Summary
- Meta Platforms posted an impressive revenue beat in the fourth quarter and a current quarter guide that was better than feared.
- A reduction in current year opex and capex were largely expected and favored by investors in the profit-preferred climate, while the incremental $40 billion buyback program authorization also bolstered confidence.
- Despite ongoing macroeconomic uncertainties, the company's consistent post-IDFA progress continues to underscore its technological advantage as well as the benefit of dominant social media user reach, assuaging future FCF concerns.
Meta ( META ) has been one of the biggest gainers in the recent market rally, initially fuelled by investor optimism over job cuts announced in the prior quarter to protect margins, and subsequently by signs of potentially easing financial conditions. The stock has gained more than 65% from its November bottom, and continues to climb in post-market trading (as much as +18% at the time of writing) thanks to an impressive revenue beat and an incremental $40 billion buyback program authorization surprise. Markets also reacted favorably to Meta’s guidance and commentary for the current quarter, which remains in line with our expectations that much of the negatives facing the underlying business’ fundamentals have already been reflected in the stock’s current value.
While Meta continues to face challenges that are idiosyncratic of ongoing macroeconomic uncertainties – spanning struggles in recapturing ad market share post-IDFA and the metaverse spending overhang – we're maintaining the view that much of the said negatives have already been priced into the stock’s lows previously contested in November. Going forward, investors will likely continue to focus on Meta’s execution, which appears to be progressing favorably, albeit at a slow pace, from here on out. This is further corroborated by improvements in its ad take-rates and impressions following the implementation and continued ramp-up of post-IDFA initiatives discussed in previous coverages (e.g. Advantage+, APIs, Meta Pixel, Reels, etc.), and the largely expected continuation of losses in Reality Labs, which the latest opex and capex cuts will make a welcomed partial offset for.
Admittedly, the stock is not fully out of the woods yet, given idiosyncratic risks that would up Meta’s vulnerability to ongoing market volatility. But consistent, though gradual, improvements to its core advertising business and fundamentals continue to be supportive that it will be unlikely for the stock to breach the $110-level again, which we view as the steady-state firm valuation for Meta. We continue to expect a modest, but consistent, recovery trajectory for Meta, supported by durable secular growth trends in digital advertising that is still on the table for the company given its ongoing progress in overcoming post-IDFA challenges, which will continue to be the key driving force for unlocking further upside potential.
A Slow, But Steady, Turnaround in Ads
An improvement to fourth quarter advertising revenues, marked by a relatively modest decline (or modest increase on a constant currency basis), continues to support our views that Meta is making stable progress on its upstream battle against challenges from the Apple ( AAPL ) signal loss, as well as broader macro-driven industry headwinds. With its core sales generating ad segment progressing favorably, total revenue in the fourth quarter topped $32 billion (-4/5% y/y or +2% y/y cc), and exceeded consensus estimates by $480 million.
Specifically, Meta’s post-IDFA initiatives implemented over the past year have been met with improving feedback from advertisers so far. Many have cited improving cost-per-action (“CPA”), which will continue to bolster incremental ad dollars flowing back to Meta’s ad distribution channels over time, especially as the company presses forward with ramping up the various post-IDFA initiatives implemented – spanning Advantage+ , Conversions API / Conversions API Gateway , Aggregated Event Measurement , and Meta Pixel (previously discussed in detail here and here ). Continued DAU / MAU growth (+4% y/y; + 2% y/y) observed in the fourth quarter also reinforces Meta’s leading reach in social media ads as well, supporting the narrative that it would remain at the forefront in recapturing returning ad-dollars in social media formats when compared to peers like Snap ( SNAP ) and Pinterest ( PINS ).
Meta’s robust fourth quarter advertising sales performance also supports ongoing progress in ramping up Reels monetization. Specifically, Reels was called out as a “major driver” of Meta’s latest outperformance, supported but complementing AI developments aimed at overcoming the IDFA signal loss challenges, and accommodating the shift in user preference to short-form video discovery.
The company’s efforts in bolstering its competitiveness in short-form video monetization is also corroborated by an improving share of user screen time over the past quarter. A recent survey conducted by RBC Capital Markets indicates that more than 53% of Facebook / Instagram users have spent more time on the apps compared to levels between six and 12 months ago, with 36% indicating they have spent less time on the apps over the same comparative period, implying a net positive in share of user screen time. Meanwhile, key competitor TikTok saw a 25% increase in users who have spent more time on the platform over the past six to 12 months, while 24% have spent less, representing a net neutral showing.
While Meta is likely to be progressing favorably capturing share in the short-form video advertising market by steadily improving the feature’s reach, the transition remains a drag on overall margins in the advertising business. Specifically, Meta had previously indicated that Reels remains a $500 million headwind on the segment’s sales, and continue ramp-up and adjustments to the relatively new feature’s roll-out and monetization efforts will remain a cost-driver that will take time to neutralize over the next 12 to 18 months:
Moving to monetization, I’ve discussed in the past how the growth of short-form video creates near-term challenges since Reels doesn’t monetize at the rate of Feed or Stories yet. That means that as Reels grows, we are displacing revenue from higher monetizing surfaces…Even with the progress we have made, we are still choosing to take a more than $500 million quarterly revenue headwind with this shift, but we expect to get to a more neutral place over the next 10 – sort of 12 to 18 months.
With Reels sort of playing a “cannibalizing” role in ad revenues in the near-term, given the feature’s “monetization gap” from legacy distribution formats like Stories and News Feed, execution risks remain high for Meta to address the urgency to bolster free cash flow generation required to support its longer-term growth investments (e.g. metaverse). Specifically, Reels margins are likely to weaken further before they get better, given increasing trends of revenue-sharing across competing short-form video platforms like YouTube Shorts that could weigh on Meta’s existing offerings to content creators. For now, Meta has been incentivizing content creators to expand the Reels catalogue across its main social media apps through revenue sharing strategies such as “ Rights Manager .” Rights Manager pays creators 20% of revenue on eligible Reels, with a “separate share going to music rights holders and to Meta.” Meta also has an invite-only “ Reels Plays Bonus ” for content creators that meet certain view thresholds. This rivals YouTube’s upcoming offering, which expands its existing “ YouTube Partner Program ” (“YPP”) to include “ revenue sharing on ads ” distributed through YouTube Shorts, as well as revenue sharing on music rights starting February 1.
While Meta has made meaningful progress in catching up to TikTok’s lead in short-form videos, YouTube’s leading share in the global video-sharing market, paired with the upcoming revenue sharing program for Shorts, could potentially be a challenge for Reels. Specifically, YouTube already garners over 2.6 billion visits per day, with “ over one billion hours of videos ” watched by users on a daily basis, which paired with the upcoming revenue sharing program for Shorts could entice content creators away from creating Reels. Content creators have also recently taken to their respective Facebook / Instagram platforms to express how those apps currently offer the least revenue sharing incentives when compared to TikTok and YouTube (which will be greater with added revenue sharing programs specific to Shorts).
[In] 2023, I want to shift my focus from Instagram over to YouTube and TikTok…So in case you guys didn’t know I am in a bonus program on all three platforms…That is how I make some of my money…Instagram has been my main platform for the last several years. But it pays the worst…Instagram doesn’t pay as well as [the] other two that’s why I want to be more active on those platforms…
Source: @gaming_foodie, Instagram Stories (January 31, 2023)
To improve its stance within the increasingly saturated short-form video landscape, Meta may have to further improve its revenue sharing program, among other incentives, for content creators to ensure its Reels catalogue continues to grow steadily, which would be required to ensure engagement on its platform needed to attract ad dollars. But while we view this as a potential risk that could derail Reels’ monetization strategy over the next 12 to 18 months, durable DAU / MAU growth observed across Meta’s family of apps observed in the fourth quarter – DAU reached the 2 billion milestone – and large share of user screen time remains a competitive advantage to support the new feature’s competitiveness, while also complementing the ongoing improvements observed in ramping up the post-IDFA ad formats.
Looking ahead, we view management’s conservatism over Meta’s advertising demand environment in the current quarter to be in line with the seasonal start-of-year slowdown following a strong holiday quarter. The modestly positive guide is also consistent with continued low visibility on the near-term macroeconomic backdrop as well.
As mentioned in our previous coverage on the stock, the combination of declining household savings and increasing consumer debt, as well as pulled forward ad demand during the pandemic continues to add complexity in the industry’s recovery prospects. Specifically, the U.S. economy is expected to contract in the second and third quarter, despite better-than-expected growth last quarter, as consumption continues to deteriorate. American household savings have continued on a decline below pre-pandemic levels in the low 2% range , while accumulated revolving credit outstanding, which includes consumer credit card debt, is slowing inching towards the $1.2 trillion level . The consumer slowdown can be directly observed through cooling e-commerce spending and prices – the Adobe Digital Price Index ( ADBE ), which measures online prices, dropped almost 2% y/y (-3.2% m/m) in December, marking the “largest decline in 31 months." And the slowdown in e-commerce spending makes stiffening headwinds to the digital advertising industry still – especially social media ad formats like those offered by Meta, which targets SMBs offering goods and services looking for customer acquisition growth . Meanwhile, the pandemic-era boom in digital ads, which was likely years of pulled forward demand, remains on a trajectory of normalization that could further stall Meta’s near-term recovery outlook.
Meta also faces a tougher PY comp backdrop, given the aforementioned macroeconomic headwinds did not become as prevalent until the second half of 2022. As macroeconomic uncertainties continue over the coming months, the anticipation for ensuing weakness in ad demand, paired with the stronger PY comp landscape makes management’s cautious optimism for the current quarter almost prudent to temper investors’ expectations, and mitigate risks of over promising and under delivering.
But the second half of the year could offer a sliver of hope for Meta. Based on the consideration that Meta would continue to make favorable progress in ramping up its post-IDFA ad formats and Reels monetization, and a potential improvement in visibility over the macroeconomic backdrop, the company’s core advertising business could potentially benefit from re-acceleration. Specifically, current market forecasts predict social media advertising demand to increase by 7% in 2023 , re-accelerating from 4.4% in 2022, with much of the growth expected to materialize in the second half of the year, and through 2024. Taken together with the easier PY comp set up from 2H22 when cyclical headwinds facing the ad industry were comparatively more prevalent, as well as Meta’s recent cost reduction efforts that will likely have a more evident impact on margins through the year (discussed further in later sections), the company could be well-positioned for further improvements in the second half of 2023.
The Metaverse Stays
Aside from its core advertising business, Meta’s bet on the metaverse is likely not going away – nor anywhere – anytime soon. In line with investors’ expectations, the company remains committed to significant investment outlays over the coming years in building out its vision of next-generation social in the virtual world, with no immediate signs of potential return in sight:
We believe investors have zero faith in seeing a return on the company’s metaverse investments anytime soon, and this quarter may be a good opportunity to communicate a more balanced approach where management reiterates its commitment to the LT [longer-term] goals even as it finds ways to more judiciously invest in metaverse initiatives.
Source: RBC Capital Markets Ad-Tech Report
Yet, Reality Labs revenue continued to reverse some of the declines in previously quarters, totaling $727 million (-17% y/y; +155% q/q) likely helped by holiday shopping seasonality strength during the final three months of 2022. But operating margins remain pressured at -590%, underscoring Meta’s continued allocation of significant R&D and other opex, as well as capital spending to bolster its anticipated longer-term growth initiative.
Meta’s commitment to building out the metaverse, paired with the lack of structural evidence over the near- to medium-term for mainstream adoption (aside from potential enterprise / industrial use, such as digital twins and virtual assistants / avatars) and monetization will likely continue to be an overhang on the stock’s outlook. The significant outlay (projected at about 20% of planned capex) also comes at an inopportune time, given the elevated cost of capital resulting from surging interest rates and a slowing market that has investors worried about margins.
Meanwhile, competition also is gaining momentum, with Apple soon entering the arena with its own mixed reality headsets later this year. While Meta’s Oculus goggles have long been dominant in the nascent VR industry, with competing products like Microsoft’s ( MSFT ) HoloLens and Valve’s Index trailing by wide margins, traction so far remains mediocre. Demand has largely been more present in consumer end-markets (e.g. gaming), with the Quest Pro’s – Meta’s latest foray in enterprise-focused mixed reality applications – take-rates off to a slow start . Although Meta benefits from a first mover advantage of sorts in the industry for now, slow mainstream adoption of the device category has not allowed the competitive lead to materialize into pricing power that can bolster the segment’s margins. Paired with ongoing macroeconomic headwinds spanning rising costs of capital as discussed earlier, and rapid deterioration in the segment’s current core consumer end-market, the backdrop does not bode well with investors’ confidence in the company’s metaverse ambitions. Continued investment outlays poured toward building out the metaverse also will place incremental pressure and urgency on Meta’s currently slow-recovering core advertising business to perform in order to assuage investors’ concerns, given the segment is the key and sole meaningful source of cash flows to support the company’s ongoing ambitions.
Pulling the Cost Lever
For now, management’s guide for opex and capex reductions, which were in line with our previous expectations, to optimize efficiency across the business could make a potential partial offset to the metaverse overhang. Specifically, the recent reduction in force (“RIF”) actions undertaken, alongside with continued workspace consolidation efforts drove one-time restructuring charges of $3.76 billion in the Family of Apps segment and $440 million in the Reality Labs segment, representing a 13 percentage point headwind on consolidate operating margins, and partially explaining the quarter’s slight earnings miss (EPS $1.76 vs. consensus $2.24); office consolidation drove $1 billion of full year 2023 restructuring charges. The company has now guided full year 2023 expenses in the $89 billion to $95 billion range, down from the previous $94 billion to $100 billion range as a result of the “slower anticipated growth in payroll expenses and cost of revenue." Meanwhile, capex for the current year has also been guided down from the previously $34 billion to $37 billion range to the $30 billion to $33 billion range as a result of “low data center construction spend," playing to its 2023 theme “Year of Efficiency”:
Beyond this, our management theme for 2023 is the 'Year of Efficiency' and we're focused on becoming a stronger and more nimble organization…The reduced (capex) 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.
Source: Meta Platforms 4Q22 Earnings
The development falls in line with recent speculation that Meta may be pulling back toward a more cautious stance on both capital and operational spending, marked by cancellation of its data center expansion efforts in Denmark late last year, and headcount reductions :
Specifically, there is a "growing view that Meta could cut capex in particular by as much as 30% to 50% relative to the initial guide", which focuses primarily on "increasing AI capacity" partially attributable to its metaverse ambitions.
Source: “ Meta Platforms: Expect More Turbulence in 2023 ”
It's also a welcomed sight, as investors hope for more conservative spending habits that could help the company preserve its margins through the near-term industry-specific and macro-driven challenges. We also view Meta’s doubling down on efforts pertaining to AI capabilities a plus to supporting its ongoing initiatives in overcoming IDFA headwinds – and other privacy policy updates across the Android operating system and elimination of Chrome browser cookies by 2024 – and onboarding a more structural competitive advantage in targeted social media advertising space.
The cost optimization efforts undertaken, without compromising on ongoing ad share recovery efforts, will likely address investors’ growing demand for healthy free cash flow generation to offset the anticipated yearslong metaverse overhang. And the expected benefits of recent cost reduction efforts will likely place a more evident impact on Meta’s fundamentals in the second half of the year, coinciding with an easier PY comp set up as discussed in earlier sections that could potentially bolster the recovery narrative for the stock.
The Bottom Line
The positive progress delivered by Meta in its core advertising business over the fourth quarter is largely welcomed, and the conservative guide for the current quarter can be viewed as reasonable given market awareness of the current macro backdrop and cyclical headwinds facing the company, aside from idiosyncratic challenges in the transition post-IDFA. But 2023 remains a year ladened with executions risks for Meta, nonetheless. This is consistent with expectations that post-IDFA recovery will be a multi-year endeavor for Meta, considering the need to adjust AI-enabled solutions for targeted ad delivery over time, acquaint advertisers / vendors with the appropriate tools to take full advantage of the post-IDFA offerings, and ramp up the new initiatives to improve CPA, conversion, measurement, and other ad performance metrics demanded by the industry. There's also growing urgency for the core advertising business to show a structural turnaround in order to compensate for metaverse outlays and ensure the durability of recently improving investors’ confidence stays. But improving overall efficiency at the company, paired with the incremental $40 billion buyback program recently approved remain supportive of Meta's confidence in turning the company around, and will likely help assuage investors' concerns over the stock's prospects.
Considering the execution risks in Meta’s transition within its core advertising business post-IDFA, and beyond in terms of its metaverse ambitions, the stock will likely remain vulnerable to ongoing market volatility in response to evolving macroeconomic factors, spanning inflation, rate hikes, and a likely recession. But given most negatives have likely been already priced into the Meta stock, which still trades at a significant discount to its broader internet peer group despite the recent rebound, we remain confident in bear case support levels in the $110-range. Considering there is still meaningful headroom for improvement in Meta’s underlying fundamentals as it forges its way through post-IDFA social media advertising with consistent progress in building a “structural advantage around ad targeting,” the stock remains well positioned for further upside potential from current levels, making any near-term pullback in tandem with market weakness an reasonable buy-in opportunity.
For further details see:
Meta Platforms Q4 2022 Quick Take: Bringing It Home