Meta Q3 2022 earnings: “Those who are patient and invest with us will end up being rewarded”

Meta released its Q3 2022 earnings yesterday. The company reported revenue of $27.7BN, which represents a 4% decrease on a year-over-year basis (or a 3% increase on a constant-currency basis). Meta provided guidance for Q4 of between $30-32.5BN which, at the high end, would result in a 3% year-over-year decline for that quarter. The company recorded increases in DAP and MAP (daily active people and monthly active people) across its family of apps of 4%, each.

The company’s expense base increased by 19% compared to Q3 2021, and it indicated that it expects growth in its cost of revenue to accelerate in 2023, primarily as a result of “infrastructure-related expenses.” Regarding Reality Labs, Meta’s internal metaverse incubator, the company stated that it does “anticipate that Reality Labs operating losses in 2023 will grow significantly year-over-year.”

Meta noted that, while ad impressions delivered across its family of apps increased by 17% on a year-over-year basis, its average price per ad decreased by 18% on the same timeline. Given that the increase in ad impressions outpaced DAU growth, it seems reasonable to conclude that Reels — Meta’s short-form video product — is achieving Meta’s ostensible goal of increasing ad impressions per session. The decrease in average price per ad served is likely the result of lower Reels monetization, which Meta described last quarter, but also, and more consequentially, of Apple’s App Tracking Transparency (ATT) privacy policy.

As I’ve argued with results this quarter for Netflix, Snap, and Alphabet, and for Spotify last quarter, references to nebulous “macroeconomic headwinds” are beginning to lose explanatory power for weak revenue performance given the general buoyancy this quarter of many portions of the tech and advertising landscape. This quarter saw strong earnings from major advertising holding groups WPP (which raised Q4 guidance), Publicis (which also raised Q4 guidance), and Omnicom, none of which are particularly exposed to ATT. And Netflix beat consensus estimates for Q3 as it prepares to launch its own ad platform in November. While macro effects, and especially the general reversion of consumer behaviors to pre-COVID norms, certainly have impacted the digital advertising sector, I would argue that the acute frictions seen over the past few quarters by the companies most historically dependent on behaviorally-targeted digital advertising are primarily the consequence of ATT and not inflation or the war in Ukraine.

Mark Zuckerberg noted in prepared remarks on the analyst call that the growth of Reels adoption has resulted in incremental engagement across the family of apps, and that Reels has seen a more than 50% increase in videos watched over the past six months, with the feature on a $3BN revenue run rate. And as with last quarter’s earnings, which I covered here, Zuckerberg described the company’s transition to an open graph as an investment: not only in terms of the opportunity cost inherent in shifting user attention to a lower-monetizing content format (Reels), but also in terms of the capital expenditure into computing hardware required to optimally segment and route the vast universe of possible Reels content to users based on their preferences and tastes.

And this investment is considerable. As a recent activist letter, titled “Time to Get Fit,” points out, Meta spends lavishly on capital expenditures (“capex”) even in comparison to its largest peers. From the letter:

Even excluding its large metaverse investment, Meta has gone from $15B in annual capex in 2018, 2019, and 2020 to $30B in annual capex in 2022. To put that in perspective, excluding your large metaverse investment, Meta is investing more in capex than Apple, Tesla, Twitter, Snap, and Uber combined!

Per the chart below, courtesty of TSOH Investing, Meta’s R&D expenditure has nearly doubled since 2020 and has nearly quadrupled since 2018.

The question is: what is the purpose of this investment, to what projects is it being directed, and what catalyzed it?

My sense is that Meta is simultaneously pursuing four critical initiatives:

  1. Extracting every last ounce of value from its existing ad tech infrastructure as a reaction to ATT through initiatives like its Advantage+ tool, which I unpack here, with conversion modeling, and with on-site engagements like click-to-message ads and FB Shops;
  2. Transitioning the core content proposition of the Facebook and Instagram apps away from the social graph and into an open graph oriented around short-form video, which I outline in Unpacking Meta’s pivot to an open graph and short-form video;
  3. Developing what I’d describe as the standards and core technologies for the next generation of privacy-safe digital advertising measurement and attribution through initiatives like Interoperable Private Attribution (IPA) and the open source Robyn Media Mix Model (MMM) project;
  4. Building the Metaverse.

Of these, initiatives two and four represent immense expenditures on which the company’s future is being staked; initiative three is a long-term project that likely can’t bear fruit for at least a few years; and initiative one is the company’s best hope at shoring up revenue in the very short term. And I’d argue that all of these initiatives were precipitated, at least indirectly, by ATT, which is creating so much turmoil for social media platforms and certain categories of digital advertisers at the moment.

Even Meta’s deliberate multi-year metamorphosis into a “metaverse company” is a reaction to ATT: not directly, but in the sense that Apple always had the platform power to orchestrate a disruptive policy like ATT, as I detail in The coming war between Apple and Facebook, published in 2017. In a letter to top lieutenants in 2015, as the company considered acquiring the games development platform Unity, Mark Zuckerberg outlined the need to own a computing platform as a bulwark against its total subjection to Apple and Google’s whims as gatekeepers of the mobile ecosystem. While Zuckerberg likely couldn’t foresee the exact contours of a policy like ATT at that time, he certainly understood that such a platform policy was possible.

And it is against this backdrop of ATT — and the total subversion of the prior digital advertising status quo that it provoked, which has put downward pressure on Meta’s topline revenue and upward pressure on its expense base in response — that Meta’s dilemma becomes clear. The company must strike a workable balance across the capital needs of the short-term critical refurbishment of its existing infrastructure, the construction of foundational new advertising technology frameworks, and the development of the next computing platform and attendant ecosystem of content. Any one of these projects would be profoundly expensive on its own. In combination, they have obviously challenged investor patience: as I write this, the stock trades at price levels not seen since 2016.

In the call, Zuckerberg addressed the potential of these initiatives in response to a question about how investors should appraise Meta’s investments:

I mean I just say that there is a difference between something being experimental and not knowing how good it’s going to end up being. But I think a lot of the things that we are working on across the Family of Apps are we are quite confident that they are going to work and be good. The Reels work, the discovery engine work, all the ads work on signals, the business messaging work, we can’t tell you right now how much – how big they are going to scale to be. But I think that each of these things are kind of going in the right direction…I mean there is macroeconomic issues. There is a lot of competition. There is ads challenges, especially coming from Apple…And I appreciate the patience. And I think that those who are patient and invest with us will end up being rewarded.