XLC - Meta's Q2 Earnings: Is It Really A Disaster?

• Following Meta's Q2 earnings announcement, the stock price of the largest social media conglomerate plunged by more than 8%.
• Meta generated revenues of about $28.82 billion, down 1% as compared to Q2. Analysts had expected revenue of $28.92 billion.
• Meta significantly reduced Q3 2022 guidance and thus delivered another blow to analyst consensus view.
• Meta highlights three key challenges that contributed to the unsatisfying quarterly performance.
• I see a positive upside catalyst as I expect Meta to increasingly focus on cost discipline as well as aggressively work on business innovation.

Meta Platforms, Inc. (META) reported earnings on the 27th of July, and the company missed both revenue and EPS estimates. Moreover, given the challenging macro-environment, Meta significantly reduced Q3 2022 guidance and thus delivered another blow to analyst consensus view. Unsurprisingly, the stock price derated significantly and Meta lost about 8% following the earnings release.

In this article, I take a close look at Meta's Q2 2022 results. I have analyzed Meta's numbers, attended both analyst calls, and engaged with multiple Meta investors and buy-side analysts. In my opinion, here is everything you need to know.

Meta's Q2 results

Meta closed the quarter with 3.6 billion monthly active users, which represents a year-over-year increase of about 1%. The company estimates that about 2.9 billion users engage with any of Meta's apps at least once a day. Moreover, engagement trends have been stronger than expected, with MAU/DAU being about 67% - close to the highest ratio ever reported. Consumption of Reels increased 30% year-over-year, and Reels have grown to account for more than 20% of time spent on Instagram. According to the company, Reels are now at an annual revenue run-rate of more than $1 billion, which is a faster monetization rate than stories achieved over a similar period.

Now, let us look at the financials numbers: for the period from April to end of June, Meta generated revenues of about $28.82 billion, down 1% as compared to Q2 in 2021. Analysts had expected revenue of $28.92 billion. However, without the currency headwind, Meta would have achieved a +3% year-over-year revenue growth. Meta's net income decreased to $6.69 billion, versus $10.39 billion for the same period one year prior. Notably, the number of ads served increased by +15% year-over-year, while the price for Meta's ads decreased by -14%. So, basically, Meta is pushing more advertising but making less money.

Meta's business slowed despite the company's growth efforts: The company's headcount increased more than 30% year-over-year to 83,500 full-time employees. In Q2 2022 alone, Meta added more than 5000 full-time hires. Similarly, R&D expenses - already significantly elevated in 2021 - increased by 43%. Looking at these numbers, CEO Mark Zuckerberg's hope becomes a necessity:

I expect us to get more done with fewer resources

In that context, Zuckerberg highlighted something that many investors surely appreciate - lower R&D investments:

given the more recent revenue trajectory we're seeing, we're slowing the pace of these 2 investments and pushing some expenses that would have come in the next year or two off to a somewhat longer timeline.

The reasons for Meta's earnings miss

Zuckerberg highlighted three key challenges that the company is facing: First, Meta's business is challenged by the emergence of Reels. Although Reels see strong growth and engagement, monetization of these content formats is materially more difficult as compared to the traditional picture/video content. That said, as Reels cannibalize consumption of other content formats, Meta faces a (presumably) temporary revenue headwind - until monetization of Reels has been strengthened.

Second, Zuckerberg noted the continued impact of Apple's IOS change, which negatively impacts the company's data insights on customers. Through the application of AI, the company is confident to be able to work around the iOS challenges.

Third, Meta noted the challenging macro-environment, which includes global pressure on ad budgets and currency headwinds.

We seem to have entered an economic downturn that will have a broad impact on the digital advertising business. And it's always hard to predict how deep or how long these cycles will be. But I'd say that the situation seems worse than it did a quarter ago.

The challenging macro-environment, although hopefully temporary, is a key argument why Meta lowered Q3 2022 guidance: The company estimates revenues for Q3 between $26 billion and $28.5 billion. This would imply another quarter-over-quarter decrease for the business' growth. Analysts had expected $30.4 billion.

Still excited about the Metaverse

One of the most interesting aspects of Meta's earnings call was related to Zuckerberg's comments regarding the Metaverse. He, like me, is still very excited about this opportunity, and it is good to see that he is pushing the vision forward, despite the market's negative sentiment regarding the Metaverse's economic potential.

I feel even more strongly now that developing these platforms will unlock hundreds of billions of dollars, if not trillions, over time.

In this context, Zuckerberg added some color to two key milestones for the company's Metaverse strategy: Horizon and Project Cambria.

We'll be launching a web version of Horizon that will be accessible on all platforms later this year, which should dramatically increase the number of people who can use Horizon. We also just launched our avatar store with digital clothes from leading fashion houses, and we're going to continue expanding that selection and the fidelity of our avatar system overall.

Later this year we'll release Project Cambria - and the experience here is getting pretty awesome. It'll be a high-end device focused on professional users and work, with high resolution color mixed reality … I think people are going to be pretty blown away by this.

That said, if investors continue to see potential in the metaverse economy, now is not a time to sell Meta stock. While Q2 was arguably a little financial disaster, the company has delivered on the business development (also considering Reels) and innovation vertical.

Conclusion

Meta's near-term challenges, especially given a softer macro-economy, are definitely real. But ultimately, I believe the company will emerge as a stronger, more disciplined business with more focus on CAPEX and OPEX discipline. Moreover, the thesis surrounding the company's potential and the thesis surrounding the metaverse have not changed. In fact, the company seems to push ahead with the long-term strategy and to make excellent progress with key milestones.

Following Meta's Q2 results, I turn more cautious on the company's short/medium-term outlook. However, I continue to be very bullish on the company's long-term potential. I reaffirm my view that Meta is about 75% undervalued, and I target > $280/share as the company's fair implied value.

My coverage initiation article on the company: Meta Platforms: Exposing Senseless Narratives

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