Mag 7 Performed Badly, can Meta Still Hang in There?

Hello everyone, I am Dolphin Jun!

$Meta Platforms(META.US) released its financial report for the second quarter of 2024 this morning (August 1st Beijing time). Due to Google setting the benchmark and the recent collapse of little brother PINS, the market sentiment before Meta's financial report was not particularly high.

In line with expectations, the market was not as optimistic about Meta as it was for Google and Pinterest. It was precisely due to the relatively cautious expectations that there was a "small pleasant surprise" in the actual performance: current advertising revenue and guidance both slightly exceeded expectations, second-quarter Capex was lower than expected, the upward revision of the full-year guidance was within expectations, and Opex did not increase the full-year guidance.

Key points of the financial report:

1. Is Q2 a real turnaround or were expectations too conservative?

For the most concerning advertising revenue in the second quarter report, the current growth rate was +22%, with guidance for the next quarter at +13% to +20%, both slightly exceeding expectations, which can be seen as a reassurance for the market.

However, in comparison with industry expectations, Dolphin Jun believes that the market's expectations for Meta are somewhat conservative. In comparison, the market's expectations for YouTube and Pinterest are more demanding in terms of year-on-year growth compared to the first quarter, while being more lenient towards Meta.

Looking at the performance feedback of Meta over the past two years, Dolphin noticed a clear pattern that the market pays more attention to Meta's advertising revenue growth rate than any other indicator. When this primary indicator is not satisfactory, only then will they start scrutinizing the always high Capex.

Therefore, with the Capex guidance for the full year raised again in Q2, and the clear statement of significant growth in 2025, the market does not seem to have shown a negative reaction. However, considering Google and Microsoft's emphasis on AI investments — it's better to over-invest than to miss out, part of the expected reaction has already been reflected at that time. Furthermore, with Zuckerberg frequently expressing positive views on AI and hosting discussions with Jensen Huang, it seems almost certain that Meta's increase in Capex is a foregone conclusion.

2. Why did Temu abandon YouTube for Meta?

In the second quarter, Meta's advertising revenue growth rate was 21.7%, which, due to a high base, slowing down to 26.8% from the first quarter is considered a normal trend, while the market expected only 19.3%.

However, at the same time, YouTube's growth rate dropped from 21% in Q1 to 13% in Q2, falling below the market's expected slowdown to 16%. Google's management explained that last year, the high base was due to the start of e-commerce advertising in the Asia-Pacific region.

But then again, Meta also received a large amount of marketing spending from Temu and Shein starting from Q2 last year. Why didn't Meta's base issue significantly drag down the current growth rate?Apart from the boosting techniques such as Advantage+, why is Meta less affected purely from a business perspective?

According to research and data from third-party platforms, the advertising placements of Temu+Shein on Meta's platforms are clearly still growing (although the growth rate is slowing down), but the scale of advertising placements on YouTube has directly declined year-on-year.

Combining research from advertising agencies, Dolphin believes that in the second year after Temu aggressively expanded its customer acquisition across all platforms, whether due to user saturation in the U.S. region or geopolitical risks, the strategic shift from "slowing total budget growth rate + marketing strategy shift = structural placements" is perceptible.

Based on Pinduoduo's approach in China to brand building, customer acquisition, and long-term operations, Dolphin believes that the evolution of Temu's marketing strategy mainly transitions from "marketing methods to enhance user brand awareness and customer acquisition" to "marketing methods to increase engagement of existing users" and potentially to "internal cash incentives/shopping subsidies to boost user activity" in the future.

In terms of advertising platforms, this corresponds to a shift from benefiting the entire industry to only benefiting platforms that align with Temu's current marketing strategy. Currently, in the stage of enhancing the activity of existing U.S. users, Meta, with its high social stickiness and massive traffic, can still dominate. However, when Temu shifts to internal cash subsidies as a means to promote user activity later on, we believe Meta will face a situation similar to YouTube in Q2.

3. VR remains lackluster, can AR glasses gain traction?

Reality Labs' revenue in the second quarter related to VR was $353 million, a 28% year-on-year growth with stable growth rates. Without new products, it is difficult for VR revenue to advance. The AR smart glasses Ray-Ban, priced at $299 in May, were launched in North America, with reports indicating strong sales and an expected Q2 sales of over 500,000 units, with an annualized expectation of 2 million.

As a result, the market's original expectations to drive more revenue growth for Reality Labs fell short of the market's expectation of a 37% year-on-year growth, with actual performance showing a 28% year-on-year growth.

4. The cycle of layoffs for efficiency improvement has ended

In the second quarter, Meta Group achieved an operating profit of $14.85 billion, with a profit margin of 38%, a 58% year-on-year growth. Such high growth rates mainly stem from the optimization of operating expenses, with sales and administrative expenses in Q2 significantly declining, leading to Meta's operating profit margin increasing from 29% in 2Q23 to 38% in Q2 this year.

However, the company had already indicated in the previous quarter that there would be a recovery in employee recruitment this year with a slight increase trend. Among the three expenses, although administrative expenses and sales expenses are still significantly declining year-on-year, research and development expenses have resumed accelerated growthTherefore, we expect that with more Capex investment, as each cost item is confirmed later, the pressure on profit margins may be further affected.

5. Performance Indicators Overview

Dolphin's Viewpoint

For the performance in the second quarter, with the precedents of Google and Pinterest, the market's original script was—

Worries about the weakening of advertising revenue due to reduced advertising placements by Temu & Shein in social ads, especially if guidance is lower than expected, while the cost reduction and efficiency improvement cycle ends, Opex reflects AI cost confirmation, and increased Capex spending plans for the logic of "prefer overinvestment". The interpretation of revenue and expenses in opposite directions leads to a two-way compression of profit margins.

In reality, Meta did not completely follow the script:

1) Mark Zuckerberg, who has recently expressed optimism about the future of AI, did raise the expenditure guidance range for the full year 2024, but the capital expenditure for Q2 was lower than market expectations, and the range of total operating expenses guidance for the full year 2024 was not raised.

2) At the same time, the advertising revenue that the market was originally concerned about, at least from the perspective of the total revenue guidance range, has steadily exceeded expectations.

Therefore, from the perspective of expectations, this performance is slightly favorable for investors in the short term. However, Dolphin also needs to remind that compared to Google and Pinterest, the market's expectations for Meta's performance in the second quarter are already low and cautious. After YouTube and Pinterest both fell short of expectations in terms of advertising revenue, the market's expectations for Meta's performance became even more conservative.

Dolphin believes that, although they are all social platforms, Meta and the other two platforms have differences in advertising effectiveness for advertisers. YouTube and Pinterest lean towards brand advertising (user mindset) and direct response advertising (direct customer acquisition), while the larger social traffic of FB and IG can activate existing users repeatedly through operating accounts to carry out marketing activities, which may be the change in marketing investment strategy after Temu's monthly active users in the U.S. no longer grow rapidly. However, this is precisely where YouTube (low social attributes, lower stickiness than IG) and Pinterest (small traffic) do not have outstanding advantages.

Therefore, Dolphin believes that, the better-than-expected performance in Q2 can correct Meta's short-term market sentiment. But the revenue and capital expenditure guidance provided by Meta also confirms the logic of our trend in profit changes—pressure on advertising growth in the second half of the year (high base + macro weakness + Temu's user activation method shifting from external marketing to internal direct cash subsidy marketing), and the gradual confirmation of AI incremental costs will weaken profit margins in both directions. This means that after the short-term valuation P/E is repaired to a neutral position that matches the growth rate (CAGR 15%~18% for 2024-2026), further upward movement will increase the risk of facing EPS downward revisions in the second half of the year.**

In the past few days, including after-hours trading today, Meta's market value has also recovered significantly. Currently, the implied 25-year P/E ratio is 20x, corresponding to a CAGR growth rate of around 15% for 24-26 years. This means that the short-term valuation repair is almost complete. In order to return to the previous high levels, a stronger macro consumption environment is needed under the pressure of a high base, or encountering a new "Temu/Shein", but obviously this condition is not present at the moment.

Of course, short-term adjustments do not mean that Meta will have no highlights in the future. Taking a longer-term view, the combination of AI+AR+social can still bring many possibilities. We do not make synchronous adjustments to Meta's medium to long-term valuation, but based on the turning point of weakening macro margins, higher base numbers, and increased cost expenditures, we recommend paying attention to the risk of short-term EPS downward revisions.

Detailed analysis is as follows:

I. Under the conservative expectations, advertising presents "small joys"

In the second quarter, Meta's revenue was 39.1 billion, a year-on-year increase of 22%, which experienced a certain normal slowdown due to the higher base. The main area that exceeded expectations is still the advertising business, accounting for 98% of the revenue. The VR market was originally expected to contribute a lot of incremental revenue through AR, but the actual Reality Labs revenue fell short of expectations.

Guidance:

(1) Total revenue slightly exceeds expectations

Meta's management expects a range of 38.5-41 billion in total revenue for 3Q24, corresponding to a year-on-year growth of 13%-20%, with the median slightly higher than the market consensus of 39.2 billion. If Meta's guidance this time follows its usual conservative style, then the implied revenue outlook for the next quarter will be close to the upper end of the range, indicating a good performance in year-on-year growth.

On one hand, this indicates that Meta still has high confidence in its advertising business, and on the other hand, it may have good expectations for the revenue generated by AR glasses in Q3.

1. Advertising business: Decrease in volume, increase in price

For the advertising business, it is always preferable to analyze the trends of changes in volume and price growth in the current period, which helps to better understand the current macro environment, competition, and other issues.

(1) The growth rate of advertising impressions has significantly slowed to 10%, but the user base is still expanding (total daily active users in the ecosystem increased by 6.5% year-on-year), resulting in only a slight increase of 3% in the average impression per user.

In theory, Reels is a period of rapid ad fill, so the sudden slowdown in impressions may indicate that Meta is deliberately tightening the faucet (ad inventory) in order to maintain high CPM within the platform, thereby optimizing its profit ROI.

Due to the fact that Facebook's main site and ecosystem's monthly active users have not been disclosed since Q1, but the regional distribution remains relatively stable, with user growth coming from international regions such as Asia-Pacific.

(2) Accelerated 10% growth in advertising unit price

As we mentioned before, the advertising unit price is related to whether the economy is in an upswing cycle and whether the platform's competitive advantage has improved, but this is under the condition of stable traffic on the Meta platform.

In the past year, although Reels has contributed new advertising inventory, the pricing within the ecosystem has been relatively low due to ROI issues. However, with the increase in AI video content recommendation ratio (reaching 50% in 1Q24), the accuracy of advertising and conversion rates have also improved to some extent, providing natural momentum for price increases. In the second quarter, the macro environment remains strong, and most peer platforms are also increasing their prices.

In the second quarter, Meta's comprehensive CPM growth rate reached 10% (vs 4Q23 6%), further accelerating from the previous quarter. Third-party platforms show that IG's CPM pricing growth rate is rebounding. However, after entering the third quarter, there are clear signs of early weakening in overall CPM.

The impact of the base period of Reels' initial monetization in the third quarter is coming to an end, and the slowdown in CPM growth at this time likely reflects the macro environment or deteriorating competitive landscape. From actual performance, the current decline in CPM is more closely related to the weakening of the macro environment.

2. Can AR glasses take on a big role?

In the second quarter, despite the strong sales of Ray-Ban, VR revenue overall showed "no surprises," with a 28% growth rate compared to the previous quarter's 30%, which is relatively stable but below market expectations.

Combining IDC data and revenue calculations, assuming that 500,000 Ray-Ban units were sold in Q2, it is estimated that sales of the Quest series in the first half of the year were very poor, with Q2 basically at the lowest level since 2021 (all estimates by Dolphin, for trend reference only)

II. There is an upward trend in expenses, and the cycle of layoffs for efficiency improvement has ended

With the continuous increase in Meta personnel and indications that there will be a significant number of new hires this year, it indicates that the dividends from layoffs for efficiency improvement are no longer available. In the second quarter, the number of employees was 70,799, with a net increase of 1,470 compared to the previous quarter, accelerating expansion.

In the second quarter, operating expenses were within expectations. Although there was no further increase in the guidance range for full-year Opex, the increase in research and development expenses indicates a certain degree of rising employee costs. Sales and administrative expenses in the second quarter are still being restrained in adjustment, possibly to balance the pressure brought by the growth in research and development expenses.

Although the gross profit margin barely maintained stability at 81.3% in the second quarter, following the seasonal pattern (Q2 is generally a peak season with higher absolute revenue and relatively higher gross profit margin compared to Q1), we speculate that the gross profit margin in Q2 was definitely affected by the drag of AI cost recognition.

Ultimately, in the second quarter, Meta's operating profit margin was 38%. Looking at the two major businesses of advertising and VR, as expected by the company management, the losses in VR are still expanding. To significantly reduce losses, there is a need for a major product to sell well.

However, in the short to medium term, due to unresolved issues regarding whether the technology is disruptive and the problem of lackluster demand, there is currently no potential hardware in sight. Although the market expectations for Ray-Ban are high, the limited unit price and the need for a complete content ecosystem in the future cannot support a substantial reduction in losses in the short term for the RL business.

Dolphin Investment Research "Meta" Historical Articles:

Financial Report Season (Past Year)

April 25, 2024 - "Meta: Plans to Invest in AI for Years, Not Overly Concerned About Short-Term Profitability (1Q24 Earnings Call Summary)"

April 25, 2024 - "Meta: Nightmare of Sharp Decline Coming Again? Shocking More Than Thrilling"

February 2, 2024 - Earnings Call - "Meta: Stable and Strong Advertising, Maintaining Continuous Investment, Striving to Become the Next Generation Computing Platform (4Q23 Earnings Call Summary)"

February 2, 2024 - Financial Report Review - ""Surging" Meta: Exploding Expansion in China, Mark Zuckerberg Generously "Gifting""

October 26, 2023 - Earnings Call - "Meta: Significant Contribution from Chinese Advertisers (3Q23 Earnings Call Summary)"

October 26, 2023 - Financial Report Review - "Meta: Strong Return of Advertising, Why Isn't the Market Buying It?"

July 27, 2023 - Earnings Call - "Meta: Focusing on AI Empowerment, Not Just Commercialization (2Q23 Earnings Call Summary)"

July 27, 2023 - Financial Report Review - "TikTok Fading, Meta Completely Reborn"

April 27, 2023 - Earnings Call - "The "Efficiency Year" Shows Good Execution Results, Reels Making Waves (Meta 1Q23 Earnings Call Summary)"2023 年 4 月 27 日财报点评"Meta: Crossing the Tribulation and Resurrecting at Full Health"

2023 年 2 月 2 日电话会"Full of 'Efficiency', Mark Has Learned to 'Behave' (Meta 4Q22 Earnings Call Summary)"

2023 年 2 月 2 日财报点评"Good News Stacking Up, Meta's Gorgeous Turnaround?"

2022 年 10 月 27 日电话会"Despite Being Criticized for 'Encirclement', Mark Still Insists on Betting on the Metaverse (Meta 3Q22 Earnings Call Summary)"

2022 年 10 月 27 日财报点评"Meta, the Stubborn One, Continues to Bet Big on the 'Metaverse' Despite Severe Losses"

2022 年 7 月 28 日电话会"Macroeconomic Environment, Apple ATT, Multiple Headwinds in Competition, Management's Short-Term Outlook Is Very Conservative (Meta Earnings Call)"

2022 年 7 月 28 日财报点评"No 'Google-Style' Reversal in Expectations, Meta's Decline Is Hard to Hide"

2022 年 4 月 28 日电话会"To Address Competition, No Rush to Commercialize Reels (Meta Earnings Call Summary)"

2022 年 4 月 28 日财报点评"Skyrocketing - a Change of Faith? Meta's Turning Point Has Not Yet Arrived"

2022 年 2 月 3 日电话会"Can We Expect Reels to Reactivate Meta User Growth Like Stories Did 3 Years Ago? (Earnings Call Summary)"February 3, 2022 Financial Report Review " From Bad to Worse, Facebook Becomes "God of Misfortune" After Renaming to Meta "

In-depth Analysis

December 8, 2023 " The Love-Hate Relationship Between Meta and Chinese Concept Stocks Going Global: TikTok Challenges, Temu Offers "

June 27, 2023 " TikTok Stumbles, Meta Feasts "

February 21, 2023 " US Stock Market Advertising: After TikTok, Will ChatGPT Spark a New "Revolution"? "

July 1, 2022 " TikTok Wants to Teach the "Big Brothers" How to Work, Google, Meta Are About to Change "

February 17, 2022 " Internet Advertising Overview - Meta: Low Combat Power is the Original Sin "

September 24, 2021 " Apple Strikes First, Is Facebook the First "Big Player" to "Bleed"? "

August 6, 2021 " Facebook: Digging Deeper into the "Golden Business Value" of the World's Top Internet Users Harvesting Machine "

November 23, 2021 " Facebook: Heavy Investment Shift to "Meta", Turning Point Not Far After Double Pressure "

Risk Disclosure and Statement of this Article: Dolphin Research Disclaimer and General Disclosure