META: Digital Advertising Business

Photo by Dima Solomin on Unsplash

Disclaimer: I am not a professional financial advisor. All financial opinions written in this article are from my personal research and experience, and it is not a recommendation to buy or sell the stocks. 

Brief History

META brief history. Source: META’s company profile.

Facebook, or now META (changed in 2021) was founded in 2004. It was one of the world’s most successful social media platforms. From 2004 to 2020, it acquired many new companies, including Instagram, Messenger, WhatsApp, Oculus, and others. Despite the fact that some of the products have been or will be discontinued, ex: Libra/Diem (Digital Currency) and Novi (Payment Wallet). 

Facebook’s main business, like many other digital platforms, was advertising, but in 2019, they added a new revenue stream called Reality Labs, which is a virtual reality and augmented reality hardware and software.

Revenue Structure

Estimation of META’s revenue by portion.

In META’s annual report, revenue is grouped into two categories: FoA (Family of Apps) and RL (Reality Lab).

• FoA (98%): All of META’s digital advertising products, excluding virtual reality products, such as WhatsApp, Instagram, Messenger, and so on.
• RL(2%): Oculus hardware and software-related stuff.

Note: Keep in mind that the number for Whatsapp and Instagram revenue is purely an estimation gathered from various resources.

META’s Revenue. Source: META’s Annual Report.

Revenue has been increasing for the past decade. This is a good sign.

META’s operations income. Source: META’s Annual Report.

Since 2019, the new segment, RL or Reality Labs, has been included in the annual report. Reality Labs currently contributes about 1–2% of revenue.

However, after deducting revenue from costs and expenses, the total income from operations is still reporting a loss, and management has stated that this condition will continue for some time. Reality Labs’ operational costs reduce income by 14–17%.

Q2 2022 earnings call -> RL income, driven primarily byOculus Quest 2 sales.

META’s revenue by geography. Source: META’s Annual Report.

Looking at revenue by geography from 2016 to 2021, the majority of it is still generated in the United States.

In 2021, Europe will still include Russia and Turkey, while the Rest of the World will include Africa, Latin America, and the Middle East. However, in the earnings call for Q1 2022, they stated that META had been blocked by Russia, which caused a revenue drop in Q2 2022.

META’s Q2 earnings report. Source: META Q2 earnings report.

META’s explanation for the revenue decline in Q2 2022:

• Due to the Ukraine-Russia war, access has been restricted, resulting in a significant drop in Europe DAU and MAU.
• Economic downturn
• Foreign Currency Exchange headwinds, 3–4% loss, because dollar strengthens against other exchange rates. 
• Q2 2022 earnings call -> “Had foreign exchange rates remained constant with Q2 of last year, total revenue would have been approximately $1.3 billion higher”
• Some content is replaced with Reels content in order to increase growth and engagement with Reels; however, reels are not yet monetized at the same rate as Stories or Feed.

META’s revenue by geography. Source: META Q2 earnings call.

We can see that Europe’s revenue is declining in Q1 2022 and dropping even more in Q2 2022. Approximately -12.7% from the previous year.

Whatsapp, Telegram, and Viber are the top three messaging apps in Russia. This is merely an assumption based on a number of findings.

According to Megafon, Telegram has surpassed WhatsApp as Russia’s most popular messaging app in the first quarter of 2022.

WhatsApp — Revenue

Estimation of WhatsApp Revenue & Price per conversation. Source: Metrics & Rates

WhatsApp makes money from users’ business accounts when initiating conversations with customers.

There are 2 types of conversations on the WhatsApp Business API, each with different rates (1000 free conversations per month for the free tier):

• User-initiated: A conversation that initiates in response to a user message. Any time a business replies to a user within the 24-hour customer service window, that message will be associated with a user-initiated conversation.
• Business-Initiated: A conversation that initiates from a business sending a user a message outside the 24-hour customer service window. Messages that initiate a business-initiated conversation will require a message template.

In 2021, it generated $8.7 billion in revenue, almost all from the WhatsApp for Business app.

WhatsApp — Users

WhatsApp Users. Source: Business of Apps

WhatsApp is one of the most used apps in the world and the most popular messaging app in over 100 countries. It reached 2.2 billion active users in 2021. It was particularly popular in India and Brazil.

WhatsApp Pay

Free for Consumers, Not For Businesses.

Only recently merchants have access to use WhatsApp Pay in their WhatsApp Business Account. While Users can send and request money to their Contacts without any additional charge, businesses must pay a 3.99% fee per received transaction.

There are limitations to using Whatsapp Pay:

• Limited amount per transaction
• Limited amount per month
• Limited times transactions per day

Instagram — Revenue

Estimation of Instagram’s Revenue. Source: Business of Apps

• Instagram Cost per Click (CPC) Instagram CPC ranges from $0.40 to $0.70 for all metrics. CPC considers all user clicks on an ad, including link clicks, likes, reactions, comments, and shares. Instagram CPC ranged from $50 to $0.95 in 2021 for ads with a destination URL.
• Instagram Cost per Engagement (CPE) Instagram CPE tends to range from $0.01 to $0.05.
• Instagram Cost per Impressions (CPM) Instagram CPM tends to range from $2.50 to $3.50 to improve the performance of your advertising campaigns and relevant ad sets. Facebook tends to have twice as many CPMs as Instagram. Instagram has more CPCs than Facebook.
• Checkout on Instagram Currently only available to US businesses. Instagram makes money by charging transaction fees on these sales. They typically charge 5% per shipment or a flat fee of $0.40 if shipments are less than $8.00.

Instagram — Users

Instagram Users. Source: Business of Apps.

• 70% of Instagram users are under 35 years old, but similar to Facebook, the percentage of users over 35 has increased every year since 2018.
• Almost half of all Instagram users are in the Asia-Pacific region, with India and Indonesia two of the five largest markets in terms of active users.

Facebook Messenger — CTM (Click-to-Messaging)

Facebook Messaging

Click-to-Messaging: 40% of advertisers already using this format.

META estimates that 1 Billion users are messaging with a business each week across Family of Apps. In the Q2 earnings call, META stated that they wanted to push this method since the CTM is proving particularly popular with SMBs in emerging markets like Brazil and Mexico.

Facebook Messenger — Users

Messaging app users. Source: Business of Apps.

Facebook Messenger is popular in India, Brazil, the US, and the UK.

Seasonality Revenue

Average Revenue Per User (ARPU). Source: META’s Annual Report.

Revenue is traditionally high in the fourth quarter of each year, owing to seasonal holiday demand.

This reflects significant revenue growth between the third and fourth quarters and a decrease between the fourth and subsequent first quarters.

For example, between the third and fourth quarters of 2021, 2020, and 2019, META's total revenue increased 16%, 31%, and 19%, respectively, whereas total revenue for the first quarters of 2021, 2020, and 2019 decreased by 7%, 16%, and 11%, respectively, compared to the fourth quarters of 2020, 2019, and 2018.

Cost Structure

META’s cost structure. Source: META’s Annual Report.

Cost of Revenue

• Expenses related to the delivery and distribution of META products -> operation of META data centers and technical infrastructures, such as depreciation expense on servers, network infrastructure, and buildings, as well as payroll and related expenses, which include share-based compensation for employees on operations teams, as well as energy and bandwidth costs
• Costs associated with partner arrangements, including traffic acquisition costs and credit card and other fees related to processing customer transactions; RL cost of products sold; and content costs.

R&D expenses: payroll and related expenses, which include share-based compensation and facility-related costs for employees on engineering and technical teams, account for the majority of expenses.

G&A primarily consists of legal-related costs, which include accruals for estimated fines, settlements, or other losses related to legal and related matters, as well as other legal fees.

Marketing and sales expenses are primarily made up of marketing and promotional costs, as well as payroll and related costs, which include share-based compensation for employees working in sales, sales support, marketing, business development, and customer service.

Q2 2022 Earnings Call Update:

• R&D -> increased 43%, mainly driven by hiring to support Family of Apps and Reality Labs.
• G&A -> increased 53%, mainly driven by legal-related and employee-related costs.
• “5,700 net new hires in Q2, the majority in technical functions”

Cashflow & Buyback

META’s Cashflow. Source: META’s Annual Report.

META has been repurchasing class A common stock since 2017, accounting for 60–80% of cash flows from financing activities.

The majority of cash flows from investing are comprised of:

• Property and Equipment -> server and network assets, which are reflected in the balance sheets.
• Marketable security purchases, sales, and maturities

Marketable securities (portion):

• Government securities (34.72%)
• Securities issued by government agencies (18.88%)
• Securities issued by corporations (46.40%)

META repurchased $9.39 billion of Class A common stock in the first quarter of 2022. META still had $29.41 billion available and authorized for repurchases as of March 31, 2022.

iOS ATT

Photo by William Hook on Unsplash

META executives explain in their Q4 earnings call that they expect around $10 billion in losses in 2022 as a result of iOS App Tracking Transparency (ATT).

What’s iOS ATT

Every iOS device has an IDFA, or Identifiers for Advertisers, which allows publishers and advertisers to track users using their unique mobile device ID and link a click on an ad with an app install at a later time, allowing marketing campaign results to be accurately measured.

However, Apple recently released iOS 14.5 with new privacy changes that allow users to disable/enable the ATT.

“Meta claims that the ATT hit is affecting not only its revenue but also small businesses that rely on the company’s ad services to reach the right customers.” — YahooFinance

To address the issue, META has been working on new basic ads that will allow them to better measure their ads with fewer data. META’s update on handling the aggregated event

Estimation of iOS users in July 2021: 14.8% of Facebook’s mobile users aged 18+ accessed the platform via an app on an Apple iOS device in July 2021.

META Pixel & Conversion API

The META Pixel is a piece of code that you place on your website to measure the effectiveness of your advertising by analyzing the actions that visitors take on your site.

The goal of META pixel is to increase sales and track the effectiveness of your advertisements.

How it works:

• Once you’ve configured the Meta pixel, it will record whenever someone interacts with your website. Adding an item to their shopping basket or making a purchase are examples of actions.
• These actions, or events, are received by the Meta pixel. You’ll be able to see the actions that your customers take from there. You’ll also be able to retarget those customers with future Facebook ads.
• If you use the pixel to share events with Meta, we recommend that you also use the Conversions API. The Conversions API works with your pixel to help improve the performance and measurement of your Facebook ad campaigns.
• If you use the pixel to share events with Meta, you will also be recommended to use the Conversions API. The Conversions API works in conjunction with your pixel to improve the performance and measurement of your Facebook ad campaigns.

Conversions API

The Conversions API is built to establish a direct and dependable link between marketing data (such as website events and offline conversions) and Meta from your server, website platform, or CRM.

This marketing data is used to power Meta’s ad personalization, optimization, and measurement, ensuring that your ads are shown to people who are more likely to be interested in them.

TLDR: Facebook conversions API will help you collect accurate data and improve the performance of your Facebook ads in a post-iOS 14 update world.

Why Conversions API Helps Overcome iOS ATT?

The Facebook pixel is a browser-based application. That simply means it collects information through the user’s browser.

It enables you to track conversions via your website’s server rather than your customers’ browsers. It tracks “server events” rather than “browser pixel events.”

The conversions API does not rely on cookies. That means your website visitors’ browser settings and performance don’t affect its tracking capabilities.

However, this does not imply that the pixel is no longer useful. It’s just that it’s useful in a different way. In fact, you should have your Facebook pixel in place before attempting to set up the conversions API.

Connecting the conversions API and your Facebook pixel increases your chances of registering a conversion. If you use both tools to track the same events, you may register some conversions twice. Fortunately, Facebook has a process called “deduplication” that can correct double-tracking.

Obstacles

There are numerous obstacles that META must face. From the rise of competitors in the advertising industry to lawsuits and regulations.

Reels vs TikTok (Short-Form Videos)

There is no denying TikTok’s disruptive power. In 2020, TikTok reduced some users’ engagement with Meta products.

There are some subtle differences between Instagram Reels and TikTok, but both apps essentially serve the same purpose: they allow users to quickly create, edit and share short-form video content.

META released Instagram Reels in 2020 to compete with TikTok. According to the Q1 2022 earnings call, Reels already accounted for 20% of the time people spent on Instagram. More than a 30% increase in engagement with Reels across Facebook and Instagram in Q2 2022.

Currently, META AI recommends Reels about 15% of the content in a person’s Facebook feed and slightly more than that in their Instagram feed from people, groups, or accounts that you do not follow. Do anticipate that these figures will more than double by the end of next year.

Reels are also easier to monetize, though not at the same rate as feeds or stories. According to the Q2 earnings call, META's current focus with Reels right now is increasing ad load, improving performance, and making sure ads are simple for advertisers to create. Also using AI to better understand the content published in Reels, so users can connect to the most relevant content, and marketers can show more relevant ads.

I believe META made a wise decision in introducing Reels, because Instagram feeds are primarily for social (family and friends), whereas TikTok is primarily for discovery (content creator). Instagram now has a weapon to combat TikTok with Reels. META, on the other hand, may be doomed if TikTok cracks its “social” entities.

Regulations & Privacy

• META is faced with numerous class-action lawsuits. Over 40+ listed lawsuits according to Wikipedia. As a result of a former employee’s allegations and the release of internal company documents relating to, among other things, algorithms, advertising and user metrics, and content enforcement practices, as well as misinformation and other undesirable activity on the META platform, and user well-being, META is under intense scrutiny.
• Limited Ecosystem: Google and Apple control the operating system; for example, in 2021, iOS/Apple made changes to its products and data policies that limit Meta’s and others’ ability to target and measure advertising, negatively impacting. 
• What is the significance of this? Mobile devices generate the majority of revenue. Perhaps this is one of the reasons Mark Zuckerberg wants to create Metaverse. I believe he is tired of the limitations imposed on META.
• Currently restricted to countries such as China, North Korea, Iran, and recently Russia. Hong Kong and Turkey are under heavy scrutiny.

Looking Forward

There is a lot more to learn about the META business model and its potential. For the time being, they are combating TikTok’s disruptive growth with Reels engagement; we’ll need to keep an eye on that.

They anticipate that Q3 2022 revenue will be similar to Q2 2022 revenue because the economic downturn will last longer.

Recently, META issued a $10 Bn bond, the purpose is to fund share buybacks and revamping its business.

Bond Details:

• $2.75 Bn, 2.5% Notes, maturity 2027
• $3 Bn, 3.85% Notes, maturity 2032
• $2.75 Bn, 4.45% Notes, maturity 2052
• $1.5 Bn, 4.65% Notes, maturity 2062

I also recently learned that one of my favorite value investors, Li Lu, has sold all of the META positions in the Himalaya Capital Portfolio and purchased additional Google class A and class C shares. Makes me wonder the reason why.

I can’t deny that META is currently declining overall, and gamble quite a big risk as the leading point for new technologies such as Virtual Reality and Augmented Reality. Looking ahead, I believe that with good management, META will thrive in these difficult times.

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