Amidst criticism of "group attacks", Zuckerberg still insists on betting on the Metaverse (Meta 3Q22 Call Summary)

Below are the key contents of Meta's Q3 2022 earnings call. The interpretation of the financial report can be reviewed in "Meta, Strongly Gambling on 'Metaverse' Despite Bloody Losses".

Management Report

In 2023, we will focus our investment on a few priority areas with high growth, while most other teams will remain the same or shrink in the coming year. We expect that by 2023, the company's size will be roughly the same as it is now, or slightly smaller.

The three main areas we will focus on are: AI discovery engine that drives Reels, other recommended experiences, our advertising and commercial messaging platform, and our vision for the metaverse.

Our goal is to increase the operational revenue of the application portfolio, so that even with our investment in AI infrastructure and reality labs, we can still meaningfully increase the operational revenue of our entire company in the long run. The surge in our current capital expenditure is mainly due to our AI infrastructure construction. We expect that in the long run, the proportion of capital expenditure to revenue will decrease. We expect that in 2023, the expenditure of Reality Labs will once again grow substantially, with the largest driving factor being the launch of the next generation Quest, and the completion of our recruitment work in 2022. However, we will pay the first full year salary next year.

After 2023, we hope to adjust the investment pace of Reality Labs to ensure that we can achieve the goal of increasing the operational revenue of the entire company. Our long-term capital allocation philosophy is to allocate part of the profits generated by the application portfolio to these areas of future focus, while bringing greater capital returns to shareholders.

Analyst Q&A

Q: Talk about capital expenditure and return on investment. Capital expenditure is still slightly higher than expected by investors. Can you give us some examples of where these new AI investments will be made? What is the reasonable time frame for investors to expect substantial returns from these projects?

A: We expect capital expenditures to be between 34 billion and 39 billion U.S. dollars in 2023, and our investments in artificial intelligence will drive all growth. We are very focused on evaluating the ROI of AI investments, which will determine our future level of spending. But so far, we have seen the development of AI work has a continuous and strong impact on our recommended products.

In the Q2 earnings call, we shared the progress of AI technology in expanding our recommendation model, which has increased watching time of Facebook Reels by 15%, and this growth continues. We hope to further improve watch time through this work.

In terms of advertising, we are also continuing to launch more AI and machine learning improvements in some new advertising products. These examples we have seen are very encouraging. Our level of capital expenditure investment will depend on the returns generated by our AI investments. If we generate significant user stickiness and revenue gains, we will continue to invest here. If we don't, we will adjust our spending accordingly.

Q: Can you provide us with the latest information on trends in time spent by US and global users so that investors can have more confidence in the platform's sustainability in your most traditional markets?

A: We are very pleased with the user stickiness we've seen. Reels time spent by users is increasing, specifically, both Instagram and Facebook are growing year over year in total time spent in the US and globally. We haven't specifically optimized for time spent because that would tend towards longer videos, we're actually more focused on short-form video and other types of content.

Q: You've mentioned hoping to restore revenue growth in 2023. Can you share some key drivers behind this? How much of this is macro-driven vs. driven by these projects you're working on?

A: We will continue to see significant macro headwinds in the industry, which partially depends on the broader economic and recovery picture we see. But in terms of growth, we continue to make progress in many areas, such as Click-to-Messenger ads, which are seeing strong momentum. Today, our revenue is at $9 billion, and the leading factor behind that is Click-to-Messenger ads, which are particularly important in some developing markets.

Overall, we're focused on a few areas to increase revenue as we come out of this difficult cycle. We've seen progress in many areas, but that will depend to some extent on the overall macro picture.

From a signal perspective, we won't face as much resistance next year because of the significant changes we're making on the platform now. So it won't have as big of an impact on next year's growth rate.

Q: The 2023 operating cost guidance appears historically conservative (higher). How much conservatism is in there? How flexible is the ability to adjust these costs?

A: Next year's guidance estimates a one-time expense of $2 billion in 2023, which is part of our office consolidation as we continue to rationalize our office layouts. We also expect that more than half of the cost growth in 2023 comes from operating costs and the rest from cost of sales.

In terms of operating costs, the growth in operating costs in 2023 is primarily driven by personnel-related costs from the employees we have hired by 2022, with the bulk of the hiring focused on technical and higher-level positions. So we expect slower wage growth in 2023 as a result of slower growth in total employees. We anticipate the number of employees at the end of 2023 to be roughly similar to what we have now. In terms of revenue costs, we expect the growth rate of revenue costs to accelerate in 23, driven by the devaluation brought about by the large-scale capital expenditure investments we are currently making and Reality Labs, which will launch the next generation of consumer Quest headsets later next year.

Q: How does Reels compare to News Feed in terms of retention rate? Are you a bit concerned that this is less proprietary than your previous content?

A: Reels is an incremental spending of time, so we see Reels' contribution to overall platform engagement. From a profitability perspective, we are still working to narrow the gap between Reels and Feeds and Stories, but it will take time for Reels to become a revenue driver.

As Mark said, the annual revenue run rate (ARR) for Reels on both Ins and Facebook is $3 billion, with the annual revenue run rate for the previous quarter being $1 billion, but Reels still has a negative drag on this quarter's revenue of $500 million.

Therefore, we expect it to eventually become the main driver of total revenue, but this may take 12 to 18 months. Overall, we are satisfied with the impact of Reels on the business, especially in terms of user stickiness.

Q: In terms of capital expenditures, is this year's and next year's construction a one-time event and then perhaps it can go back to around 15% of revenue?

A: I think our capital expenditure investment is part of artificial intelligence and non-artificial intelligence.

In terms of artificial intelligence, what will really drive the growth of capital expenditures in 2023 is artificial intelligence, and we will adjust the speed of future investments based on the return we can see and measure. Frankly, we hope there will be more investment opportunities here, as we expect this to be a high-return area.

In terms of non-artificial intelligence, a lot of spending is on our data centers, and we have increased investment in data centers in recent years to build before our anticipated capacity needs, which will continue in 2023. We do hope that over time, this portion of capital expenditures will become more effective, and we are actively looking for higher efficiency in this area. So I don't know if we have an accurate benchmark for the combination of these two things. I think the intensity of future capital spending will depend on the return we generate by increasing our artificial intelligence investments.

Now Reels and Discovery are currently the main resources and energy inputs, especially the commercialization of Reels. We've been through this before, like when we first added Stories or when we shifted from PC to mobile. This is a confidential document, please provide authorized access.

(Unauthorized personnel will face legal consequences.) Fixed and variable expenses in the 2023 operating cost guidance, with over 50% coming from operating expenses and the rest from business costs. So there is depreciation growth in the business cost, which is, of course, a fixed cost, and the cost increase caused by new products from Reality Labs and Quest.

In terms of operating expenses, most of the growth in operating expenses in 2023 comes from the wages of our employees we have hired already. We expect that our staff numbers will remain unchanged at the end of 2023. This is also an area where we are very disciplined. Finally, there is a $2 billion dollar office facility integration cost included in the 2023 operating costs.

Q: How do you evaluate the company's performance so far in terms of product launch, cooperation with Horizon World, and other projects compared to your expectations when you decided on the metaverse strategy a few years ago? Are they consistent with your expectations? If not, what are the key determining factors?

A: Compared to what we have done and what I expected, what we are doing is quite extensive. I think the important thing is inside, while most people see the virtual reality headset, Quest 2 is the first mainstream VR head-mounted device.

We focus on developing four major platforms.

1. The first is the social metaverse platform, where you can see early versions of Horizon and a virtual avatar system. This is an area where we iterate publicly, and development is moving fast, but obviously there is still a long way to go to meet our expectations.

2. VR is the second-largest platform. I think there will be a consumer-centric product that could reach a very large scale, but I think there will also be a work-centric product, just as you wouldn't do most of your work on a $500 device. We have more powerful computers and workstations with more technology. So we start with Quest Pro, which is just the beginning.

3. AR is the third-largest platform, which requires a lot of effort, but we believe that over time, it will create a lot of value. In this area, my main judgment is how well the R&D work is progressing. Some things are progressing better than I expected, and some things seem to be taking longer. But overall, what I mean is that there is no evidence that other companies in the world are doing better research in these areas than us, even though we have not yet released AR glasses.

4. The fourth platform is neural interfaces. Input will be a very important part of all computing platforms. We believe that when you wear glasses and walk down the street, you won't need traditional controllers anymore, you won't want your hands to hover in the air, and you won't always want to talk to things, even though that's a way we often use. Sometimes you want something more confidential.

I know sometimes when we launch a product, people say, "You spent so much money and made this thing." I think that's not the right way to think. I think we are developing many different products and platforms, and we believe we are doing leading work that will mature into different products at different rates in the next 5 to 10 years. In all of these areas, we’re making excellent progress. I think it’s critical for the future.

Given macroeconomic environment and other business performances, we’re adjusting to a range of investments. But fundamentally, my point is that while I know many people may not agree with this investment, I believe it to be a very important things. I think it would be a mistake if we didn’t pay attention to any one of these areas, and I think these areas will be fundamentally important to the future. So we’ll work to do this in a responsible way and match the growth in other businesses over time. But I think ultimately these will be very important investments for our business going forward.

I think this is one of the most historically significant things we’re doing, and I think people will look back on this work in decades to come and talk about the importance of the work that was done here.

Q: And the company’s view on how long it will take to recover (from Apple ATT’s impact) or create a new probabilistic ad targeting model, that may have cost you $10 billion before, and has material financial impacts. But I didn’t hear you say this is a priority investment in your last statement?

A: We’ve been continuing our broader work of rebuilding our advertising technology in meaningful ways. So that our system can improve performance and measurement – we’re investing short, mid, and long term.

Short and mid-term, we have been heavily focused on improving our ad system to increase conversion rates through products like guided ads and click-to-Messenger ads. We will continue to invest in AI and machine learning to improve targeting and delivery. We’re pleased with the progress we’ve made this quarter to help advertisers improve performance and targeting.

It would be remiss of me if I didn’t talk about AI and how AI is helping advertisers. One example in this area is Advantage+ Shopping. We launched it in August. It’s a product powered by machine learning that helps clients test, learn and optimize their activity faster. It’s still early, but recent tests with different advertisers found that ad spend returns increased by 32% with the use of Advantage+ Shopping. Longer term, we’ll focus on investing in privacy-enhancing technologies, both our own solution suite and working with the industry. It’s all with the spirit of investing in this technology to help advertisers get more value.

Q: Summing up the investor sentiment right now, there’s too many experimental bets in the core areas and not enough validated bets. I’m curious if you could just explain a little bit more about why you think that’s worth it?

A: We’ve made a lot of investments in our portfolio. Obviously, our investments in products like Reels and WhatsApp’s business messaging platform, both in terms of user stickiness and monetization, will bring significant returns to the business. Most of our spend is targeted at our Family of Apps investment, which touches on user stickiness and profitability. AI is used in many cases. We have made good progress in these areas, and then we use our messaging platform, which is currently an under-monetized resource, to build larger scale on these platforms as a source of future revenue growth. We have proven this with our business - our Click-to-Messenger advertising business has now reached $9 billion. We believe we can build a considerable business around paid messaging, which will also be complementary. So, I think there are many other endeavors in our app series investment portfolio, in addition to what we are doing in Reality Labs and the Metaverse.

There is a difference between experimental things and not knowing how good they will eventually be. We are very confident about many of the things we are doing in our app series. Reels work, discovery works, all ads work, commercial information works, and we can't yet tell you how they will develop. But I think these things are heading in the right direction.

The Metaverse is a long-term set of work we are doing. So, there is no simple one thing that we can do to solve all the problems. I mean, there are macroeconomic issues. The competition is very intense. There are advertising challenges, especially from Apple. And there are some longer-term projects where we need to assume expenses because we believe they will provide greater returns over time. I think we will address these issues at different times. Thank you for your patience. I think those who are patient and who invest with us will eventually be rewarded.

It is a challenging time for advertisers at present. In times of economic uncertainty, they are focused on how to achieve strong investment returns. Returning to apps and services, Reels is still the fastest growing form on Instagram and Facebook. We are focused on ensuring that businesses have a strong return on investment in Reels. One example is CORKCICLE, a thermal cup brand that has incorporated Reels into its "business-as-usual" strategy, increasing the return on advertising spending by 34% and sales by 34%. Therefore, our investments are progressing and helping advertisers find the return on investment they are looking for.

Risk Disclosure and Statement for this article: Dolphin Analyst Disclaimer and General Disclosure