Meta's Q4 2022 report got the market excited and the stock went soaring in after hours trading. There sure were some pleasing sights in the report, notably the decision to reign in both operating and capex costs. However, according to Anirban, below the surface there remains many challenges. Anirban delves into those challenges and explains why now might not be the time to be too excited about Meta.
February 1, 2023
Meta (NASDAQ: META) reported earnings, and the stock jumped 20% in after-hours trading. Admittedly, Meta’s stock has been sold off for a while, so signs of green shoots can result in enthusiasm.
At the headline level, Q4 2022 closed out a horrendous 2022 with yet another set of poor numbers. Total revenue was down 4% year-over-year to $32.2 billion. The company’s costs increased by 31%, driven partly by a write-down of “certain data center assets” and rising infrastructure-related costs. Overall, nothing to write home about there.
Sure, Meta’s family of apps maintains their fantastic hold on civilization. In their prepared remarks, management noted that almost 3 billion people use one of their apps daily. The optionality to monetize this base, over time, remains the company’s greatest asset.
But I also see too many challenges in front of the company.
Consider the situation with ad impressions, the bread and butter of the business. During the fourth quarter, the average price per ad decreased by 22%. So, to maintain its revenue, Meta increased the total ad impressions across its services by 23%. Meta can’t continue to increase advertising cadence will ultimately result in a deterioration of service experience, which might result in a reduction in engagement. However, the problem for Meta is that its user base is already too large, so it doesn’t have the option of leveraging user growth to counter any decrease in ad prices.
There’s some sunshine through the cloudy days in business messaging revenue (mainly WhatsApp), growing 19% in Q4 to $184 million. Is it enough to counteract the pressures elsewhere, though? I don’t think so.
We see these higher-level problems – the double whammy of the saturation of the number of ads that can be stuffed into feeds and timelines plus lower demand for ads – show up in the company’s Q1 2023 guidance. At the midpoint of its guidance, Meta expects revenue of $27.3 billion, which will be once again below the Q1 2022 revenue of $27.9 billion if it comes through. In other words, Meta is very much in ex-growth mode.
But management won’t acknowledge the “ex-growth” nature of their core business. And thus, they continue spending like drunken sailors!
There are clues all over the map (err, their results).
Take Reality Labs. It delivered a paltry $727 million in sales, down 17% year-over-year. What was the culprit? Lower Quest 2 sales. Santa should have picked up more of Meta’s hardware this Christmas!
The news that the company is starting to reign in its expenses (perhaps) excited the market. For instance, capital expenditures for 2023 are projected to be in the $30-33 billion range versus earlier estimates of $34-37 billion.
There was some acknowledgment of their poor prior capital allocation decisions by Zuckerberg in his prepared remarks (emphasis mine):
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.
This is good news because Meta is still a highly cash-generative business. It will deliver plenty in free cash flow if it can just help itself and stop spending like money grows on trees. As the company has been doing off late, free cash flow can be returned to shareholders via stock buybacks. Meta generated $5.3 billion in free cash flow this quarter and spent $6.9 billion repurchasing shares.
While this is an excellent interim step, the question about Meta’s future remains. Reels, Meta’s answer to TikTok, remains a headwind regarding monetization. Metaverse remains largely a potential in anything but the real world, thanks to the need for a developer ecosystem and non-experience of maturing a consumer product like someone like Apple (NASDAQ: AAPL) has over the years. More broadly, the TikTok challenge points to the near ending challenge of fighting off the next best thing in social media. Invaders will come again and again, and while they might not take away Meta’s role as the king of the hill, they surely will stop Meta from continuing to grow unabated.
Finally, it is always curious when management talks about technology trends that are the day’s newsmakers. Here’s Zuckerberg talking about AI that can create text, chat, images, and videos:
Generative AI is an extremely exciting new area with so many different applications, and one of my goals for Meta is to build on our research to become a leader in generative AI in addition to our leading work in recommendation AI.
This passing reference to “Generative AI” seems unnecessary and out of place. Make what you will of it, but this sort of statement out of the blue only makes me worry about the longer-term strategy of this business.
I may be too cynical, given my bearish view. One thing is for sure. The coming few quarters will shed a lot more light on Meta’s dynamics and future potential.
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