[Investment Talk] How to evaluate Meta's performance? Large fluctuations in advertising cycles, and staying profitable in the metaverse.

If we talk about the biggest price fluctuations among tech giants on the U.S. stock market in recent years, there is no doubt that it is Meta. From a high point of $384 in 2021 to a low point of $88 in 2022, it once dropped by 77%. By October 2023, Meta's stock price has returned to $330, nearly tripling from its lowest point. The roller coaster-like stock price trend is truly thrilling.

Meta's ability to counterattack in terms of stock price is largely related to the reversal of its performance difficulties.Since the end of 2021, when Facebook announced its name change to Meta and made significant investments in the metaverse, Meta's performance has been lackluster for several quarters, and its stock price has plummeted. It was not until the fourth quarter of 2022 that Meta's performance hit rock bottom and started to rebound, causing the stock price to undergo a V-shaped reversal.

Therefore, we can also see that Meta's stock price has a significant elasticity and is highly correlated with its performance. As a result, its earnings reports have become the focus of market attention. How should we evaluate the company's financial situation? We can pay attention to several key points: user traffic, advertising revenue, and the financial situation of the metaverse business.

1. User traffic

For social ecosystems like Meta, user traffic is its foundation, and the growth of user traffic is the fundamental driving force for revenue growth. Currently, Meta owns phenomenal social products such as Facebook, Instagram, and WhatsApp, with Facebook as the core platform. For changes in user traffic, we need to focus on user scale, user stickiness, and the situation of similar competitors.

In terms of user scale, in the second quarter of this year, Meta's overall monthly active users reached 3.88 billion, an increase of 70 million compared to the previous quarter, and daily active users reached 3.07 billion, an increase of 50 million compared to the last quarter, both reaching historical highs. Despite the high base, the continuous growth momentum is good.

In terms of user stickiness, the key is to look at the proportion of daily active users in the monthly active users, which has remained close to a relatively high level of nearly 90% for a long time and is very stable.

In terms of competition, in recent years, the new entrants in social media are mainly short video leader TikTok, which once captured a large user base and user time in the U.S. market. However, with TikTok being regulated and Meta subsequently introducing similar short video products Reels on Inst and FB, it has also driven the overall user growth for Meta.

Overall, Meta's user traffic foundation is relatively stable. In future earnings reports, we can continue to focus on whether Meta can continue to strengthen its user base.

2. Advertising revenue

Built on huge user traffic, advertising business has become Meta's main source of revenue, accounting for over 98% of its revenue. From this perspective, Meta can be said to be the most pure advertising company among the tech giants. Although Meta has resolutely transitioned through a name change to convey its determination to enter the metaverse business, the market is still most concerned about its advertising business up to now.

Meta's performance has fluctuated greatly over the past few quarters, experiencing a turnaround from decline to growth. From a revenue perspective, it is mainly determined by the advertising business.

So how can we determine the trend of its advertising business growth? Mainly focus on two points.

First, the economic cycle. Although Meta is an internet company, its advertising business has a strong cyclical nature, as advertising demand is closely related to the economic cycle. Starting from mid-2022, the pressure of the Fed's interest rate hikes led advertisers to lower expectations for economic growth and corporate product demand, reducing ad spending and putting pressure on Meta's growth. Meta's revenue also declined year-on-year from Q3 2022.

However, from this year, advertisers have found that the actual economic situation is far better than the original pessimistic expectations, leading to an increase in ad spending and thus driving Meta back to growth. Currently, the market's expectation for U.S. GDP growth remains strong, and Meta may still experience a period of sweetness.

Secondly, the augmentation of artificial intelligence on advertising. Meta's management stated in a post-quarter conference call after the second quarter's earnings report that AI-recommended content is the fastest-growing content item in Facebook subscriptions. Additionally, the company has launched the automated advertising product 'Meta Advantage,' which is used by almost all Meta advertisers for at least one AI-driven product.

It is evident that AI can optimize the efficiency of content promotion, as well as increase the conversion rate of ad placements. However, both of these may not yield short-term results, and we need to focus on the optimization of AI for Meta's advertising business from a long-term perspective.

3. Metaverse business losses

In order to reduce reliance on the advertising business, Google has developed its cloud business, while Meta has heavily invested in the metaverse. The difference is that Google's cloud business development has been relatively smooth, whereas Meta's journey into the metaverse has been full of obstacles.

This is mainly because the metaverse is still in the market introduction stage, and the content ecology and business ecology have not yet been developed. Most of the willing buyers are novelty users, and it is far from popularization. Therefore, Meta's reality lab (Reality Labs) in the metaverse business has low revenue, but high initial capital expenditure and operating losses, which has become a drag on Meta's profitability and cash flow.

In terms of losses, the revenue of the reality lab is generally several hundred million dollars per quarter, and it is relatively unstable. However, the operating losses can reach several billion dollars, reaching 4.28 billion dollars in Q4 2022.

From the perspective of free cash flow, due to the large amount of research and development expenses and capital expenditures required by the reality lab, it will have a relatively large negative impact on cash flow. From the Futubull app, we can see that Meta's quarterly free cash flow once dropped from over 10 billion dollars to less than 200 million dollars.

The good news is that in the recent two quarters, Meta has revealed in conference calls that it is reducing the investment budget for the metaverse business, indicating a certain shift in the company's operational focus. The operating losses of Meta's reality lab have also narrowed, and with the growth of the advertising business, its free cash flow situation has also greatly recovered.

Therefore, although the future prospects of Meta's metaverse business may be promising in the long run, there is still a lot of uncertainty, and the market is not willing to buy into a distant vision. On the contrary, the market may be more concerned about the losses brought by this business. Therefore, in the recent financial quarters, we need to pay more attention to the losses of the metaverse business and it is preferable to avoid an expansion of losses, thus affecting the overall profitability and cash flow situation.

To summarize,

User traffic is the foundation of Meta, and we can pay attention to its user base, user stickiness, and the development of competitors.

The advertising business is the absolute mainstay of Meta's revenue, and we need to pay attention to changes in the economic cycle and the added value brought by AI to the advertising business.

元宇宙業務是Meta的新發力方向，但暫時還處於大幅虧損狀態，我們需要警惕其虧損擴大的可能性。

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