, the author of MBI Deep Dives, suggests Meta have repurchased ~8M shares in the first 22 days of April, on the back of their ~34M shares repurchased in Q1. He also shared the mind-boggling table that shows the relative level of spending that Meta conducts in comparison to peers on a CapEx and R&D basis.
When you frame it as Meta ($570B market cap) spending more on CapEx and R&D than Apple, a company whose market cap surpasses $2.5T, it’s quite something. Updating that table, after Meta allocated $5.4B in CapEx and a further $7.7B in R&D during Q1, the fact remains the same.
On an R&D/EV basis, Meta allocates more towards R&D than any other company in the above table, and with considerable R&D and CapEx required to sustain FOA, navigate iOS headwinds, build-out commerce, and acquire data centres for FOA and FRL, it’s clear to see where Meta are spending, and equally clear this level of reinvestment is unlikely to slow down anytime soon. This is what both excites and terrifies investors.
There is a running joke on the interwebs that the blood for Meta Platforms will only stop when people cease to continue quoting how “cheap” the stock is, oft sharing an EV/EBIT, or a P/E, or some other multiple alongside it.
Whilst Meta might trade at a relatively low valuation, looking back to moments when; (a) the stock had more promise and sentiment was stronger (albeit still poor); (b) the bull case was less convoluted; (c) growth was faster, and; (d) the company was not a handful of years into a potential decade-long investment cycle for some venture which may or may not result in success, is not a useful allocation of time.
Priced like FOA is terminally ill, and FRL is a zero, Meta currently trades at ~17x NTM earnings, ~14x NTM EV/EBIT, ~4x NTM sales, ~14x TTM free cash flows and free cash flow per share has doubled since 2020. Despite trading at 5-Y lows, my comments prior highlight that using pre-covid, pre-ATT, pre-TikTok dominance, Meta multiples as a base rate, is likely a great way to lose money. Or at the least, the wrong way to think about valuation.
The growth has changed, the sentiment has changed, the market environment has changed, the competitive environment has changed, the long thesis has changed and so too has Meta’s capital allocation. Put simply, the facts have changed. This isn’t the business which stood 5-years prior, and should not be valued as such. I own Meta in considerable size, ~19% of my taxable portfolio and ~12% of my total invested assets, at a cost basis around where it trades today. As such, I don’t feel compelled to double down on this business. Whilst it trades lower, I am arguably buying a more speculative, uncertain, business, with a wider dispersion of potential outcomes, than I would have when originally purchasing shares in mid-2020.
Fragments of the Meta long-thesis from circa 2018 are shedding like a Huskey’s coat in summer. The quantification of Meta’s uncertain bet on FRL, the recent stories about troubles in their e-commerce division, which has seen numerous senior executives jump ship, and the Apple iOS update clogging the main artery that is Meta’s advertising business. Bears have every right to have a doctor on speed dial for Meta’s potential myocardial infarction.
Frankly, I may have overstayed my welcome in Meta, or perhaps be making too large of a bet. I can see with my own eyes how the thesis creep has sauntered its way into the business which stands today, yet I am unrelenting in my desire to hold. There are parts of me that believe this management team is too quality, the valuation is too attractive (yelp) and the sentiment is too hysterically negative. Other parts of me ponder if I am my own worst enemy, holding the wool over my own eyes in a feeble attempt to cling on. I respect thesis creep, I understand the new thesis, but perhaps I am not mature enough yet as an investor to know when is the time to move on and when is the time to stand by my conviction. I likely have not been hurt enough yet to learn that lesson.
These are my mistakes to learn. Might I remind readers that I am 25 and still have costly lessons ahead of me. In the grand scheme of things, I am a toddler in the investment world. This should always be at the forefront of readers’ minds when consuming my work.
Thanks for reading.
Author of Investment Talk