Meta Q3 Review: Mountain Of Problems
Summary:
- While Meta Platforms had a solid quarter in terms of revenue and profits, the company is facing legal troubles and regulatory restrictions, posing large financial and reputational risks.
- Apple’s privacy changes continue to threaten Meta’s revenue growth by limiting its ability to target and measure ads on iOS devices.
- Meta’s ad sales are sensitive to economic and geopolitical uncertainties, with ad spending declining during periods of instability. The world is getting more crazy, not less. This will impact them.
Investment Thesis
Meta Platforms (NASDAQ:META), the parent company of Facebook, Instagram, and WhatsApp, is facing several challenges that will restrict its short-term revenue growth. While the company has seen its stock price increase almost 250% since November 2022, there are concerns about Meta’s business practices and ability to monetize its platforms moving forward.
Legal troubles from regulators, lawsuits related to allegations of unethical business practices targeting children, and violations of privacy laws present financial and reputational risks.
In addition, the loss of ad revenue and targeting capabilities from Apple’s privacy changes has been a continuing issue. Meta heavily relies on advertising, which is being disrupted.
Finally, recent geopolitical conflict shows the business model’s sensitivity to global conflicts and economic uncertainty, which can temporarily depress ad spending on Meta’s platforms.
Though the company is investing heavily in new technologies like AI (and has great partnerships), along with continuing Metaverse bets, meaningful traction will take time. In the near-term, Meta is more vulnerable due to the factors above constraining its core advertising business. Meta’s stock has seen a major increase of 237% since November 2, 2022, therefore, caution is warranted given the challenges to short-term growth. In my opinion, this is a short term hold until these uncertainties start to clear.
Good Earnings, But Legal Troubles Present Risks
On the surface, Meta’s Q3 earnings results look like a solid beat. The company reported earnings of $4.39/share easily beat estimates of $3.60, and revenue of $34.15 billion also surpassed estimates of $33.52 billion. Both represent strong growth from the year ago period.
However, this Q3 recap isn’t just about a recap of the earnings call. This is about a recap of the other things that happened with Meta recently, and their implications. Recent lawsuits are a big deal.
Meta is navigating through multiple lawsuits and regulatory challenges stemming from claims of privacy law violations and the introduction of features that are purported to be potentially addictive for children.
Recently, a bipartisan group of 42 state attorneys general sued Meta, alleging that features on Facebook and Instagram are intentionally addictive and harm children. This demonstrates the broad legal risk Meta faces on the child safety issue. The lawsuit accuses Meta of violating privacy laws by data mining underage users.
Meta also faced restrictions back in March of 2022 from new laws like the Digital Services Act (DSA) in the EU, which prohibited targeting children with ads and imposed transparency requirements on algorithms. The DSA posed compliance costs and still remains a barrier to Meta’s greater ad targeting capabilities.
On top of regulatory action, in December 2022, Meta faced a lawsuit from shareholders alleging the company made false statements about its privacy controls and exposed user data to the UK-based consulting firm Cambridge Analytica.
The new lawsuits and investigations, combined with new regulatory limits, presents financial risks from potential fines and damages. More importantly, Meta’s reputation could be damaged by the perceptions it faces in these lawsuits. This ongoing series of legal actions and legislative measures consistently aimed at Meta, could definitely be cause for concern. It appears as though the company is facing a relentless bombardment of legal obstacles that affect a sensitive revenue model. This could make attracting users and advertisers more difficult. Until Meta resolves its legal troubles, its growth faces uncertainty.
The lawsuits are no joke. Previous lawsuits have resulted in billions of dollars in fines when the rules were weaker. The laws around these lawsuits are getting tougher, meaning that future judicial actions will have more teeth -and likely more financial pain.
Revenue Threatened by Apple Privacy Changes
Meta outlined on its Q3 2023 earnings call that revenue growth has slowed substantially, rising just 23% year-over-year versus 56% growth in Q3 2021 (Q3 Earnings Call). One factor restraining revenue is Apple’s privacy changes on iOS devices. In 2021, Apple began requiring apps to ask iOS users for permission to track their activity across apps and websites owned by other companies. Given most iPhone owners opted out of tracking, Meta’s ability to target and measure ads on iOS dropped significantly and continues to show its sensitive business model.
As mobile engagement grows and Apple further tightens privacy controls, changes like the 2021 policy will continue hampering Meta’s ads business. Meta is heavily reliant on highly targeted advertising, but privacy initiatives by Apple, regulators, and other tech companies will durably erode some of these capabilities over time. When a company is carrying tougher brand characterizations, combined with an ad revenue model that involves making sure advertisers are happy to advertise on their platform (and the perception among consumers), the combination becomes challenging. These privacy controls will likely not go away.
Sensitivity to Conflict Causing Near-Term Revenue Declines
In Q3 2022, Meta experienced its first ever year-over-year revenue decline due to pullbacks in ad spending amid the Ukraine war and weakening global economic conditions. This illustrated the sensitivity of Meta’s ad sales to economic and geopolitical uncertainties.
On the Q3 2023 earnings call, Meta CFO Susan Li said ad spending trends have already softened in Q4 2023 correlated to heightened conflict in the Middle East, echoing the sensitivity seen last year. Though Meta does not have high direct exposure to affected regions, its global ad business appears prone to slowing during periods of instability. Snapchat indicated similar issues on their earnings call earlier this week. This geopolitical issue is systemic.
If major economies enter recessions in 2023 or conflict escalates, Meta’s revenue growth would likely face renewed pressure. Advertising tends to decline during downturns as brands reduce budgets, presenting a near-term headwind.
Until the economy stabilizes and geopolitical tensions ease, Meta is more vulnerable to revenue declines. These sensitivities will add volatility to growth over the next year. Nevertheless, Meta’s endeavors to diversify its revenue streams hold the potential to alleviate the cyclical nature of ad spending in the long run, particularly given that a substantial 95% of their total revenue currently hinges on advertising.
Outlook Clouded Despite Metaverse Bets & Bing Integration
Meta is investing heavily in futuristic platforms like the metaverse to establish new revenue streams beyond digital advertising. However, these emerging technologies are unlikely to contribute meaningful sales for years.
Meta’s Reality Labs segment, which contains its VR and AR hardware and metaverse investments, generated only $210 million in Q3 2023 revenue, which is down 26% primarily due to lower Quest 2 sales. Most importantly, this division racked up $3.7 billion in operating losses (Q3 earnings transcript). Meta CFO Susan Li confirmed that Reality Labs losses will increase in 2023 as product development continues (Q3 earnings transcript).
Between major redesigns to its ads systems to adjust for privacy changes and its experimental metaverse projects, Meta is in an investment cycle. Profits and free cash flow have declined as Meta spends aggressively on uncertain future opportunities.
In addition, investments around their partnership with Microsoft’s (MSFT) Bing will yield powerful tools and in time will have massive potential. But doing it right is important, this takes time. Their last major rollout (Threads) did not get the traction that was first expected.
The payoff timeline for Meta’s bets is likely measured in years, provided they gain mass adoption. In the near-term, growth will be challenged until Meta’s investments bear fruit.
Conclusion
Meta faces a rocky short-term outlook as legal troubles, economic volatility, and big technology bets cloud its near-term growth. Revenue is expanding more slowly as ad targeting capabilities are restricted. Periodic pullbacks in ad spending amid global uncertainty also present headwinds. The business model could be more feeble than first thought.
However, Meta retains enormous scale with 3.96 billion monthly users across its apps at the end of Q3 2023. It also continues to deliver operating margins near 40% even with heavy investment (Q3 earnings call). Once Meta resolves its legal issues and adapts its ad systems to privacy changes, sustained long-term growth is achievable.
But in the upcoming several months, upside for the stock looks limited, especially after a 237% surge since November 2, 2022. Meta trades at a reasonable 22x forward earnings due to its growth hiccups and legal risks. With legal and regulatory risks in full view and near-term growth constrained due to a potential war in the Middle East, caution is warranted on Meta’s stock.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Noah Cox is the Co-Managing partner of Noahs' Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.