Good morning,
Facebook, not content with being the subject of news stories, decided to use its earnings call to make news of its own.
On to the update:
Facebook Earnings
From the Wall Street Journal:
Facebook Inc. blamed Apple Inc.’s privacy rules for posting slower sales growth and warned of further uncertainty for the social-media giant’s crucial advertising business. Facebook’s ad sales, its primary revenue source, saw slower growth in the first full quarter since Apple in April started requiring apps to ask users whether they want to be tracked. That change has made it harder for advertisers to target their ads at audiences and get information regarding how well their ads performed.
Facebook also said Monday that it was changing its reporting structure to break out a unit called Facebook Reality Labs that encompasses augmented-reality and virtual-reality products and services. The move will separate results for that unit from the core business segment, including its flagship Facebook platform and other apps such as Instagram. The company said it expects investment in Facebook Reality Labs to reduce its overall operating profit in 2021 by around $10 billion.
Facebook Chief Executive Mark Zuckerberg, on an analysts call, also addressed Facebook’s growing competition for young adult users from Apple’s iMessage app and the rise of ByteDance Ltd.’s TikTok, saying that retaining and adding members of this demographic segment is essential for the company’s long-term success…Facebook said it expected to increase its investments in the coming years The company added that next year’s expenses would be as much as $97 billion, including spending on items such as technical and product staff and infrastructure-related costs.
So let’s recount: Facebook has slowing sales growth due to platform risk, is committing to spending $10 billion (and growing!) per year on its metaverse ambitions, feels (rightly) threatened by TikTok, and is jacking up capital expenditures by 65% next year. Oh, and as you may have heard, the company is going through a tough press cycle. What was the hit to the stock?
Up on the day, up after hours, and up pre-market.
This isn’t the whole story, of course; Facebook is still down from its September 7 high of $382, and before Snap’s earning came out the stock was at $342. Snap likely did Facebook a favor by being the first to miss analyst estimates because of Apple’s App Tracking Transparency (ATT) changes, but as I predicted yesterday the impact on Facebook was very significant: the company is forecasting year-over-year revenue growth of only 17% (at the mid-range of their estimate); previous holiday quarters have seen annual revenue growth of 33% (2020), 25% (2019), and 30% (2018). That’s a big drop!
What did help is that Facebook has done a much better job of preparing investors for these numbers; while the company admitted the ATT revenue hit was at the high end of their estimated range, it was still in the range they forecasted. Facebook also announced an increased stock buyback program. What I suspect matters even more, though, is that Facebook generally, and Zuckerberg specifically, has accrued a huge amount of investor trust; this is the common thread tying together all of these announcements.
Investor Trust
First, with regards to ATT, Facebook started with this August blog post admitting it was underreporting iOS web conversions by approximately 15%; on the earnings call COO Sheryl Sandberg announced that Facebook would address “more than half of the underreporting by the end of this year”. This isn’t simply good news for Facebook’s business, it’s also reassurance to investors that Facebook has the situation under control.
There was one point about this underreporting that is worth highlighting; here is CFO Dave Wehner on the follow-up call with analysts
On the underreporting, and Susan correct me, but one of the things I would say is it tends to be really client sized does effect this. So when we have a larger advertiser it’s easier to model the conversion. So what we’ll do is we’ll probably be more effective at correcting for the underreporting for larger advertisers…maybe we get the 7 percent but that’s not — that’s not consistent across client. So that’s where we’re saying this tends to be something that’s more disruptive for smaller advertisers because it’s harder to model when you’ve got smaller budgets and smaller cohorts because of the aggregated event approach as opposed to individual attribution.
This ties into the discussion in yesterday’s Daily Update and last year in Privacy Labels and Lookalike Audiences; the tighter the feedback loop between conversions and targeting the more it is that small advertisers can compete with larger ones. As targeting shifts to more modeling and cohort analysis, though, the more difficult it will be for smaller advertisers to get equivalent return on their advertising spend.
The answer for those advertisers is straightforward: sell directly on Facebook’s platform, where everything is first-party data, which means that tight feedback loop can be preserved; here too Facebook has accrued trust with investors because the company has been building out Facebook Shops since the month before ATT was even announced. Facebook Shops still has a long way to go, but Facebook can much more credibly point to it as a way around ATT than a company like Snap can.
Second, in terms of competing with TikTok, Facebook not only has Reels, it also has its history with Stories; Zuckerberg interrupted Wehner during the Q&A to make this specific point:
Maybe I’ll just add something on Reels. Yes. I think that this is going to be a very meaningful qualitative change in how people use a lot of different products across the Internet. I mean I think every once in a while, a format comes along that allows new types of content, right? So we saw this with News Feed. We saw it with Stories. And I think Reels, from everything I’ve seen, has the potential to be something of that scale where there are different flavors of it and different apps. But I think as a format, it can be very fundamental.
I think we’re still closer to the beginning of that journey than we are to its maturity in terms of just having rolled out some of the initial tests and experiences and rolled it out in Facebook. And I mean you mentioned all the countries that it’s in in Instagram, but it’s just continuing to grow very quickly. So I think that, that’s going to be a big part of the focus here. And I’m excited over the next year or two to see how that grows into something that I would bet will be like Stories in our product today. Sorry, Dave, go for it.
TikTok, it should be noted, is far larger than Snapchat was in 2016, when Facebook incorporated Stories into Instagram, and growing faster as well; TikTok is also much less network dependent than Snapchat was, which limited the latter’s growth, even as it gave Instagram a big advantage. The point, though, is that Facebook has successfully responded to a format-based threat before, and is getting credit for that fact.
Third, the big increase in capital expenditures is easier to swallow precisely because it was framed as addressing these first two problems; Wehner said:
Our 2022 outlook really reflects a significant increase in our planned investment in areas like AI and machine learning. And a lot of that will be dedicated to investing in areas where we can use machine learning to improve ranking and recommendations to power experiences across our products in areas like Feed and in emerging areas like Reels.
We’ll also be dedicating that to ads as we work to improve ads relevance and leveraging machine learning and AI to help balance out the loss of signal that we’ve experienced from some of the platform changes. So we think that we can, as part of sort of making our ads even more effective, make up for that loss with the large investments on the machine learning and AI side. And I think our position gives us a good ability to do that. So that’s really part of the logic behind the big increase in the CapEx budget next year.
Machine learning is computationally expensive; when you are leveraging machine learning to give billions of users a completely new kind of algorithmically-driven video experience, and simultaneously rebuilding your entire advertising platform to focus on modeling instead of direct attributions, it is absolutely believable that it is 65% more expensive! And, at the same time, this is also another reason for investors to trust Facebook: which of their competitors can spend as much to rebuild their own ad products?
Facebook Reality Labs
From CNET:
Facebook didn’t get a new name as widely expected, but the social network did unveil a new reporting structure. On Monday, the social media giant said it would begin reporting results as two businesses: its core family of social networking apps and its Facebook Reality Labs, which houses its augmented and virtual reality efforts.
I expect that I will write more about Facebook’s metaverse plans after Facebook Connect; what is worth underlining is that re-naming and re-organizing the company is a reminder that it is Facebook, to a much greater degree than the other Big 5 tech companies, that is very much making strategic decisions, as opposed to coasting on a monopoly (another reminder that Facebook doesn’t have one).
For now, though, there are two additional points worth making about Facebook and investors when it comes to Facebook Reality Labs. First, only a founder-CEO could likely get away with spending $10 billion a year — again, with a promise that that will increase — for something that won’t drive meaningful revenue for years; Zuckerberg said:
For the next 1 and 3 years, especially, I think what you’ll see is us putting more of the foundational pieces into place. This is not an investment that is going to be profitable for us anytime in the near future…So on the next 1 to 3 years, I wouldn’t focus on the sort of business outcomes there quite as much as I would just the products and infrastructure that we’re putting in place.
I think you’ll see all of those pieces start to get built out and start to mature a bit over the next few years. And then if we do a good job on this, and I would say later in this decade, is when we would sort of expect this to be more of a real business story.
This is much more of a VC-style bet, but the scale is just another level entirely: Magic Leap has raised somewhere over a billion dollars, but that’s a bit over a month of Facebook’s promised metaverse investment. It’s also 33% more money than the amount that Other Bets was spending when Larry Page set up Alphabet.
That, though, is reassuring in its own way: Facebook seems far more focused and, thanks to Zuckerberg’s drive to own the next platform, determined to make sure this investment bears fruit. Here the company’s concern about ATT and Tiktok and all of the rest are a reason to be optimistic: there is no danger of the company getting bored or losing focus.
And, in the meantime, it’s worth remembering that Google’s stock actually got a healthy bump from the Alphabet formation: breaking out Other Bets exposed just how profitable Google’s core product was; separating Facebook Reality Labs may do the same for Facebook’s ad business.
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