Meta Platforms$Meta Platforms, Inc.(FB)$ is facing challenges on multiple fronts. Can it overcome them?
Let me start off this article by saying that I have a vested interest in Meta Platforms – the company formerly known as Facebook – and I’m still optimistic about its future. But I am also cognizant of the many challenges that the company faces.
In light of this, and with the company’s stock price falling hard in recent months, here are some of these challenges and my thoughts on what the company needs to do to overcome them.
Flattening user engagement
In the fourth quarter of 2021, the parent company of Facebook and Instagram reported a decline in the number of daily active users.
This was the first-ever quarter where daily active users for Facebook ended the quarter lower than where it was at the start of the quarter.
While the daily active users declined just 1 million from 1,930 million to 1,929 million, it is still a worrying stat.
Facebook has built a giant network that has gotten stronger with each additional user. However, a decline in engagement could lead to a vicious cycle. This is because the engagement levels are only as strong as the content that is on the Facebook platform.
If users leave, it reduces content. Less engaging content results in more users leaving, which in turn leads to even lesser content. This could have a downward-spiraling effect on Facebook. Although the risk of this problem becoming out of control is low, it is still a possibility.
Meta Platforms’ CEO and co-founder, Mark Zuckerberg, pointed out during the latest earnings conference call that shifting consumer preference for TikTok has been one of the big challenges for Facebook and is one of the reasons why the daily active user count has declined.
With Facebook currently contributing a large chunk of Meta Platforms’ overall advertising revenue, this is a real existential problem for the company.
I think Zuckerberg and his team have taken some practical steps to address the issue, such as rolling out Facebook and Instagram’s very own TikTok copycat short-form video service, Reels, which has proven to be a major hit. Reels is growing fast and Zuckerberg has even named Reels as “the biggest contributor to engagement growth.”
There is still a long way to go to compete with TikTok as many people who use both apps tell me that TikTok has better short-form content on its platform. Nevertheless, Meta has the advantage of having a larger user base now and if executed well, Reels will be able to wrestle some of that attention back to Facebook.
Changes to ad tracking
With increasing scrutiny towards data protection, there have been significant changes made to prevent the tracking of user behaviour.
In 2021, Apple released changes to iOS which limited Meta Platforms’ ability to track user behaviour outside of its own 1st-party websites. The changes resulted in a lower ability for advertisers to measure the efficacy of ads.
This has significantly handicapped Meta Platforms as many Facebook and Instagram marketers depend heavily on ad tracking. Facebook advertisements are often for performance marketing, which is driven by immediate results. Without the ability to track the efficacy of their Facebook marketing campaigns, marketers may lower their net spend on Facebook and Instagram.
Meta Platforms’ management said during the latest earnings call that it anticipates the iOS changes to have a US$10 billion revenue impact in 2022. In 2021, Meta Platforms’ total revenue was US$114.9 billion, so US$10 billion is a high single-digit percentage of the company’s overall revenue.
Although the near term impact is significant, the good news is that management is taking some steps to address the issue. Sheryl Sandberg, COO of Meta Platforms, said:
“So when we talked about mitigation, we’ve said there are two key challenges from the iOS changes: targeting and measuring performance. On targeting, it’s very much a multiyear development journey to rebuild our ads optimization systems to drive performance while we’re using less data. And as part of this effort, we’re investing in automation to enable advertisers to leverage machine learning to find the right audience with less effort and reduce reliance on targeting. That’s going to be a longer-term effort.
On measurement, there were two key areas within measurement, which were impacted as a result of Apple’s iOS changes. And I talked about this on the call last quarter as you referenced. The first is the underreporting gap. And what’s happening here is that advertisers worry they’re not getting the ROI they’re actually getting. On this part, we’ve made real progress on that underreporting gap since last quarter, and we believe we’ll continue to make more progress in the years ahead.”
There is still a lot of work to do but given management’s long-term track record of excellence, I am optimistic that the team is up for the challenge and has taken the right steps to improve its ad targeting and tracking.
Rising costs
Lastly, there will be rising costs due to Meta Platforms’ investments in its metaverse projects. Investors are concerned about the amount of money that the company would be burning on these projects. In 2021, Meta Platforms burned through US$10.2 billion on its “Reality Labs” segment, which houses the company’s metaverse-related projects. Zuckerberg mentioned that he thinks building this segment will cost US$10 billion a year for a few years. Even for a company as large as Meta Platforms, this is a big investment to make.
Even though Meta Platforms is in good financial shape now, what investors are more concerned about is whether this investment will pay off or would it be better spent on share buybacks, dividends, or other investments.
I think the revenue potential for the metaverse, if materialised, is enormous and Meta Platforms is in a good position to win its share of the spoils. But only time will tell if the company can execute. For now, I’m happy to trust Zuckerberg’s vision for the future.
Final thoughts
Meta Platforms is facing challenges on multiple fronts. The stock price is currently reflecting that with the stock price well below its all-time highs and down more than 30% year-to-date.
On a positive note, Zuckerberg and his team have, over the life of Meta Platforms’ existence, overcome numerous other challenges before. The company’s stock is also trading at just 15.5 times trailing free cash flow and the company has US$48 billion in cash and short term investments.
This translates to a chunky 6.5% free cash flow yield. At this price, I think the risk-reward potential looks very promising.
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