[October.2024] A Peek into Meta's Earnings: Cyclical Advertising Revenue and Loss Changes in Metaverse

$Meta Platforms (META.US)$ has been one of the most volatile tech giants in the US stock market over the past few years. From its peak of $384 in 2021 to its low of $88 in 2022, the stock price plummeted by as much as 77%. However, in 2024, the share price had once rebounded to $540, hitting a 5x peak from its lowest point. With such a rollercoaster ride, Meta's stock performance has undoubtedly kept investors on edge.

Meta's recent stock price rebound may be attributed to various factors, including some breakthroughs in its earnings performance. In late 2021, Facebook announced its name change to Meta and made significant investments in the metaverse. However, the company's performance has been lackluster for several consecutive quarters, which was partly reflected in plummeting share prices during the same period.

Meta's highly elastic stock price has brought its financial reports into the spotlight as well. Each earnings release may signal a potential investment opportunity, but before diving in, investors need to understand how to interpret their financial statements.

How should we interpret Meta's earnings reports? Is its reversed performance sustainable? To help answer these questions, we may focus on several key indicators from Meta's recent earnings report, including user traffic, advertising revenue, and losses in Meta's metaverse business.

1. User Traffic

User traffic is the backbone of social ecosystems like Meta, and growth in this area drives revenue growth. Meta owns social media platforms such as Facebook, Instagram, and WhatsApp, with Facebook being the cornerstone. To properly gauge changes in user traffic, we may examine user scale, engagement, and value from similar products.

In terms of user scale, Meta has had an impressive year. In Q4 of 2023, monthly active users(MAU) across all platforms reached 3.98 billion, up 20 million from the previous quarter. Daily active users(DAU) also hit a record high of 3.19 billion, up 50 million from the previous quarter.

In Q2 2024, Meta's daily active users reached 3.24 billion, an increase of 50 million from the previous quarter. This continuous growth on a large basis may send a positive signal. However, the company did not disclose MAU data this quarter.

When measuring user engagement, we primarily examine the proportion of daily active users in relation to monthly active users. This ratio has remained relatively high and stable at nearly 80%.

From a user value perspective, the key metric to watch is Average Revenue per Person (ARPP). Since Q3 2022, Meta's ARPP has consistently increased for eight quarters, with each quarter showing growth of over 10%, indicating a rapid and sustained improvement in user value.

Overall, Meta's user traffic foundation seems to be relatively stable. In the upcoming financial reports, we can continue monitoring whether Meta can strengthen its user base.

2. Advertising Revenue

Thanks to its vast user traffic, advertising has become Meta's primary source of revenue, accounting for over 98% of its total revenue. From this perspective, Meta is perhaps the most ad-centric among tech giants. Despite its decisive move to enter the metaverse business through a name change, the market remains most interested in its advertising business.

Meta's performance has been volatile in recent quarters, experiencing a reversal from decline to growth. In terms of revenue, its advertising business has been the primary driver behind this reversal.

There may be two key factors to consider to assess the growth of Meta's advertising business.

Firstly, the economic cycle. While Meta is a tech company, its advertising business has strong cyclical attributes and is closely tied to the economy. From mid-2022, as the US Federal Reserve raised interest rates, advertisers lowered their expectations for economic growth and market demand. This resulted in reduced ad spending and put pressure on Meta's growth. As a result, Meta's revenue declined year-on-year（YoY） from Q3 2022 onwards.

However, since 2023, advertisers may have found that the actual economic situation is better than their estimate. Since 2023, advertisers have found the economic situation to be much better than their previously pessimistic expectations, leading to an increase in ad spending. This has helped Meta return to growth.

In Q2 2024, Meta's ad revenue grew by 21.7% year-over-year. While this growth rate has slowed compared to the previous quarter, it remains above 20%. Currently, market expectations for U.S. GDP growth remain strong, suggesting that Meta may continue to experience a period of favorable conditions.

Secondly, we may examine the impact of artificial intelligence (AI) on advertising. During the earnings call, the Meta management highlighted that AI-driven content recommendations are growing the fastest among Facebook subscriptions. Additionally, the company launched the automated advertising product Meta Advantage, with almost all Meta advertisers using at least one AI-driven product.

AI may optimize the efficiency of content promotion and increase the conversion rate of advertising. However, neither of these effects may be immediately apparent. Consequently, we should take a long-term perspective when considering the impact of AI on Meta's advertising business.

3. Loss on the Metaverse Business

To reduce its reliance on advertising, Google developed its cloud business, while Meta placed a high-stakes bet on the metaverse. However, unlike Google's cloud business, the road to the metaverse has been bumpy for Meta.

This is mainly because the metaverse is still in its nascent stage, and content and commercial ecosystems have yet to be established. Most users who are willing to pay for it are early adopters, and mass adoption may still be a long way off. As a result, Meta's Reality Labs, which serves as its testing ground for metaverse business, generates low revenue with high initial capital expenditures and operating losses. This drags Meta's profit and cash flow.

Looking at the losses more closely, Reality Labs' revenue generally only amounts to a few hundred million dollars per quarter and is relatively unstable. However, operating losses amount to several billion dollars, reaching $4.65 billion in Q4 2023. In Q2 2024, Reality Labs' revenue declined to $350 million, with over $4 billion losses.

From the perspective of free cash flow, Reality Labs' high research and development expenses and capital expenditures have a significant negative impact on Meta's cash flow. As we can see from data on moomoo, Meta's quarterly free cash flow dropped from over $10 billion to less than $500 million, partly due to these factors.

In recent conference calls, the company revealed that it is cutting its investment budget for virtual reality, which indicates a shift in its focus. Additionally, for the recent quarters, the operating losses of Reality Labs have shown signs of narrowing. Although there was a notable rebound in losses in Q4 2023, the robust growth of the advertising business has led to a significant overall recovery in free cash flow, maintaining over $11 billion for five consecutive quarters.

However, while from the perspective of meta management, the metaverse business may have a promising future in the long term, there is still a great deal of uncertainty, and the market may be unwilling to pay for a distant vision. Instead, the market may be more concerned about the losses generated by this business. Therefore, in the coming quarters, we should pay close attention to the losses incurred by the metaverse business. It is important to avoid a situation where the losses expand and once again impact the overall profit margin and cash flow of the company.

Having read this far, you may now have a deeper understanding of how to interpret Meta's financial reports. It's noteworthy that the release of earnings reports from prominent companies may present unique trading opportunities for different types of investors.

For instance, if an investor, after analyzing past reports and considering recent developments, believes a company's latest earnings will send positive signals and boost the short-term stock price, they might consider taking a long position. This could involve buying the underlying stock or purchasing call options.

Conversely, if the investor expects the earnings to be unfavorable and potentially pressure the stock price, they might consider taking a short position, either through short selling or buying put options.

If the report's outcome is unclear but volatility is expected, they might use a straddle strategy, buying both calls and puts.

However, investors should carefully assess their risk tolerance, particularly when considering high-risk trades like short selling or options, before making any trading decisions.

Summary

There are several key factors to consider when evaluating Meta's performance.

Firstly, user traffic is the foundation of Meta's business. We should monitor its user base, user engagement, and competitive landscape.

Secondly, advertising is the main source of revenue for Meta. Therefore, we should consider paying attention to changes in the economic cycle and the impact of AI on enhancing Meta's advertising business.

Finally, the metaverse business may be Meta's new growth point in the distant future, but it currently operates at a significant loss. As such, we should be vigilant about the possibility of expanding losses.

Each earnings report may present new investment opportunities, so investors should align their strategies with their risk capacity.