Category: Consumer

Big Tech Q4 Earnings: Capex Increases

Posted on by io-fund

Below, we look at key Big Tech earnings reports and the major takeaways from Alphabet, Meta and Apple.

Alphabet Q4 results: Cloud accelerates while ad revenue falls short

Alphabet beat top-line and bottom-line estimates. The company’s revenue growth of 13% was the highest growth since Q2 2022. Google Cloud revenue accelerated four points from 22% in the previous quarter to 26% in Q4. However, the company’s ad revenue fell short of estimates as it grew by 11% YoY to $65.5 billion and missed consensus estimates of $65.8 billion. The rise of Capex also led to the stock selling off post-results.

However, the rise of Capex is a notable positive for AI accelerators, which our portfolio is loaded with as the increase in capex will funnel through to GPUs and other AI beneficiaries. Per Alphabet’s earnings call: “In 2024, we expect investment in CapEx will be notably larger than in 2023.”In 2024, we expect investment in CapEx will be notably larger than in 2023.”

Revenue and EPS:

Revenue grew by 13% YoY to $86.31 billion, beating estimates by 1.2%. Analysts expect revenue to grow 13% YoY to $78.58 billion in the March quarter and 11% in the next two quarters.

GAAP EPS came at $1.64 and beat consensus estimates by 2.8%. This is up from $1.05 in the same period last year.

Margins

  • Gross margin improved 300 bps YoY to 56.5% yet was 20 bps lower than the Sept quarter.
  • Operating margin improved 360 bps YoY to 27.5% yet was 30 bps lower than the Sept quarter.
  • Net margin improved 610 bps YoY to 24% yet was 170 bps lower than the Sept quarter.

This year’s December quarter expenses included $1.2 billion in exit charges related to office space optimization, and last year's Dec quarter included $1.2 billion in inventory-related charges.

The CFO reiterated the company’s efforts to reduce costs in the earnings call and this should further help the company to improve its margins. “Turning to margins and expenses. As we have repeatedly stressed, we remain committed to our framework to durably reengineer our cost base as we invest to support our growth priorities. Key contributors to moderating our expense growth include: first, product and process prioritization to ensure we have the right resources behind our most important opportunities and to reallocate resources where we can; second, organizational efficiency and structure. We're focused on removing layers to simplify execution and drive velocity.”

Cash Flows and Balance Sheet

  • Operating cash flow margin was 21.9% compared to 31.1% in the same period last year and 40% in the Sept quarter.
  • Free cash flow margin was 9.2% compared to 21.1% in the same period last year and 29.5% in the Sept quarter.
  • Cash flows were lower mainly due to the deferral of tax payments to the fourth quarter. The CFO said in the earnings call, “We delivered free cash flow of $7.9 billion, which was affected by the timing of the $10.5 billion tax payment we made on October 16 that we called out previously related to the deferral of certain tax payments to the fourth quarter.”
  • Capex also increased 45% YoY to $11 billion in the Dec quarter, which also led to the lower free cash flow.

The CFO said in the earnings call. “With respect to CapEx, our reported CapEx in the fourth quarter was $11 billion, driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. The step-up in CapEx in Q4 reflects our outlook for the extraordinary applications of AI to deliver for users, advertisers, developers, cloud enterprise customers and governments globally and the long-term growth opportunities that offers. In 2024, we expect investment in CapEx will be notably larger than in 2023.”driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. The step-up in CapEx in Q4 reflects our outlook for the extraordinary applications of AI to deliver for users, advertisers, developers, cloud enterprise customers and governments globally and the long-term growth opportunities that offers. In 2024, we expect investment in CapEx will be notably larger than in 2023.”

As stated, comments on capex are good for our semiconductor portfolio mix.

The company has cash and marketable securities of $110.9 billion compared to $119.94 billion in the Sept quarter. Meanwhile, debt was $13.25 billion compared to $13.78 billion in the Sept quarter. The company repurchased $62 billion worth of shares in 2023.

Key Metrics:

Google Cloud Revenue

Google Cloud revenue grew by 26% YoY to $9.2 billion, helped by the increasing contribution from AI. Even though the growth is slower than the 32% growth in the same period last year, it has accelerated from 22% in the previous quarter.

The operating margin for Google Cloud came in at 9% compared to 3% in the previous quarter and negative (0.2%) in the same period last year. The strong growth in the quarter also helped the company to narrow the gap to 4 percentage points with Microsoft Azure’s leading growth of 30% compared to 7 percentage points in the previous quarter.

The CFO said, “The Cloud team is intensely focused on bringing the benefits of Gemini, our industry-leading AI technology, to enterprises and governments globally, and we are gratified with the level of engagement. The strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area.” 

Google Advertising Revenue

Google Advertising revenue grew by 11% YoY to $65.5 billion, compared to 9% growth in the previous quarter and a (-4%) decline in the same period last year. However, they fell short of the consensus estimates of $65.8 billion.

  • Google Search and other advertising revenues grew by 13% YoY to $48 billion. It was up from 11% growth in the previous quarter and a decline of (-2%) in the same period last year.
  • YouTube ads revenues grew by 16% YoY to $9.2 billion. It is up from the 12% growth in the previous quarter and a decline of (-8%) in the same period last year.
  • Network advertising revenues declined by (2%) YoY to $8.3 billion.

Earnings Call

The company’s CEO Sundar Pichai was positive on the launch of Gemini and said in the earnings call, “We closed the year by launching the Gemini era, a new industry-leading series of models that will fuel the next generation of advances. Gemini is the first realization of the vision we had when we formed Google DeepMind, bringing together our two world-class research teams. It's engineered to understand and combine text, images, audio, video and code in a natively multimodal way and it can run on everything from mobile devices to data centers.

Gemini gives us a great foundation. It's already demonstrating state-of-the-art capabilities and it's only going to get better. Gemini Ultra is coming soon. The team is already working on the next versions and bringing it to our products. That starts with Search.”Gemini Ultra is coming soon. The team is already working on the next versions and bringing it to our products. That starts with Search.”

He also mentioned that subscriptions revenue reached $15 billion in annual revenue, up 5x since 2019, helped by strong demand for YouTube Premium and Music, YouTube TV, and Google One. The CFO said, “Subscriptions, Platforms and Devices revenues, which we previously referred to as other revenues, were $10.8 billion, up 23%, primarily reflecting growth in YouTube subscription revenues.”

Conclusion:

While the overall report was good, it is clear that the market expects perfection in key metrics. The slight miss in the advertisement revenues and the rise of capex overshadowed the acceleration in Google Cloud. With that said, for our purposes, the increase in capex commentary is critical to hear for our current portfolio mix, which is overweight AI semis.

Meta Q4: Back to Juggernaut Status

Meta’s Q4 report beat on the top and bottom lines and initiated a $0.50 dividend in a surprise move, The strength of the report is cementing the Facebook parent’s status as a juggernaut of tech once more. Key metrics were very strong across the board, and Q1’s guide pointed to 25% revenue growth at the midpoint, suggesting that 2023’s momentum is continuing into next quarter.

Revenue and EPS:

  • Meta reported revenue of $40.11 billion for Q4, above the higher end of its guide of $36.5-$40.0 billion range and beating estimates for $39.17 billion. Revenue grew 24.7% YoY.
  • For the full year, Meta reported revenue of $134.9 billion, representing YoY growth of 15.7%.
  • Meta guided for $34.5-$37 billion in revenue for Q1, representing YoY growth of 24.8%
  • EPS of $5.33 beat estimates by 7.9%, and represented YoY growth of 203%.
  • For the full year, Meta reported EPS of $14.87, representing YoY growth of 73.1%.

Margins:

  • Gross margin was 80.8% in Q4, a 100 bp QoQ decline but a 670 bp YoY improvement.
  • Operating margin was 40.8% in Q4, a 50bp QoQ and 2090 bp YoY improvement.
  • Net margin was 34.9%, a 100 bp QoQ and 2060 bp YoY improvement.
  • For the full year, gross margin was 80.8%, a 240 bp YoY improvement.
  • For the full year, operating margin was 34.7%, a 990 bp YoY improvement.
  • For the full year, net margin was 29.0%, a 910 bp YoY improvement.

Accelerating ARPU

Although Q1’s guide is for 24.8% growth, triple-digit EPS growth and strong YoY expansion in margins, the highlight of the report lies within acceleration in ARPUs to record levels – ahead of what is expected to be a strong ad market backdrop this year.

Growth in ad impressions cooled, but remained above 20% (versus a fairly tough comp at 23% in the year ago quarter). Ad pricing returned to growth, increasing 2% YoY after seven quarters of declines. We highlighted in mid-January while discussing Meta’s clear leadership in the social media space that “what investors should watch for is if improved ad targeting from AI features can help drive ad pricing back to growth, supported by a favorable spending backdrop and continuing strength in ad impressions globally.” Meta delivered exactly that, though impressions growth decelerated a bit more rapidly QoQ than in Q3.

This recovery and inflection in ad pricing helped drive an acceleration in advertising revenue growth. Overall advertising revenue increased 23.8% YoY to $38.7 billion, a rapid acceleration from the 4.1% growth posted in Q1 when Meta inflected back to growth. US & Canada ad revenue grew 18.5% YoY, while Europe ad revenue growth was the strongest, increasing 32.7% YoY.

Accelerating ARPUs in Facebook’s two core geographies drove this growth – we said two weeks ago that Meta was “on track to potentially reach a record level” for ARPU in Q4, and it did exactly that.

ARPU in US & Canada accelerated to 16% YoY to $68.44, compared to 14% YoY growth in Q3 and a (3%) YoY decline in the year ago quarter. Europe ARPU growth remained steady compared to Q3 at 34% YoY to $23.14, up from 14% YoY in Q2 and a (12%) YoY decline in the year ago quarter. Meta has displayed unbelievable strength in improving monetization in US & Canada, with ARPU rising nearly $20, or 40%, since Q1. 

Q1 will be the next true test for Meta, as it needs to show that it can maintain this strength in ARPU, though it faces a very easy comp with 1% growth in ARPU in the three regions highlighted above. If Meta can report US & Canada ARPU above $60 and Europe ARPU above $20, it will be well on track to proving that it can successfully and meaningfully increase monetization via AI. Q1’s strong guide at nearly $1.9 billion above consensus estimates at midpoint suggests that this is possible.

What also cannot be written off is Meta’s ability to deliver strong operating margin expansion and generate substantial cash flow, while continuing to invest heavily in AI and AR.

In Q4, operating margin expanded over twenty percentage points YoY to 40.8%, the second straight quarter with operating margin above 40% since Q1 and Q2 2021. As a result, FY23 operating margin improved 990 bp YoY to 34.7%. This is helping drive a strong improvement in the bottom line, with Meta reporting a net margin of 34.9%, a second straight quarter above 33% and a strong 2040 bp YoY expansion.

This operating margin expansion comes as Meta continues to pour substantial amounts of cash into Reality Labs. Operating losses for Reality Labs totaled ($16.1) billion for FY23, generating a ~1195 bp headwind to operating margin.

Not only has Meta driven a visible increase in operating margin while meaningfully accelerating revenue over the last four quarters, but it has also driven a massive increase in cash flow.

For FY23, Meta delivered 40.9% YoY growth in operating cash flow to $71.1 billion, as it saw OCF margin expand 940 bp YoY to 52.7%. This is the highest margin among the Magnificent 7. Free cash flow also increased 134% YoY to $43.01 billion, with FCF margin increasing 1610 bp YoY to 31.9%.

Commentary:

Meta guided for a strong Q1, calling for 24.8% YoY growth though it comes against a weak 2.6% YoY comp; however, the ad market backdrop is looking increasingly favorable and supportive of a high-teens growth rate, with current expectations pointing to 16.7% revenue growth for Meta in 2024 to $157.6 billion.

Social media ad spend is expected to remain robust in 2024, with one of the fastest projected growth rates in the ad industry at +13.8% to reach $227.2 billion globally, less than 1% shy of search ad spend.

In the US, growth is expected at a similar rate, with Insider Intelligence projecting 13.5% YoY growth to $82.9 billion for US social network ad spending. This marked a $7.8 billion increase from the Q1 2023 forecast, as Insider Intelligence sees the market benefiting from “higher ad loads, a focus on lower-funnel ads, and an improved advertising economy,” driven by Meta and TikTok.

CEO Mark Zuckerberg said Meta’s year of efficiency in 2023 paid off, with the company returning to strong revenue growth with strong engagement across its apps, while it also “established a world-class AI effort that's going to be the foundation for many of our future products.” By the end of 2024, Meta will have approximately 350,000 H100 GPUs and 250,000 H100 equivalents (perhaps a mix of AMD’s MI300X and/or Meta’s in-house ASICs?), to power its AI ambitions, which span LLMs, in its Llama, Llama 2 and Llama 3, Reels, and other AI features and new products.

Meta is also starting to see more positive contributions from products outside of Facebook, primarily Reels, Meta’s answer to TikTok. Management said Reels “and our discovery engine remain a priority and major driver of engagement,” and “Reels is now contributing to our net revenue across our apps.” Management added that it is seeing “sustained growth in Reels and Video overall as daily watch time across all video types grew over 25% year-over-year in Q4.” Reels can continue to aid growth for Meta in 2024, and while its engagement rate of ~6-9% is slightly below TikTok’s average engagement of 9-11%, Reels is estimated to have higher reach and interactions, which can benefit ad pricing despite the lower engagement rate.

While 2023 was Meta’s year of efficiency, 2024 may shape up to be Meta’s year of leverage. Key metrics support a return to >40% operating margin for the full year and a possible >33% net margin, driven by increasing ad pricing after inflecting back to growth, strong engagement and impressions growth, aided by the release of numerous AI features. Reaching those margins for the full year would imply EPS growth of nearly 38% to $20.50 on $160B in revenue.

AI can help provide increased operating leverage, similar to what we have seen with Microsoft as it boosts growth and creates additional engagement opportunities. Meta is investing heavily in both AI and non-AI hardware and data centers, with its capex guided for $30 to $37 billion in 2024.

Meta said that for “generative AI, we fully rolled out our Meta AI assistant and other AI chat experiences in the U.S. at the end of the year and began testing more than 20 GenAI features across our Family of Apps.” Increasing user engagement via AI features can drive higher ad loads, and thus higher pricing by increased optimization: Meta said that its “approach to optimizing ad levels in our apps has become increasingly sophisticated” as it continues to deliver performance gains for advertiser campaigns.

Note on Meta’s Capex:

The management has guided $30 billion to $37 billion in 2024, an increase of $2 billion at the high range of the prior guide. The guide represents 19.2% YoY growth in capex at the mid-point compared to an actual $28.1 billion in 2023. Since 2023 was a ‘Year of Efficiency,’ the company’s capex was down (12.3%) YoY compared to a growth of 66.5% in 2022.

Apple: Strong Q1 FY24 results overshadowed by weak guidance

Apple beat on the top line and bottom line. The profit margins and cash flow margins improved in the Dec quarter. The gross margin guide for the March quarter was also strong. However, management’s revenue outlook for the next quarter implies revenue will decline (5%) YoY and miss consensus estimates by 6%. China revenue of $20.8 billion also missed analyst estimates of $23.8 billion.

Revenue and EPS

Revenue grew by 2.1% YoY to $119.58 billion, beating estimates by 1.1%.

  • iPhone sales accelerated to 6% YoY growth to $69.7 billion, up from 3% in the Sept quarter, partly due to strong demand for the iPhone 15 line-up.
  • Mac Sales rebounded to 1% YoY growth to $7.8 billion from a (34%) decline in the September quarter. We want to watch this line item for a rebound in the broader PC market.
  • iPad sales disappointed as they declined by (25%) YoY to $7 billion. The slide was steeper than the Sept quarter decline of (10%).
  • Wearables, home, and accessories revenue declined by (11%) YoY to $12 billion, from a (3%) decline in the Sept quarter.
  • Services revenue grew by 11% YoY to $23.1 billion. Services remain a long-term opportunity for the company to monetize its installed base of over 2.2 billion active devices. Services revenue grew 16% in the Sept quarter.

GAAP EPS grew by 16% YoY to $2.18, beating estimates by 3.6%.

Margins

Gross margin improved 70 bps sequentially and 290 bps YoY to 45.9%. The management guide for the next quarter is in the range of 46% to 47%.

Operating margin improved 370 bps sequentially and 310 bps YoY to 33.8%.

Net margin improved 270 bps sequentially and 280 bps YoY to 28.4%.

Cash flow and balance sheet

Operating cash flow margin improved 930 bps sequentially and 440 bps YoY to 33.4%. Free cash flow margin improved 970 bps sequentially and 560 bps YoY to 31.4%. Free cash flow also benefitted from lower capex when compared to the same period last year.

The company has cash and marketable securities of $172.6 billion and debt of $108 billion. They repaid $4.0 billion of commercial paper and had net cash of $65 billion compared to net cash of $51 billion in the Sept quarter. Management reiterated its plan to be net cash-neutral over time. The company returned about $27 billion to the shareholders in the recent quarter in the form of dividends and share repurchases.

What to watch in the coming quarters

  • While providing the outlook for the next quarter, the CFO said they expect foreign exchange to be a 2-percentage headwind. The outlook suggests that revenue will decline by (5%) YoY in the March quarter and this missed consensus estimates by 6%. iPhone sales are expected to decline by about (10%) YoY in the March quarter.

The CFO said, “As a reminder, in the December quarter a year ago, we faced significant supply constraints on the iPhone 14 Pro and 14 Pro Max due to COVID-19 factory shutdowns. And in the March quarter a year ago, we were able to replenish channel inventory and fulfill significant pent-up demand from the constraints. We estimate that this impact added close to $5 billion to the March quarter's total revenue last year. When we remove this impact from last year's revenue, we expect both our March quarter total company revenue and iPhone revenue to be similar to a year ago.” We estimate that this impact added close to $5 billion to the March quarter's total revenue last year. When we remove this impact from last year's revenue, we expect both our March quarter total company revenue and iPhone revenue to be similar to a year ago.”

The company is facing competition from other smartphone companies in China due to foldable designs and advanced AI features. The company’s total revenue from China in the recent quarter was $20.8 billion, which missed estimates of $23.8 billion.

  • The performance of the services segment will also be crucial as the company has an installed base of over 2.2 billion active devices and over 1 billion paid subscriptions. The management expects a similar double-digit revenue growth rate in the next quarter to what the company reported in the December quarter: 11% YoY growth.

Management is expected to share more details later this year on how the company plans to capitalize on Artificial Intelligence. Tim Cook said in the earnings call. “That includes artificial intelligence where we continue to spend a tremendous amount of time and effort, and we're excited to share the details of our ongoing work in that space later this year.”

Vision Pro launched and has sold an estimated 200,000 units.

Lastly, the recent changes to the app store to comply with the EU’s Digital Markets Act are to be watched. The impact is limited at the moment since the change is only to Europe. The company will have lower commissions on the app store in Europe, which will now range between 10% to 17% instead of the typical 30%.

The CFO answered an analyst’s question on the call on the impact of the changes. “As Tim said, these are changes that we're going to be implementing in March. A lot will depend on the choices that will be made. Just to keep it in context, the changes applied to the EU market, which represents roughly 7% of our global app store revenue.”

Conclusion

The company's strengths are strong margins, cash flows, a stable balance sheet, and a loyal customer base. Tackling the revenue slowdown in China and capitalizing on its vast installed base is crucial for the company. Keep an eye on the app store commissions as Europe’s move to reduce these commissions will likely serve as inspiration to developers globally to push for the same.

Equity Analysts Damien Robbins and Royston Roche contributed to this article.

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Big Tech Q4 Earnings: Capex Increases

Posted on by io-fund

Below, we look at key Big Tech earnings reports and the major takeaways from Alphabet, Meta and Apple.

Alphabet Q4 results: Cloud accelerates while ad revenue falls short

Alphabet beat top-line and bottom-line estimates. The company’s revenue growth of 13% was the highest growth since Q2 2022. Google Cloud revenue accelerated four points from 22% in the previous quarter to 26% in Q4. However, the company’s ad revenue fell short of estimates as it grew by 11% YoY to $65.5 billion and missed consensus estimates of $65.8 billion. The rise of Capex also led to the stock selling off post-results.

However, the rise of Capex is a notable positive for AI accelerators, which our portfolio is loaded with as the increase in capex will funnel through to GPUs and other AI beneficiaries. Per Alphabet’s earnings call: “In 2024, we expect investment in CapEx will be notably larger than in 2023.”In 2024, we expect investment in CapEx will be notably larger than in 2023.”

Revenue and EPS:

Revenue grew by 13% YoY to $86.31 billion, beating estimates by 1.2%. Analysts expect revenue to grow 13% YoY to $78.58 billion in the March quarter and 11% in the next two quarters.

GAAP EPS came at $1.64 and beat consensus estimates by 2.8%. This is up from $1.05 in the same period last year.

Margins

  • Gross margin improved 300 bps YoY to 56.5% yet was 20 bps lower than the Sept quarter.
  • Operating margin improved 360 bps YoY to 27.5% yet was 30 bps lower than the Sept quarter.
  • Net margin improved 610 bps YoY to 24% yet was 170 bps lower than the Sept quarter.

This year’s December quarter expenses included $1.2 billion in exit charges related to office space optimization, and last year's Dec quarter included $1.2 billion in inventory-related charges.

The CFO reiterated the company’s efforts to reduce costs in the earnings call and this should further help the company to improve its margins. “Turning to margins and expenses. As we have repeatedly stressed, we remain committed to our framework to durably reengineer our cost base as we invest to support our growth priorities. Key contributors to moderating our expense growth include: first, product and process prioritization to ensure we have the right resources behind our most important opportunities and to reallocate resources where we can; second, organizational efficiency and structure. We're focused on removing layers to simplify execution and drive velocity.”

Cash Flows and Balance Sheet

  • Operating cash flow margin was 21.9% compared to 31.1% in the same period last year and 40% in the Sept quarter.
  • Free cash flow margin was 9.2% compared to 21.1% in the same period last year and 29.5% in the Sept quarter.
  • Cash flows were lower mainly due to the deferral of tax payments to the fourth quarter. The CFO said in the earnings call, “We delivered free cash flow of $7.9 billion, which was affected by the timing of the $10.5 billion tax payment we made on October 16 that we called out previously related to the deferral of certain tax payments to the fourth quarter.”
  • Capex also increased 45% YoY to $11 billion in the Dec quarter, which also led to the lower free cash flow.

The CFO said in the earnings call. “With respect to CapEx, our reported CapEx in the fourth quarter was $11 billion, driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. The step-up in CapEx in Q4 reflects our outlook for the extraordinary applications of AI to deliver for users, advertisers, developers, cloud enterprise customers and governments globally and the long-term growth opportunities that offers. In 2024, we expect investment in CapEx will be notably larger than in 2023.”driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. The step-up in CapEx in Q4 reflects our outlook for the extraordinary applications of AI to deliver for users, advertisers, developers, cloud enterprise customers and governments globally and the long-term growth opportunities that offers. In 2024, we expect investment in CapEx will be notably larger than in 2023.”

As stated, comments on capex are good for our semiconductor portfolio mix.

The company has cash and marketable securities of $110.9 billion compared to $119.94 billion in the Sept quarter. Meanwhile, debt was $13.25 billion compared to $13.78 billion in the Sept quarter. The company repurchased $62 billion worth of shares in 2023.

Key Metrics:

Google Cloud Revenue

Google Cloud revenue grew by 26% YoY to $9.2 billion, helped by the increasing contribution from AI. Even though the growth is slower than the 32% growth in the same period last year, it has accelerated from 22% in the previous quarter.

The operating margin for Google Cloud came in at 9% compared to 3% in the previous quarter and negative (0.2%) in the same period last year. The strong growth in the quarter also helped the company to narrow the gap to 4 percentage points with Microsoft Azure’s leading growth of 30% compared to 7 percentage points in the previous quarter.

The CFO said, “The Cloud team is intensely focused on bringing the benefits of Gemini, our industry-leading AI technology, to enterprises and governments globally, and we are gratified with the level of engagement. The strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area.” 

Google Advertising Revenue

Google Advertising revenue grew by 11% YoY to $65.5 billion, compared to 9% growth in the previous quarter and a (-4%) decline in the same period last year. However, they fell short of the consensus estimates of $65.8 billion.

  • Google Search and other advertising revenues grew by 13% YoY to $48 billion. It was up from 11% growth in the previous quarter and a decline of (-2%) in the same period last year.
  • YouTube ads revenues grew by 16% YoY to $9.2 billion. It is up from the 12% growth in the previous quarter and a decline of (-8%) in the same period last year.
  • Network advertising revenues declined by (2%) YoY to $8.3 billion.

Earnings Call

The company’s CEO Sundar Pichai was positive on the launch of Gemini and said in the earnings call, “We closed the year by launching the Gemini era, a new industry-leading series of models that will fuel the next generation of advances. Gemini is the first realization of the vision we had when we formed Google DeepMind, bringing together our two world-class research teams. It's engineered to understand and combine text, images, audio, video and code in a natively multimodal way and it can run on everything from mobile devices to data centers.

Gemini gives us a great foundation. It's already demonstrating state-of-the-art capabilities and it's only going to get better. Gemini Ultra is coming soon. The team is already working on the next versions and bringing it to our products. That starts with Search.”Gemini Ultra is coming soon. The team is already working on the next versions and bringing it to our products. That starts with Search.”

He also mentioned that subscriptions revenue reached $15 billion in annual revenue, up 5x since 2019, helped by strong demand for YouTube Premium and Music, YouTube TV, and Google One. The CFO said, “Subscriptions, Platforms and Devices revenues, which we previously referred to as other revenues, were $10.8 billion, up 23%, primarily reflecting growth in YouTube subscription revenues.”

Conclusion:

While the overall report was good, it is clear that the market expects perfection in key metrics. The slight miss in the advertisement revenues and the rise of capex overshadowed the acceleration in Google Cloud. With that said, for our purposes, the increase in capex commentary is critical to hear for our current portfolio mix, which is overweight AI semis.

Meta Q4: Back to Juggernaut Status

Meta’s Q4 report beat on the top and bottom lines and initiated a $0.50 dividend in a surprise move, The strength of the report is cementing the Facebook parent’s status as a juggernaut of tech once more. Key metrics were very strong across the board, and Q1’s guide pointed to 25% revenue growth at the midpoint, suggesting that 2023’s momentum is continuing into next quarter.

Revenue and EPS:

  • Meta reported revenue of $40.11 billion for Q4, above the higher end of its guide of $36.5-$40.0 billion range and beating estimates for $39.17 billion. Revenue grew 24.7% YoY.
  • For the full year, Meta reported revenue of $134.9 billion, representing YoY growth of 15.7%.
  • Meta guided for $34.5-$37 billion in revenue for Q1, representing YoY growth of 24.8%
  • EPS of $5.33 beat estimates by 7.9%, and represented YoY growth of 203%.
  • For the full year, Meta reported EPS of $14.87, representing YoY growth of 73.1%.

Margins:

  • Gross margin was 80.8% in Q4, a 100 bp QoQ decline but a 670 bp YoY improvement.
  • Operating margin was 40.8% in Q4, a 50bp QoQ and 2090 bp YoY improvement.
  • Net margin was 34.9%, a 100 bp QoQ and 2060 bp YoY improvement.
  • For the full year, gross margin was 80.8%, a 240 bp YoY improvement.
  • For the full year, operating margin was 34.7%, a 990 bp YoY improvement.
  • For the full year, net margin was 29.0%, a 910 bp YoY improvement.

Accelerating ARPU

Although Q1’s guide is for 24.8% growth, triple-digit EPS growth and strong YoY expansion in margins, the highlight of the report lies within acceleration in ARPUs to record levels – ahead of what is expected to be a strong ad market backdrop this year.

Growth in ad impressions cooled, but remained above 20% (versus a fairly tough comp at 23% in the year ago quarter). Ad pricing returned to growth, increasing 2% YoY after seven quarters of declines. We highlighted in mid-January while discussing Meta’s clear leadership in the social media space that “what investors should watch for is if improved ad targeting from AI features can help drive ad pricing back to growth, supported by a favorable spending backdrop and continuing strength in ad impressions globally.” Meta delivered exactly that, though impressions growth decelerated a bit more rapidly QoQ than in Q3.

This recovery and inflection in ad pricing helped drive an acceleration in advertising revenue growth. Overall advertising revenue increased 23.8% YoY to $38.7 billion, a rapid acceleration from the 4.1% growth posted in Q1 when Meta inflected back to growth. US & Canada ad revenue grew 18.5% YoY, while Europe ad revenue growth was the strongest, increasing 32.7% YoY.

Accelerating ARPUs in Facebook’s two core geographies drove this growth – we said two weeks ago that Meta was “on track to potentially reach a record level” for ARPU in Q4, and it did exactly that.

ARPU in US & Canada accelerated to 16% YoY to $68.44, compared to 14% YoY growth in Q3 and a (3%) YoY decline in the year ago quarter. Europe ARPU growth remained steady compared to Q3 at 34% YoY to $23.14, up from 14% YoY in Q2 and a (12%) YoY decline in the year ago quarter. Meta has displayed unbelievable strength in improving monetization in US & Canada, with ARPU rising nearly $20, or 40%, since Q1. 

Q1 will be the next true test for Meta, as it needs to show that it can maintain this strength in ARPU, though it faces a very easy comp with 1% growth in ARPU in the three regions highlighted above. If Meta can report US & Canada ARPU above $60 and Europe ARPU above $20, it will be well on track to proving that it can successfully and meaningfully increase monetization via AI. Q1’s strong guide at nearly $1.9 billion above consensus estimates at midpoint suggests that this is possible.

What also cannot be written off is Meta’s ability to deliver strong operating margin expansion and generate substantial cash flow, while continuing to invest heavily in AI and AR.

In Q4, operating margin expanded over twenty percentage points YoY to 40.8%, the second straight quarter with operating margin above 40% since Q1 and Q2 2021. As a result, FY23 operating margin improved 990 bp YoY to 34.7%. This is helping drive a strong improvement in the bottom line, with Meta reporting a net margin of 34.9%, a second straight quarter above 33% and a strong 2040 bp YoY expansion.

This operating margin expansion comes as Meta continues to pour substantial amounts of cash into Reality Labs. Operating losses for Reality Labs totaled ($16.1) billion for FY23, generating a ~1195 bp headwind to operating margin.

Not only has Meta driven a visible increase in operating margin while meaningfully accelerating revenue over the last four quarters, but it has also driven a massive increase in cash flow.

For FY23, Meta delivered 40.9% YoY growth in operating cash flow to $71.1 billion, as it saw OCF margin expand 940 bp YoY to 52.7%. This is the highest margin among the Magnificent 7. Free cash flow also increased 134% YoY to $43.01 billion, with FCF margin increasing 1610 bp YoY to 31.9%.

Commentary:

Meta guided for a strong Q1, calling for 24.8% YoY growth though it comes against a weak 2.6% YoY comp; however, the ad market backdrop is looking increasingly favorable and supportive of a high-teens growth rate, with current expectations pointing to 16.7% revenue growth for Meta in 2024 to $157.6 billion.

Social media ad spend is expected to remain robust in 2024, with one of the fastest projected growth rates in the ad industry at +13.8% to reach $227.2 billion globally, less than 1% shy of search ad spend.

In the US, growth is expected at a similar rate, with Insider Intelligence projecting 13.5% YoY growth to $82.9 billion for US social network ad spending. This marked a $7.8 billion increase from the Q1 2023 forecast, as Insider Intelligence sees the market benefiting from “higher ad loads, a focus on lower-funnel ads, and an improved advertising economy,” driven by Meta and TikTok.

CEO Mark Zuckerberg said Meta’s year of efficiency in 2023 paid off, with the company returning to strong revenue growth with strong engagement across its apps, while it also “established a world-class AI effort that's going to be the foundation for many of our future products.” By the end of 2024, Meta will have approximately 350,000 H100 GPUs and 250,000 H100 equivalents (perhaps a mix of AMD’s MI300X and/or Meta’s in-house ASICs?), to power its AI ambitions, which span LLMs, in its Llama, Llama 2 and Llama 3, Reels, and other AI features and new products.

Meta is also starting to see more positive contributions from products outside of Facebook, primarily Reels, Meta’s answer to TikTok. Management said Reels “and our discovery engine remain a priority and major driver of engagement,” and “Reels is now contributing to our net revenue across our apps.” Management added that it is seeing “sustained growth in Reels and Video overall as daily watch time across all video types grew over 25% year-over-year in Q4.” Reels can continue to aid growth for Meta in 2024, and while its engagement rate of ~6-9% is slightly below TikTok’s average engagement of 9-11%, Reels is estimated to have higher reach and interactions, which can benefit ad pricing despite the lower engagement rate.

While 2023 was Meta’s year of efficiency, 2024 may shape up to be Meta’s year of leverage. Key metrics support a return to >40% operating margin for the full year and a possible >33% net margin, driven by increasing ad pricing after inflecting back to growth, strong engagement and impressions growth, aided by the release of numerous AI features. Reaching those margins for the full year would imply EPS growth of nearly 38% to $20.50 on $160B in revenue.

AI can help provide increased operating leverage, similar to what we have seen with Microsoft as it boosts growth and creates additional engagement opportunities. Meta is investing heavily in both AI and non-AI hardware and data centers, with its capex guided for $30 to $37 billion in 2024.

Meta said that for “generative AI, we fully rolled out our Meta AI assistant and other AI chat experiences in the U.S. at the end of the year and began testing more than 20 GenAI features across our Family of Apps.” Increasing user engagement via AI features can drive higher ad loads, and thus higher pricing by increased optimization: Meta said that its “approach to optimizing ad levels in our apps has become increasingly sophisticated” as it continues to deliver performance gains for advertiser campaigns.

Note on Meta’s Capex:

The management has guided $30 billion to $37 billion in 2024, an increase of $2 billion at the high range of the prior guide. The guide represents 19.2% YoY growth in capex at the mid-point compared to an actual $28.1 billion in 2023. Since 2023 was a ‘Year of Efficiency,’ the company’s capex was down (12.3%) YoY compared to a growth of 66.5% in 2022.

Apple: Strong Q1 FY24 results overshadowed by weak guidance

Apple beat on the top line and bottom line. The profit margins and cash flow margins improved in the Dec quarter. The gross margin guide for the March quarter was also strong. However, management’s revenue outlook for the next quarter implies revenue will decline (5%) YoY and miss consensus estimates by 6%. China revenue of $20.8 billion also missed analyst estimates of $23.8 billion.

Revenue and EPS

Revenue grew by 2.1% YoY to $119.58 billion, beating estimates by 1.1%.

  • iPhone sales accelerated to 6% YoY growth to $69.7 billion, up from 3% in the Sept quarter, partly due to strong demand for the iPhone 15 line-up.
  • Mac Sales rebounded to 1% YoY growth to $7.8 billion from a (34%) decline in the September quarter. We want to watch this line item for a rebound in the broader PC market.
  • iPad sales disappointed as they declined by (25%) YoY to $7 billion. The slide was steeper than the Sept quarter decline of (10%).
  • Wearables, home, and accessories revenue declined by (11%) YoY to $12 billion, from a (3%) decline in the Sept quarter.
  • Services revenue grew by 11% YoY to $23.1 billion. Services remain a long-term opportunity for the company to monetize its installed base of over 2.2 billion active devices. Services revenue grew 16% in the Sept quarter.

GAAP EPS grew by 16% YoY to $2.18, beating estimates by 3.6%.

Margins

Gross margin improved 70 bps sequentially and 290 bps YoY to 45.9%. The management guide for the next quarter is in the range of 46% to 47%.

Operating margin improved 370 bps sequentially and 310 bps YoY to 33.8%.

Net margin improved 270 bps sequentially and 280 bps YoY to 28.4%.

Cash flow and balance sheet

Operating cash flow margin improved 930 bps sequentially and 440 bps YoY to 33.4%. Free cash flow margin improved 970 bps sequentially and 560 bps YoY to 31.4%. Free cash flow also benefitted from lower capex when compared to the same period last year.

The company has cash and marketable securities of $172.6 billion and debt of $108 billion. They repaid $4.0 billion of commercial paper and had net cash of $65 billion compared to net cash of $51 billion in the Sept quarter. Management reiterated its plan to be net cash-neutral over time. The company returned about $27 billion to the shareholders in the recent quarter in the form of dividends and share repurchases.

What to watch in the coming quarters

  • While providing the outlook for the next quarter, the CFO said they expect foreign exchange to be a 2-percentage headwind. The outlook suggests that revenue will decline by (5%) YoY in the March quarter and this missed consensus estimates by 6%. iPhone sales are expected to decline by about (10%) YoY in the March quarter.

The CFO said, “As a reminder, in the December quarter a year ago, we faced significant supply constraints on the iPhone 14 Pro and 14 Pro Max due to COVID-19 factory shutdowns. And in the March quarter a year ago, we were able to replenish channel inventory and fulfill significant pent-up demand from the constraints. We estimate that this impact added close to $5 billion to the March quarter's total revenue last year. When we remove this impact from last year's revenue, we expect both our March quarter total company revenue and iPhone revenue to be similar to a year ago.” We estimate that this impact added close to $5 billion to the March quarter's total revenue last year. When we remove this impact from last year's revenue, we expect both our March quarter total company revenue and iPhone revenue to be similar to a year ago.”

The company is facing competition from other smartphone companies in China due to foldable designs and advanced AI features. The company’s total revenue from China in the recent quarter was $20.8 billion, which missed estimates of $23.8 billion.

  • The performance of the services segment will also be crucial as the company has an installed base of over 2.2 billion active devices and over 1 billion paid subscriptions. The management expects a similar double-digit revenue growth rate in the next quarter to what the company reported in the December quarter: 11% YoY growth.

Management is expected to share more details later this year on how the company plans to capitalize on Artificial Intelligence. Tim Cook said in the earnings call. “That includes artificial intelligence where we continue to spend a tremendous amount of time and effort, and we're excited to share the details of our ongoing work in that space later this year.”

Vision Pro launched and has sold an estimated 200,000 units.

Lastly, the recent changes to the app store to comply with the EU’s Digital Markets Act are to be watched. The impact is limited at the moment since the change is only to Europe. The company will have lower commissions on the app store in Europe, which will now range between 10% to 17% instead of the typical 30%.

The CFO answered an analyst’s question on the call on the impact of the changes. “As Tim said, these are changes that we're going to be implementing in March. A lot will depend on the choices that will be made. Just to keep it in context, the changes applied to the EU market, which represents roughly 7% of our global app store revenue.”

Conclusion

The company's strengths are strong margins, cash flows, a stable balance sheet, and a loyal customer base. Tackling the revenue slowdown in China and capitalizing on its vast installed base is crucial for the company. Keep an eye on the app store commissions as Europe’s move to reduce these commissions will likely serve as inspiration to developers globally to push for the same.

Equity Analysts Damien Robbins and Royston Roche contributed to this article.

Recommended Reading:

FAANG-Leader Microsoft Is Banking On 4 Key Trends

Posted on by io-fund

This article was originally published on Forbes on October 29, 2021, 12:07am EDToriginally published on Forbes on October 29, 2021, 12:07am EDT

Microsoft has taken the coveted top spot as the world’s largest company by market capitalization – passing even stock market darling Apple. Microsoft was nearly left for dead, like peers IBM or General Electric, as one of the leaders from previous decades that couldn’t innovate fast enough to keep up. The period after the dot-com bubble and then the financial crisis of 2008 were difficult years for Microsoft’s stock as the company greatly lagged its peers in gains.

faang leader microsoft chart

Source: YCharts: Microsoft, Alphabet, Apple and Amazon Stock performance 2014-2020

This trajectory began to change when Satya Nadella, formally of the Azure division, became CEO in 2014 after working his way up through the company over the course of 19 years to president of the cloud business. The stock is up nearly 800% since the new CEO took over. Nadella’s multi-decade cloud experience and intense focus is what has helped Microsoft climb out of the hole that Bill Gates and Steve Balmer following decades of fighting open-source communities and anti-trust issues.

faang leader Microsoft stock performance

Source: YCharts: Microsoft, Alphabet, Apple and Amazon Stock performance 2014-2020

We’ve analysed earnings calls to see how Microsoft’s cloud focus compares to a company like Alphabet, which is diversified across many sectors, such as advertising. The contrast is remarkable in terms of how determined Microsoft’s management is on staking their ground on cloud computing with nearly every statement in the hour-long calls tying back to this sector.

Amazon Web Services could arguably be the hardest competitor in technology and Microsoft accepted this challenge despite AWS having a nearly four-year head start. Growth rates for both companies’ cloud divisions are in the 35% to 40% range.

Since 2018, we’ve covered in detail Microsoft’s hybrid cloud computing strategy and why we thought this strategy would be enough to propel Microsoft’s stock past its peers. Nearly three years after our coverage of this hybrid strategy began, we are now looking to the bellwether to analyse what trends we should pay attention to next across the cloud ecosystem.

Why Microsoft Azure Has Doubled Its Market Share

According to Gartner, cloud growth will remain robust next year on already large numbers. Public cloud services forecast on end-user spending will reach $482 billion in 2022, up from $396 billion in 2021 for growth of 21.7%.

Cloud IaaS will outpace this growth at 32.9% from $91.5 billion to $121.7 billion. Gartner also points out that public cloud spending will exceed 45% of all enterprise IT spending, up from 17% in 2021.

Amazon Web Services, Azure and Google Cloud are the top three IaaS players in the market with Azure nearly doubling its market share from a low of 11.2% in 2018 to 21% in the most recent quarter. We can see that despite this growth, AWS has not given up any turf and has remained level at 32% market share while the overall cloud IaaS market has grown substantially over time, affording others such as Azure an opportunity to capture this growth.

Primarily, it’s hybrid cloud computing that has helped drive Azure’s market share. We first covered this in 2018 and expanded on Microsoft’s strategy in 2019 when we stated:

“Investors should pay close attention to hybrid cloud when looking at Microsoft. Looking at it carefully will give them perspectives about how the company is positioned to set itself apart from other cloud companies like Amazon and Google.

Hybrid cloud is a technology which enables companies to store some of their data on their own servers while simultaneously sending other data to the private and public cloud. Companies love hybrid cloud because it is cost-efficient, transparent, and safe. Azure’s strength in hybrid computing has made it the main player in the industry. The product is used by 95% of Fortune 500 companies.”

Satya Nadella pointed out another important key aspect as to why Microsoft’s stock price has done well in the current environment where there are inflationary fears: “Digital technology is a deflationary force in an inflationary economy. Businesses – small and large – can improve productivity and the affordability of their products and services by building tech intensity. The Microsoft Cloud delivers the end-to-end platforms and tools organizations need to navigate this time of transition and change.”

I made this point over two years ago prior to the pandemic when the market was greatly doubting cloud and I said the following: “My prediction is this may be one of the last cycles when tech is considered less safe than value stocks. As the market will find out (the hard way), cloud software is actually very safe. It is insulated from trade wars and overseas manufacturing issues. It reduces costs for enterprises, which is ideal for a recession. Cloud software is at the beginning of a rapid growth cycle compared to its counterparts in tech — such as mobile, e-commerce and advertising — which are reaching saturation, are finding themselves in the cross hairs of anti-trust and are susceptible to consumer spending changes.”

Microsoft acquired Github in 2018, which helped Microsoft address its weakness of a poor reputation in open-source communities and lacking in developer relationships. Developers help determine the cloud IaaS service an enterprise or SMB customer will choose, so in-roads into this community via an acquisition has likely helped Microsoft hedge the developer favorite, AWS.

4 Key Trends from Microsoft Ignite 2021

As one of the bellwethers for cloud, Microsoft is a key company to monitor for trends that are leading the market. At Ignite 2021 Satya Nadella said, “we’re moving from a mobile and cloud era to an era of ubiquitous computing and ambient intelligence.” This next growth phase includes four key trends.

The first is the hybrid work-from-home trend with 73% of employees wanting flexible remote work options and 67% want more in-person connections. Microsoft believes the future will support both a collaboration between the physical world and digital world. Microsoft Mesh, which the company calls the Metaverse platform, can be embedded in Teams. Mesh introduces 2D and 3D meetings with personalized avatars that use AI to imitate movements even when the camera is off. Organizations can also create virtual spaces that resemble the physical office environment.

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Microsoft Loop is a new collaboration app that will expand Office. Through Microsoft Teams Connect, the company plans to make cross-organization communication easy and secure when there are meetings outside of an organization.

The second trend Microsoft pointed towards in the keynote is hyper-connected businesses. This refers to a “business process transformation” where supply and demand is informed by data and AI to help improve outcomes, such as the supply chain issues the market has experienced this year. At Ignite, the company announced Azure OpenAI Service with a video clip that showed how real-time summaries can be generated during the WNBA play-off. This will help content editors choose the right content in a few seconds using AI. Notably, Microsoft introduced the world’s first AI supercomputer five years ago during Ignite 2016 and today has some of the most powerful AI supercomputers in the cloud.

The third trend for the next phase of growth is that digital business will drive multi-cloud and multi-edge infrastructure. The company has already partnered with telecom operators like AT&T, Verizon, Telefonica, BG, Telstra, and SingTel to use its cloud services. Earlier this year, AT&T decided to move its 5G network to Microsoft Cloud. 5G and the Internet of Things could get a further boost recently as the Infrastructure Bill has been passed. The bill is expected to cost $1.2 trillion over eight years, which includes $110 billion for roads, bridges, and infrastructure, and $65 billion for broadband.

The final trend is the requirement for strong end-to-end security. The pandemic has increased digital transformation and with every business being operated remotely, the complexity has increased. According to the company, Cybercrime costs about $6 trillion per year and is expected to reach $10 trillion by 2025. In the earnings call Satya Nadella mentioned, “Our goal is to help every organization strengthen its defense through the zero trust architecture built on end-to-end solutions that span all clouds and all platforms. We analyze over 24 trillion signals across email, endpoints, and identities each day and translate this intelligence into innovative features to protect our customers.” The company has nearly 650,000 customers using its security solutions, which is up 50% YoY.

Microsoft Fiscal Q1 FY 2022 Report

The company’s revenue in fiscal Q1 FY 2022 increased by 22% YoY to $45.3B, which beat the consensus estimates by 3%.

All the three business segments showed promising growth. Revenue in the Productivity and Business Processes segment increased by 22% YoY to $15B primarily helped by the growth in Office products and LinkedIn revenue. Intelligent Cloud segment revenue increased by 31% YoY to $17B, it was primarily helped by the 50% YoY growth in Azure & other cloud services. The Personal Computing segment increased by 12% YoY to $13.3B.

Total cloud revenue growth was 36% YoY to $20.7B in comparison to Amazon Web Services 39% YoY growth to $16.1B. Notably, Microsoft does not break out Azure revenue.

faang leader Microsoft company earnings

Source: Company earnings reports

78% of the Fortune 500 companies use the company’s hybrid offerings. This quarter GE Healthcare and Procter & Gamble migrated their critical workloads to Azure.

The company also updated in the earnings call that GitHub has 73 million developers. 84% of the Fortune 100 companies use GitHub.

LinkedIn has nearly 800 million members and hiring on the platform rose 160% YoY. LinkedIn revenue grew 42% YoY.

Microsoft Teams is also growing steadily. 138 organizations have more than 100,000 users of Teams. Due to the hybrid work environment Teams chats increased 50% YoY. Schlumberger, Westpac, and SAP have chosen Teams Phone in this quarter. Microsoft 365 subscribers reached 54.1M at the end of the quarter.

The company had a free cash flow of $18.7B. Net income grew 48% YoY to $20.5B and adjusted net income grew by 24% YoY to $17.2B. Earnings per share came in at $2.71 and adjusted earnings per share came at $2.27, which beat the consensus estimates by $0.19.

Management’s revenue guidance for the next quarter is $50.6 billion across all three segments, which represents year-over-year growth of 17%. The analysts’ consensus is $50.47 billion with adjusted earnings per share of $2.31.

Conclusion:

Microsoft’s strategic bet on cloud became clear when the company placed the president of the cloud division as CEO. There is a stark change in terms of Microsoft’s performance as a public company since 2014 and we believe this new era where Microsoft leads could be just beginning. Apple must contend with consumer sentiment (and China) and must also break into new markets to maintain growth, Alphabet is spread thin across many segments with little overlap, and Amazon’s e-commerce weighs on AWS profits. Meanwhile, Microsoft’s singular focus provides a rare pure play at a $2.5 trillion market cap while cloud is setting up to capture gains from artificial intelligence.

Royston Roche contributed to this article

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

What Everyone Should Know Before Facebook’s Q3 Earnings Call

Posted on by io-fund

Facebook’s earnings call today may be the most anticipated call of Q3. The stock has tumbled since the last quarterly earnings call from a high of $217 in July to a low of $142. Three months ago, Street analysts did not think this was possible – and many still have price targets at $200. I believe bullish financial analysts are distracted by Facebook’s security costs, news feed fatigue and Instagram while underestimating the most important number on Facebook’s earnings call tomorrow –user growth rate.

Background on Facebook’s User Growth Trajectory

Facebook’s rampant growth from 2004-2017 was due to a viral coefficient formula which is also known as the k-factor. The k-factor equation was taken from epidemiology, in which a virus that has a k-factor greater than 1 indicates exponential growth. The equation for virality for websites and applications describes the growth rate:

k = i * c

i = number of invites
C = conversion rate

When K is equal to one or greater, you have viral growth.

Facebook’s growth rate trajectory was exponential because people found the network more rewarding when more people they knew joined the network. The same will be true for Facebook’s deceleration, as well. As people start to spend less time on the social network, there will be viral deceleration.

To illustrate, a loss of 1 million users in the United States to Facebook is not a 1:1 loss, like it would be for Netflix or Google, where users are isolated from each other in a “silo.”

  • If I stop using Google, your search results are not affected.
  • If I stop using Netflix, your programming choices are not affected.
  • Even Twitter can withstand user loss as the platform is not based on a reciprocal following structure. This is why a celebrity can have 60 million followers, yet only follow 135 people in return.

If 1 million users close their Facebook accounts in the United States, however, it will be subject to a negative k-factor. These 1 million people who delete their accounts weaken the content on the platform for the 50 million-500 million people who were connected to them (assuming each user has at least 100 friends and some are inter-connected).

Now, if 2 million of the subsequent 50-500 million start to use Facebook less due to the impact the original 1 million had, then another 500 million to 1 billion will have a less enjoyable experience, which will reduce time on site. If 5 million from those 500 million find the platform less interesting because their favorite people have left the platform, the affects will continue to spiral.

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This is why Snap has been a popular short. Snapchat continues to lose daily active users on a quarter-over-quarter basis in North America and Europe. Only last May, Snap began to report a sinking growth rate of 2.13 percent – which was its slowest ever at the time compared to 5 percent in Q4 2017. See below for how Facebook’s user growth rate compares.

It should be noted that this was once Facebook’s strength and Twitter’s weakness. New users on Facebook had a low barrier to entry because total friend count grew relative to how much you reciprocate and follow back. Twitter, on the other hand, has had a tough time attracting new users because there is no reciprocation.

Facebook Reported Slowest-ever User Growth Rate in Q2 2018

The viral-coefficient-in-the-reverse explains why the most important metric for investors to pay attention to in Facebook’s earnings report is the user growth rate. Last quarter, Facebook’s monthly user count grew 1.54 percent compared to 3.14 last quarter. Daily active users grew even slower at 1.44 percent, compared to 3.42 percent last quarter. Previously, the slowest daily active user growth rate was 2.18 percent in Q4 2017. If this number becomes stagnant, the social media platform can decelerate very quickly. This is also why it’s possible for Facebook to report strong earnings and there still be a sell-off. If and when this number goes into the red, Facebook will have reached its peak as a social media platform –and profits will soon follow this trailing decline.

Disclosure: I shorted this stock in April of 2018 and have a put option on this stock as of October 2018 as I expect the user growth rates to continue to decline in the near future. Readers should also note these declines are more likely to occur in high average revenue per user markets (ARPU) such as the United States, Canada, and in Europe.

Read more analysis on how I predicted Facebook earnings prior to Q2 and analyzed Facebook would face GDPR trouble following Q1 2018 here.

I consult for financial firms. Inquire here.

Should We Build a Backdoor into Mobile Devices?

Posted on by io-fund

Two years ago the San Bernardino shooting stirred a debate within the security community regarding warrant-proof encryption. The debate, known as “mobile backdoor access,” refers to exceptional access to encrypted communications and data by law officials. In theory, the Department of Justice wants technologists to “hide a key under the door mat” for law officials to access when they have the proper warrants. However, many security professionals and technologists have resisted this request due to creating weaknesses that are irreversible and require falsified automatic updates which may introduce other vulnerabilities.

Perhaps the biggest conflict for technologists, as pointed out by Herbert Lin, the Senior Research Scholar of Cyber Policy and Security at Stanford, is that anything less than deploying the best security (that is technologically possible) could constitute a neglect of professional obligation and ethics. Last November at the Intertrust LINE event, I had the opportunity to interview Lin, who is on the front lines of this debate. The conflict, as he pointed out in his keynote, exists in whether you can technologically design a system allowing exceptional access that is also secure. The security community says this is not possible while law enforcement says it is possible. Lin argues the parties are not talking about the same thing, as to talk about the same thing will require less-than-maximal security for users and less-than-desired capability for law enforcement (the proverbial grey area). In other words, maximal security is a technology issue, and adequate security is a policy issue — and it’s impossible to use a technical argument to solve policy.

Watch this 2 minute clip by Herbert Lin briefly covering the topic of mobile backdoor access: “Should We Build a Backdoor Into Mobile Devices?”Should We Build a Backdoor Into Mobile Devices?”

In his keynote, Lin poses questions that all sides must eventually answer during this debate and inevitable compromise, including tech vendors and the privacy community.

Questions we must answer for mobile backdoor access:

Questions for Law Enforcement:

· Why is law enforcement unwilling to acknowledge they’re asking the public to accept a lower level of cybersecurity?

· Why has a technical proof of concept not been provided? You think it can exist. Then prove it.

· How often and for what purposes are exceptional access capabilities expected to be used? If it begins for terrorism, when will it end?

Questions for Tech Vendors:

· Why do vendors provide password features if they’re against backdoors? This proves there situations where technologists have decided the benefits outweigh the consequences.

· How would exceptional access stifle innovation? Why should information technology not be subject to regulation? Lin points out technology is often subject to regulatory measures such as seat belts in cars.

Questions for the Privacy Community:

· What is the actual harm of having a back door? There are many people who are worried about being harmed that would not actually be harmed.

· How often are improper exceptional accesses expected to occur? The privacy community has the understanding there are to be zero improper uses, while one in 1 million or one in 10 million is more reasonable.

Click here to view the full keynote by Herbert Lin, entitled “Unresolved Issues Regarding Exceptional Access to Encrypted Data and Communications.”

Thanks for reading.

p.s. Don’t forget to follow me if you enjoyed this article!  On Twitter @Beth_Kindig and on Medium