Meta Platforms - Earnings Review Q2’22

Meta reported its Q2’2022 results on 27 July 2022, and the stock price is down by 5.5% since its earnings release. The below is a preview of Meta’s Q2’2022 earnings.

Financial Highlights

• Revenue for Q2’22 of $28.82B (down 1% compared to Q2’21) missing estimates by $130M and slightly lower than the mid-point guidance provided.

• GAAP EPS for Q2’22 of $2.46 (down 32% compared to Q2’21) missing estimates by $0.09.

• Operating income $8.36B, down 32% compared to Q2’21. Operating margin 29% compared to 43% in Q2’21.

Users

A metric that we follow closely is user engagement. Meta managed to retain engagement during the quarter despite the competition from TikTok and other apps striving for people’s time. User engagement in both Family of Apps (includes Facebook, Instagram, Messenger, and WhatsApp) and Facebook has grown year over year but was flat sequentially.

Source: Meta’s Q2’22 Earnings presentations, StockOpine analysis

According to management, the slight sequential decline in Facebook monthly actives was due to Internet blocks related to the war in Ukraine.

Zuckerberg’s comment on Facebook during the call suggests that Facebook outperformed their own expectations on user engagement.

Mark Zuckerberg, “Engagement trends on Facebook have generally been stronger than we anticipated, and strong real growth is continuing to drive engagement across Facebook and Instagram.”

Even though Meta faces multiple headwinds, user engagement is still strong which gives the Company the chance to maintain engagement and capitalise on it in the future.

Revenue Headwinds

Revenue slowdown was driven by foreign exchange, reduced advertiser spending and shift in ad impressions towards lower-monetizing surfaces (from feed and stories towards reels).

Foreign exchange - Meta had its first quarter of revenue decline year over year, with foreign exchange having a significant impact on revenue due to the depreciation of Euro relative to the Dollar. On a constant currency basis, Meta achieved revenue growth of 3% year over year.

Macro Concerns – Advertising demand softened in Q2’22. In addition to the normalization of e-commerce growth post-pandemic and the war in Ukraine, management highlighted that inflation and recession fears have also affected advertiser spending in Q2’22.

Dave Wehner, “Advertising revenue growth slowed throughout the second quarter as advertiser demand softened. The deceleration has been broad-based across verticals, and we believe businesses are lowering their advertising spend in response to the increased economic uncertainty.”

Reels gaining engagement over feed and stories – Engagement in Q2’22 continued to shift from feed and stories towards reels. The shift to reels is a headwind on revenue since reels is monetized at a lower rate.

Mark Zuckerberg, “One near term challenge is the growth of short-form video. Reels doesn't yet monetize at the same rate as feed or stories, so in the near term, the faster that Reels grows, the more revenue that actually displaces from higher-monetizing surfaces.”

Apple iOS changes continues to be a headwind for Meta since it affects its ability to measure and target ads. Meta is making efforts to obtain more first-party data through investments in AI. It should be also noted that by Q3’22 one year will elapse since iOS changes were fully implemented. Therefore, next quarter’s revenue growth rates will be more comparable on year-over-year basis.

Foreign exchange and macro concerns are cyclical headwinds which will ultimately normalise. In respect to the adviser spending which softened during Q2’2022, we should note that $GOOGL advertising revenue increased by c. 11.5% y/y for the same period. Thus, for the revenue flattening it is unclear whether it purely comes from Reels monetisation impact, FX or due to operational inefficiencies. We believe that the Company’s ability to accelerate revenue growth will depend on the successful monetisation of Reels.

Reels

It looks like Reels is growing quickly gaining engagement across both Instagram and Facebook.

Mark Zuckerberg, “I shared last quarter that Reels already made up 20% of the time that people spend on Instagram. This quarter, we saw a more than 30% increase in the time that people spent engaging with Reels across Facebook and Instagram.”

In terms of advertising revenue, Reels reached $1B run rate. According to Mark Zuckerberg, Reels reached the $1B run rate at a faster rate than when Stories were initially launched.

To overcome Apple’s policy changes and to make reels successful, Meta’s play is through advances in AI and the transformation of its social feed from being social driven to be AI driven (currently 15% of the content of Facebook and Instagram feed is recommended by AI).

Reality Labs

Operating losses for the segment were $2.8B compared to $2.4B in last year. As operating losses continue to grow, they put downward pressure on Meta’s operating margin.

Source: Meta’s Q2’22 Earnings release, StockOpine analysis

Operating income

Operating margin for the Q2’22 was 29% compared to 43% in last year because of the substantial increase in operating expenses.  Total expenses were $20.5B, up 22% compared to last year driven to a large extent by headcount which rose by 32%.

Going forward management plans to push back on some of its investments and reduce headcount growth to cope with the revenue slowdown.

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

Management did not offer guidance whether operating margins are expected to improve in the following years. We do not expect operating margins to return to prior year levels in the short-term due to 1) transition to reels which monetizes at lower rates, 2) macro concerns affecting ad spending, and 3) Reality Labs operating losses

Financial position, share buybacks and cash flows

Meta has a clean balance sheet with plenty of financial resources to support investments ($40.5B cash & marketable securities with zero debt).

For the quarter, Cash flow from operating activities was $12.2B (42.4% of revenue) compared to $13.2B in Q2’2021 (45.4% of revenue) whereas free cash flow was $4.5B (15.6% of revenue) compared to $8.5B in Q2’2021 (29.2% of revenue), mainly affected by the substantial increase in CAPEX to $7.7B, up by 64% y/y and 40% q/q. The substantial increase in CAPEX relates to server spend, including Meta’s AI Infrastructure.

Source: Meta’s Q2’22 Earnings release, StockOpine analysis

During the quarter Meta repurchased $5.1B worth of ordinary shares, a significant deceleration in share repurchases compared to previous quarters. Although, we appreciate the investments in RL, AI infrastructure etc. buying less at lower prices does not demonstrate the best capital allocation policy.

Outlook

For Q3 Meta expects revenue in the range of $26-28.5B implying year-over-year decrease of 6%. FX headwind on revenue growth for Q3 is expected to be 6% therefore revenue is expected to be flat on a constant currency basis.

Total expenses for the year 2022 are expected to be in the range of $85-88 billion, lower than the prior outlook of $87-92 billion.

Concluding remarks

It is vital for Meta to pass through Reels and monetize it while still retaining engagement. If Meta succeeds on that front, then advertising dollars will follow. In the call we did not receive any negative signals on that since engagement is still high and Reels is gaining adoption.

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