Category: Social Media

Meta Reports Large Q2 Beat, Ad Impressions Growth Rebounds

Posted on by io-fund

Meta reported a large beat on both the top and bottom line in Q2, with revenue nearly $3 billion ahead of estimates at $47.52 billion and EPS of $7.14 more than 21% ahead of consensus. Ad impressions growth meaningfully rebounded from the mid single-digits to the double-digits in Q2. 

For Q3, Meta also set the bar quite high by guiding for $49 billion in revenue, pointing to a consecutive quarter with >20% growth. For context, Meta was expected to report <15% growth in both Q2 and Q3. 

In the bigger picture, Meta gave a line of sight to $100 billion in capex in 2026 as it works to build out its Prometheus accelerator cluster, which Mark Zuckerberg stated is expected to be the first 1+ GW scale cluster to come online next year. Combined with accelerating expenditures, there will possibly be some pressure on operating margin next year.  

Revenue Growth Returns to 20% Range 

Meta reported 21.6% YoY growth to $47.52 billion in Q2, nine points ahead of its guidance for 12.6% growth to $44 billion at midpoint. Advertising revenue was robust, growing 21.5% in the quarter, a more than five point acceleration from 16.2% growth in Q1. 

According to management, the beat was driven by AI unlocking greater efficiency and gains in their ad system: “This quarter, we expanded our new AI-powered recommendation model for ads to new surfaces and improved its performance by using more signals and longer context. It's driven roughly 5% more ad conversions on Instagram and 3% on Facebook.” They also pointed toward advancements in the recommendation system helping to lead to a 5% increase in time spent on Facebook and 6% on Instagram. 

In addition, Meta is expanding its tools for smaller advertisers “with a meaningful percent of our ad revenue now coming from campaigns using one of our generative AI features.” 

For Q3, Meta guided for a consecutive quarter of >20% growth, seeing revenue between $47.5 to $50.5 billion, or 20.7% YoY at midpoint. This includes a 1% growth tailwind from FX. 

Meta did not provide formal guidance for Q4, though it did state that it expects YoY growth to be slower than Q3 as it laps a stronger comp in Q4 2024. 

Advertising Key Metrics – APAC Outperforms in Impressions, ARPP Rises Nearly $2 YoY 

Ad impressions meaningfully rebounded from 5% growth in Q1 to 11% in Q2, though to confirm this quarter as a possible inflection back to double-digit growth, Meta would need to either maintain this growth or accelerate from here in Q3. 

  • US & Canada impressions rebounded to 9% growth, up from just 4% in Q1. 
  • Europe impressions growth was 6%, up slightly from 5% in Q1.  
  • APAC outperformed with impressions growth of 16%, up from 9% in Q1. 
  • Rest of World impressions growth was 7%, rebounding from 1% in Q1.  

However, ad pricing decelerated slightly, down from 10% in Q1 to 9% in Q2. Meta said this slight deceleration was from stronger impression growth, though pricing benefitted from “increased advertiser demand, largely driven by improved ad performance.” 

  • US & Canada pricing increased 11% YoY, decelerating from 14% in Q1.  
  • Europe pricing increased 17%, accelerating from 9% in Q1.  
  • APAC pricing increased 2%, compared to 3% in Q1.  
  • Rest of World pricing increased 15%, compared to 17% in Q1.   

Overall, ad revenue growth was the strongest in Europe and Rest of World at 24% and 23%, respectively, while US & Canada and APAC grew 21% and 18% YoY. 

Meta’s Family of Apps daily average people (DAP) increased 6.4% YoY to 3.48 billion, and average revenue per person (ARPP) rebounded to 14.8% YoY to $13.65. This is a nearly $2 increase from Q2 last year, and closing in on Q4 2024’s record at $14.25. 

Meta is working to expand its monetization pathways across its Family of Apps, rolling out video and image ads to Threads and ads to statuses and channels on WhatsApp. However, Meta acknowledged that Threads will not be a meaningful driver, while WhatsApp ads earn lower average prices that Facebook/Instagram as usage is skewed towards lower priced markets. 

Margins Improve, but Watch 2026 Expenses 

Gross margin held steady with Q1, and operating margin improved sequentially. However, Meta made a handful of key comments about 2026 expenses that could pressure margins down the line. 

  • Gross margin was 82.1%, flat QoQ and up 0.8 points YoY. 
  • Operating margin was 43.0%, up 1.7 points QoQ and 5 points YoY. 
  • Net margin was 38.6%, down 0.7 points QoQ but up 4.1 points YoY. 

Meta provided some initial commentary for 2026 expenditures, signaling an acceleration in expenses, with growth likely far outpacing revenue growth. Meta said that 2025 total expenses will increase 20-24% YoY, and 2026 total expenses are likely to increase at a higher rate.  

Rising infrastructure costs are the primary driver from a “sharp acceleration in depreciation expense growth and higher operating costs as we continue to scale up” data center infrastructure, followed by employee compensation. Management also singled out energy costs, finance leases and increased spending on cloud services to meet capacity needs as other factors behind higher operating expenses. 

However, revenue growth for 2026 is expected to be just 14% to $215 billion, though given the magnitude of Q2’s beat and Q3’s guide (at nearly $6 billion above estimates combined), this is likely too low. Assuming revenue comes in closer to $230 billion, with an 82% gross margin and a 27-30% increase in expenses, operating margin may fall from ~39-40% towards 34-36%. 

EPS 

Meta recorded a massive EPS beat in Q2, reporting 38.4% growth to $7.14 versus estimates for 14% to $5.90. This was driven by operating leverage and Meta’s large revenue beat. 

Heading into the report, Meta was expected to see negative earnings growth in both Q3 and Q4, but given that EPS beat estimates by 21%, it’s likely that these estimates move higher in the coming days/weeks considering the upbeat revenue guidance for Q3 and expenditure guidance remaining relatively unchanged.  

For FY25, Meta was expected to report 8.5% growth to $25.90, but given the nearly $1.30 beat in Q3, FY25 EPS is likely to be revised to $27+, or at least 13% YoY. 

Cash Flows and Balance Sheet 

Operating cash flow margin dipped sequentially, though FCF took a larger hit due to rising capex. Following Meta’s large-scale move to acqui-hire Scale AI for nearly $15 billion, cash and equivalents have shrunk sharply, with analysts questioning how management plans to fund increasing capex come 2026. 

  • Operating cash flow was $25.56 billion, for a 53.8% margin. This contracted from a 56.8% margin in Q1 but was up from a 49.6% margin in the year ago quarter. 
  • Free cash flow was $8.55 billion, down more than (21%) YoY as capex rose more than 100% YoY to $17.01 billion. FCF margin was 18%, down from a 24.4% margin in Q1 and a 27.9% margin in the year ago quarter. 
  • Cash, equivalents and marketable securities totaled $47.07 billion, down from $70.23 billion last quarter. Debt remained steady at $28.83 billion. 

Earnings Q&A: 2026 Capex in Focus, Nearing $100B 

Meta’s earnings call focused primarily on its heightened expenditures for next year and 2026 capex approaching $100 billion, as well as the monetization pathways for these investments. Management reaffirmed a goal to build out multiple GW of data center capacity in a quest to reach superintelligence, under the belief that it will “improve every aspect of what we do”. However, management also was clear in stating that genAI will not be a meaningful revenue driver this year or next.  

Management stated that while the “infrastructure planning process remains highly dynamic, we currently expect another year of similarly significant CapEx dollar growth in 2026 as we continue aggressively pursuing opportunities to bring additional capacity online to meet the needs of our AI efforts and business operations.” Given that 2025’s capex is currently guided to increase ~$30 billion YoY at midpoint, this suggests Meta is targeting $100 billion in capex next year.  

CFO Susan Li provided more clarity on the driving factors of this capex increase, saying that Meta expects “a greater mix of our CapEx to be in shorter-lived assets in 2025 and '26 than it has been in prior years,” or higher spending in servers, networking, and data centers to continue building out AI training and inference capacity. 

Given the fact that cash and equivalents have shrunk rather dramatically, analysts questioned about how Meta will finance this capex, as it will strain cash flows. Li said that Meta does expect to finance “some large share” of capex itself, though it is exploring other avenues to co-develop data centers with financial partners. She added that some models will “will attract significant external financing to support large-scale data center projects,” giving them some degree of flexibility in their cash spending. 

Analysts also questioned Meta about the ROI on this capex, considering how its aggressive push into the metaverse backfired. Management said that “on the core AI side, we continue to see strong ROI,” such as the visible impacts to ad conversions and impressions. On the genAI side, Meta said it is “clearly much, much earlier on the return curve and we don't expect that the genAI work is going to be a meaningful driver of revenue this year or next year,” though the company remains very optimistic about long-term monetization pathways. However, the question here is how much will Meta pour into capex before genAI becomes a meaningful driver – including 2026’s estimate, Meta’s three-year capex is already approaching $200B+.

Damien Robbins, Equity Analyst at I/O Fund contributed to this analysis.

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. Beth Kindig and the I/O Fund own shares in "META" at the time of writing and may own stocks pictured in the charts.

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Meta Q1: Bottom Line Shines While Top Line Growth is Decelerating

Posted on by io-fund

Meta reported a strong Q1 with revenue nearly $1 billion ahead of consensus, while EPS grew 37% YoY versus expectations for less than 11% growth. Meta also boosted its capex outlook, signaling at least 73% YoY growth at midpoint after Q1 capex surged nearly 104% YoY.  

The market is pleased with Meta’s results (today) yet it’s important to note that revenue growth has been decelerating, while key metrics are mixed with some decelerating on tough comps like ad impressions while ad pricing increased YoY by 4 points.  

Overall, revenue growth of 16% is a strong report, yet this is down from 27% growth in the year ago quarter. Looking further out, Q2’s revenue guide only marginally topped estimates and pointed to a sequential deceleration to below 13% YoY. Notably, EPS growth is outpacing top line growth, which is fine by me. 

All things equal, this is a strong report – yet the market will be weighing the future impact of tariffs on an advertising platform such as Meta. Therefore, the earnings report is unlikely to make a dent if tariffs persist.  

Revenue Easily Tops Estimates, Q2 Guided to Decelerate QoQ 

Meta handily beat the consensus estimate in Q1, reporting revenue growth of 16% YoY to $42.31 billion in revenue. Advertising revenue increased 16.2% YoY to $41.39 billion. However, this was Meta’s slowest growth rate since Q2 2023, although it comes against its peak 27% growth comp from last year.  

For Q2, Meta guided for a wider range of $42.5 billion to $45.5 billion in revenue, representing YoY growth of 12.6% at midpoint, and only 0.5% ahead of consensus at $43.8 billion. This would mark a 3.4 point sequential deceleration and a nearly 10 point YoY deceleration. Meta added that the guidance also included a 1% YoY growth tailwind from FX.  

Ad Pricing Grows YoY; Ad Impressions Soften YoY 

Advertising key metrics also decelerated sequentially, supporting the guided revenue growth deceleration for Q2. Ad impressions increased just 5% YoY, slowing considerably from 2023’s peaks and facing a tougher comp at 20% YoY last Q1. Ad pricing increased 10% YoY, a 4 point acceleration from 6% a year ago. 

The low impressions growth rate comes from broad-based geographic weakness:  

  • US & Canada impressions growth was just 4%, down from 16% a year ago 
  • Europe impressions growth was 5%, down from 12% a year ago. 
  • APAC impressions growth was 9%, down from 28% a year ago. 
  • Rest of World impressions growth was 1%, down from 17% a year ago. 

US & Canada showed outstanding growth that carried rest of the regions. For next quarter, APAC will likely face some geopolitical ad spending risks from e-commerce clients despite returning to growth this past quarter. 

  • US & Canada pricing increased 14% YoY, accelerating from 5% a year ago. 
  • Europe pricing increased 9%, decelerating from 18% a year ago. 
  • APAC pricing increased 3%, compared to a (3%) decline a year ago. 
  • Rest of World pricing increased 17%, compared to 20% a year ago.  

Meta’s Family of apps daily average people (DAP) increased 6% YoY to 3.43 billion, though average revenue per person (ARPP) recorded its slowest growth rate in at least six quarters at 10.4% YoY to $12.36. 

Gross Margin Surpasses 82%, Operating Margin Dips Sequentially 

Gross margin surpassed 82% in Q1, reaching its highest level since 2019 at 82.1%. Operating margin expanded 3.6 points YoY to 41.5%, though R&D expenses rose faster than revenue, increased 22% YoY to $12.15 billion, providing a slight headwind to margin upside.  

It’s quite impressive that Meta can maintain operating margins >40% while still burning more than $4 billion/quarter on its Reality Labs division.  

Meta also adjusted its operating expenses guide for the year, now seeing $113-118 billion in expenses, down $1 billion from its prior view for $114-119 billion. This slight decrease in operating expenses should provide a small tailwind to operating margin, assuming revenue growth does not decelerate dramatically. 

Net margin also contracted sequentially as the high R&D weighed down the line. Net margin was 39.3% in Q1, expanding from 33.9% in the year ago quarter. 

Sizable 23% EPS Beat in Q1 

Meta reported a sizable earnings beat in Q1, with its $6.43 EPS beating the consensus estimate of $5.22 by over 23%. Q1 EPS grew 36.5% YoY, well ahead of the estimated 10.5% growth in the quarter.

Given the sheer size of the beat, YoY margin expansion and revenue guidance slightly above estimates for Q2, it’s likely that Q2 and FY25 EPS will be revised higher in the coming days. Q2’s EPS was expected to grow just 8.5% YoY to $5.60, while FY25 EPS was forecast to rise 3.7% YoY to $24.75 heading into Q1’s report. With the $1.22 beat, FY25’s estimate is likely to move back into the mid-to-high $25 range, or YoY growth in the high-single digits. 

Operating Cash Flow Strong, FCF Impacted by Capex 

Meta’s cash flow generation remained robust in Q1, with operating cash flow margin contracting only 1 point QoQ; however, free cash flow was impacted by Meta’s surging capex. 

  • Operating cash flow was $24.03 billion in Q1, for a margin of 56.8%. OCF margin expanded nearly 4 points YoY. 
  • Free cash flow was $10.33 billion in Q1, for a margin of 24.4%. This contracted 10 points YoY, from a 34.4% margin in Q1 2024, due to Meta’s surging capex.  
  • Cash and marketable securities declined nearly 10% QoQ to $70.23 billion, as Meta spent $13.4 billion on share repurchases in the quarter. 
  • Debt remained steady at $28.83 billion. 

Capex Guide Boosted as Q1 Capex Surges 104% YoY 

Capex was a key metric analysts were closely watching heading into Q1’s report, given that Meta was expected to see the highest YoY capex growth of Big Tech at 59% YoY, while fears of an AI spending slowdown have risen recently.  

However, Meta squashed these fears, boosting its 2025 capex outlook as Q1 capex surged nearly 104% YoY to $13.69 billion. Meta now expects 2025 capex to accelerate 14 points to 73% YoY, raising its outlook to $64-72 billion, versus its prior view for $60-65 billion. At midpoint, this was a $5.5 billion increase. 

Meta said the new outlook “reflects additional data center investments to support our artificial intelligence efforts as well as an increase in the expected cost of infrastructure hardware.”  

Earnings Call Q&A: 

United States Key Market for Meta AI: 

Management was more open than usual in discussing their strategy around their standalone AI app. Primarily, they stated the near standalone app is aimed at United States users while the Meta AI integration with WhatsApp is popular with global users.  

When pressed on how they plan to stand out given there are many AI apps, management stated something similar to our recent deep dive, which is that they plan to compete on personalization and context: “Right now, if the experience is unpersonalized, then you can kind of just go to different apps and get reasonably similar answers to different questions. But once an AI starts getting to know you and what you care about in context and can build up memory from the conversations that you've had with it over time, I think that will start to become somewhat more of a differentiator. So that's one thing that we think will matter.” 

You can read more about Llama 4’s large context window here where it was stated: “Llama 4 Scout is cheap at $0.13 per million tokens according to Groq and can be deployed on a single H100 GPU, leveraging 16 experts. Scout can remember long threads and documents of up to 10 million tokens. This is the largest context window across LLMs available today.” 

Management Shrugs off Impact from Tariffs 

At the end of the call, Mark Mahaney attempted to push Meta’s management team to provide information on how the ad platform is being impacted by tariffs by specifically asking if auto was seeing softer ad spend at all. The CFO was careful to redirect, stating: “Mark, let me take your first question about other verticals. We generally saw healthy growth in most verticals in Q1. We did see some weakness in gaming and politics.” 

Although subtle, I believe this answer was well-rehearsed and did not fully satisfy the important inquiry. 

Earlier, the CFO stated this: “But our Q2 outlook reflects the trends we're seeing so far in April, which have generally been healthy. So it's very early. Hard to know how things will play out over the quarter and certainly harder to know that for the rest of the year.” 

AI Coding Agents Will Reduce R&D Spend 

The Mag 7 has taken a breather over the past few months and is largely lagging the broad market YTD. Some of this is because of massive capex spend, as the market is unsure of where the ROI will come from. However, I suspect Big Tech is already seeing massive productivity gains internally, which is why the bottom line continues to expand. As we saw tonight, EPS growth is outpacing revenue growth. This can be achieved by using AI to replace engineers, marketing and HR departments, for example. The first companies to replace humans with AI will naturally be the Mag 7 as they are far ahead in the AI race compared to enterprise companies. 

There were hints on the call as to when the impact will be seen: “So I'd say it's basically still on track for something around a mid-level engineer kind of starting to become possible sometime this year, scaling into next year. So I'd expect that by the middle to end of next year, AI coding agents are going to be doing a substantial part of AI research and development. So we're focused on that.” 

Conclusion: 

Meta is supposedly no longer in the year of efficiency and is now in the year of AI, according to management. However, the efficiency is remarkable yet again this quarter. Although the company is decelerating from high growth in the past, the company has a big year ahead with ad improvements resulting in higher ad pricing, Meta AI standalone app recently launched (to be monetized next year), and its Llama 4 models, which are open source yet driving important productivity gains internally. Undoubtedly, the company has a lot of data for personalization and a highly engaged audience, marking two competitive advantages over other AI chatbots. 

The company can certainly be affected by tariffs, which is something all investors must weigh. Management offered no help in that regard, but one can safely assume the longer we see elevated tariffs, the lower consumer spending will be, and in turn, the lower ad spending will be. We will monitor this as we go along.

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.

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Meta Blows Past Estimates in Q4, Guides for a Soft Q1

Posted on by io-fund

Meta reported some mind-boggling growth numbers for 2024 – 22% revenue growth, 48% operating income growth driving a 7 point margin expansion, and 60% EPS growth. As we had recently discussed in Big Tech AI Stocks to Showcase AI Gains, Capex in Q4 Reports, Meta’s decision to be “aggressively investing in compute and data center capacity as it continues developing its Llama family of models, fine-tuning its feed to boost engagement and increase time spent on apps, and optimizing ad delivery” is paying off.

Meta doubled down on its $60-65 billion capex for 2025, despite fears that DeepSeek’s breakthroughs would substantially alter the AI spending narrative. In fact, Meta CEO Mark Zuckerberg explained that Meta would be investing “hundreds of billions of dollars” towards AI infrastructure in the long run, while making multiple predictions for the path of AI and AI at Meta in 2025. Core AI is paying off as ad pricing growth is accelerating, aiding high revenue growth, while margins and cash flows remain very strong.

Despite the blowout Q4 report, Meta guided for a rather soft Q1, with the midpoint of its revenue guide below consensus, forcing Q1 growth to be revised nearly 1 point lower. EPS growth is also expected to become much more challenging in the back half of 2025, with consensus estimates pointing to growth of just 4.6% in Q3 and an unusual (2%) decline in Q4.

Financials

Meta reported quite a significant beat on EPS of 19%, while revenue also beat estimates, driven by increasing monetization. However, management guided for Q1 below consensus at midpoint, pointing to a sharp 7 point growth deceleration sequentially and the slowest growth since Q2 2023.

  • Revenue of $48.4 billion beat estimates by $1.4 billion, representing YoY growth of 20.6%.
  • For FY24, revenue rose 22% YoY to $164.5 billion.
  • For Q1, management guided for revenue of $39.5 billion to $41.8 billion, which at the $40.65 billion midpoint, was approximately $1 billion below estimates for $41.6 billion. The guide was impacted by a 3% FX headwind.

Management shared interesting commentary on how they are increasing monetization to drive improved revenue performance, via improving marketing performance for advertisers. Management explained that in the second half of the year, they introduced Andromeda, an ML system in partnership with Nvidia, which “enabled a 10,000 times increase in the complexity of models we use for ads retrieval.” This allowed Meta to “run far more sophisticated prediction models to better personalize which ads we show someone,” leading to “an 8% increase in the quality of ads that people see on objectives we’ve tested,” aiding ROI for advertisers. Automation tools made an appearance as well, with Meta noting that adoption of Advantage+ Shopping campaigns (tailored for e-commerce) surpassed a $20 billion annual run-rate while growing 70% YoY in Q4.

Margins and EPS

Meta’s focus on efficiency and margins in 2023 has translated into significant gains in 2024. Not only is operating margin now approaching 50%, but what was more impressive is the 50% EPS growth this quarter on top of a 201% growth comp.

Here’s how Meta’s operating margin expansion has looked since Q4 2022:

  • Operating margin rose 5.5 points sequentially and 7.4 points YoY to 48.3%. This is also more than double the 19.9% margin reported in Q4 2022.
  • For FY24, operating margin was 42.2%, up 7.7 points from 34.5% in 2023 as operating income rose 48% YoY.
  • Net margin was 43.1% in Q4, improving from 38.7% in Q3 and 35% a year ago. Two years ago, net margin was just 14.5%.

This substantial margin expansion has led to significant earnings growth. Meta’s EPS for 2024 rose 60% after increasing 73% in 2023.

  • Q4 EPS of $8.02 beat estimates by $1.28, and increased 50% YoY.
  • FY24 EPS of $23.86 increased 60% YoY.
  • For Q1, EPS is estimated to be $5.29, for growth of 12.3% YoY. 2025’s EPS growth is expected to become more challenged, with consensus pointing to growth of just 5.5% to $25.18, with single-digit to declining growth in the second half of the year.

Cash flows have been extremely strong as well – it’s quite absurd to see operating cash flow growing at 30% at nearly a >50% margin at this nearly $100 billion scale.

  • Operating cash flow was $28.0 billion in Q4, rising more than 44% YoY and representing a margin of 58%.
  • FY24 operating cash flow was $91.3 billion, up 28% YoY. OCF margin was 56%, improving from 53% in FY23.
  • Free cash flow was $13.2 billion, up 14% YoY as capex rose 90% YoY to $14.4 billion. FCF margin was 27%.
  • FY24 free cash flow was $52.1 billion, up 21% YoY for a 32% margin.
  • Cash, equivalents and marketable securities totaled $77.8 billion, while debt totaled $28.8 billion.

Key Metrics

  • Ad impressions grew 6% YoY, slowing from the 7% growth last quarter. Europe and Rest of World dragged on growth, with impressions rising 5% and 3% YoY respectively.
  • Ad pricing increased 14% YoY, accelerating from 11% growth last quarter. Europe and Rest of World drove this growth, at 16% and 23% YoY respectively.
  • Average revenue per person (ARPP) was $14.25, up 16% QoQ and 16% YoY, highlighting Meta’s improvements in monetization.

Valuation and Risks

Despite shares rising 72% over the past year, Meta is trading as one of the cheapest stocks among the Mag 7, at 27x forward EPS. Alphabet is the only of the 7 to be cheaper on a bottom-line basis at 22x forward EPS, with Nvidia at 28x following this week’s selloff.

2025’s earnings growth forecast raises some red flags, as EPS is expected to grow just 5% for the full year, with growth decelerating significantly. Meta’s rally had gained steam as it reported consecutive triple-digit growth quarters, and this 38 point growth deceleration and risk of slipping into declining growth presents a headwind to shares, as it suggests AI monetization efforts are not translating into consistent EPS growth quarter after quarter.

On a top-line basis, Meta is trading for 11.5x revenue, and 9.4x forward revenue. This is the highest level it has traded at since 2018, and more than 50% higher than its five-year average of 7.5x revenue. Cash-flow based valuations offer a bit more room to the upside, with Meta trading at 21.8x operating cash flow, below its peaks of 24-26x in 2020 and 2021; for FCF, Meta is trading at 34x, below peaks of 43x.

One other risk presents itself from Q1’s below consensus guide, as revenue growth estimates have already come down. Prior to earnings, Meta was expected to see growth of ~14.5% to 14.6% in each quarter of 2025, though Q1 is now expected to see growth of 13.8%.

Capex Commentary – Implications for Nvidia and Broadcom

Though there were fears that DeepSeek would impact the trajectory of AI spending this year, Meta doubled down on its planned capex of $60 to $65 billion in 2025. Management explained that the increase would be driven by investments supporting genAI and core businesses, though the majority would be directed towards core, where Meta is seeing the most AI growth arise. CEO Mark Zuckerberg also discussed the “hundreds of billions of dollars that we will invest in AI infrastructure over the long-term,” as it brings 1 GW of capacity online this year while working on a 2 GW data center.

For 2025, CFO Susan Li provided a breakdown of where capex will go, saying data center spend will rise to support build outs of large-scale training clusters and higher power density facilities entering primary construction phases. Networking spend is expected to rise as higher-capacity networks get established to support both core AI and gen AI traffic.

However, perhaps the most important part of the call was Li’s discussion on AI accelerators, as it has implications for both Broadcom and Nvidia. Li explained that Meta would be “pursuing cost efficiencies by deploying our custom MTIA silicon in areas where we can achieve a lower cost of compute by optimizing the chip to our unique workloads. In 2024 we started deploying MTIA to our ranking and recommendation inference workloads for ads and organic content. We expect to further ramp adoption of MTIA for these use cases throughout 2025 before extending our custom silicon efforts to training workloads for ranking and recommendations next year.”

Management still emphasized that they are “planning to significantly ramp up deployment of GPUs in 2025, and we'll continue to engage with our vendors and invest in our own silicon to meet those needs,” though they did not comment on whether they are supply constrained like Microsoft.

Analyst Q&A

Analysts questioned Meta about the MTIA accelerator ramp, growth drivers moving forward, and most importantly, the impact of DeepSeek.

Q, Brian Nowak (Morgan Stanley): “How should we think about the main gating factors as to how quickly you'd be able to move a higher percentage of your engagement to your custom silicon?”

A, Susan Li (Meta): “We're also very invested in developing our own custom silicon for unique workloads, where off-the-shelf silicon isn't necessarily optimal and specifically, because we're able to optimize the full stack to achieve greater compute efficiency and performance per cost and power because our workloads might require a different mix of memory versus network, bandwidth versus compute and so we can optimize that really to the specific needs of our different types of workloads.

Right now, the in-house MTIA program is focused on supporting our core ranking and recommendation inference workloads. … We'll continue ramping adoption for those workloads over the course of 2025 as we use it for both incremental capacity and to replace some GPU-based servers when they reach the end of their useful lives. Next year, we're hoping to expand MTIA to support some of our core AI training workloads and over time, some of our Gen AI use cases.”

Reading between the lines here suggests that ramping MTIA is not necessarily coming at the expense of lost share to Nvidia; rather, Meta is working to replace old GPUs with custom chips to increase capacity and power workloads with more efficient chips, supplementing GPU purchases from Nvidia.

JP Morgan’s Douglas Anmuth asked about the impact of DeepSeek and other models that “potentially leverage Llama or others to train faster and cheaper,” and what impact this has.

Zuckerberg said that it is “probably too early to really have a strong opinion on what this means for the trajectory around infrastructure and CapEx,” though the mix shift between compute and inference as reasoning models arise was already something that Meta had been experimenting with.

He went on to explain, “Of all the compute that we're using, that the largest pieces aren't necessarily going to go towards pre-training. But that doesn't mean that you need less compute, because one of the new properties that's emerged is the ability to apply more compute at inference time in order to generate a higher level of intelligence and a higher quality of service, which means that as a company that has a strong business model to support this, I think that's generally an advantage that we're now going to be able to provide a higher quality of service than others.”

Conclusion

Meta’s Q4 was indeed a strong report, though Q1’s weak guide was a bit questionable given the strength of the recent report. Execution has been pristine since 2023, with operating margin more than doubling with significant cash flow and EPS growth. ROI from investments in core AI is becoming more evident as ad pricing growth is accelerating, offsetting decelerating growth in ad impressions.

Damien Robbins, Equity Analyst for the I/O Fund, contributed to this analysis.

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.

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Tencent: China AI Momentum Play with Technicals

Posted on by io-fund

Tencent stands out for its dividend, buybacks, strong margin expansion, increased cash, and plus WeChat in mainland China was quite strong this past quarter. However, we want to emphasize that any trades on Tencent or Baidu are momentum trades only. These are not shared with Pro or Essentials Members and are more like crypto, where technicals not only lead but are roughly 90% of the decisions we make around the position.

Below is research into Tencent’s financials with the gentle reminder that the technical analysis section below is the ultimate determining factor in how we manage the momentum position.

Revenue and EPS:

In the last earnings report, the conversion rate was stated to be based on USD1 to RMB7.0827. The currency rates may fluctuate in the upcoming earnings report and thus any USD numbers will not be exact.

Tencent is expected to report growth of 2% this quarter for revenue of $21.9 billion USD. This compares to $21.98 USD or RMB 155.2B in the previous quarter for growth of 7%. The company is expected to report growth of roughly 10% the next three quarters with the March quarter expected to be the bottom.

On an annual basis, 2023 reported growth of 10% for RMB 609B or $86B USD compared to a decline of (-1%) for RMB 554.6B or $79.6B USD for the full year 2022. Looking forward, Tencent is expected to report growth of 8.9% for USD $92.2B. The company is expected to report roughly 10% growth over the next few fiscal years with 2022 expected to be the bottom on an annual basis.

This quarter, the company is expected to report EPS of USD $0.64, or calculated to be RMB $4.53 EPS. This is flat from RMB $4.50 EPS reported last quarter yet the estimates represent growth on a year-over-year basis of 33%, up from RMB $3.10. Next quarter, Tencent is expected to report EPS of $0.64 or RMB $4.53 to be flat QoQ yet up 21% year-over-year.

On an annual basis, adjusted EPS is expected to grow 23.4% for USD $2.80, calculated to be RMB $19.9 EPS. This is up from RMB $16.3 adjusted EPS in FY2023. EPS is expected to grow 16% in FY2025 and 29% in FY2026.

Tencent focuses closely on Profit Attributable to Shareholders on a Non-IFRS basis (which is Non-GAAP adjusted net income for our reporting standards). In the most recent quarter, this was RMB $42.7B or USD $6B and was up 44% YoY.

EBITDA of $54B RMB or $7.6B USD was up 22.7% from $44B RMB in the year ago quarter. Adjusted EBITDA of $59.5B RMB or $8.4B USD was up from $49.6B RMB in the year ago quarter. The adjusted EBITDA margin increased to 38% up from 34% in the year ago quarter.

Margins:

Tencent is seeing expanding margins and this is a key piece as to why Tencent could see favorable price action.

Last quarter, the gross margin of 50.2% expanded from 43% in the year ago quarter and was up 120 basis points QoQ. Gross profit was up 25% from $61.8 RMB to $77.68 RMB or USD $11B.

Per management: “Importantly, our gross profit growth has consistently surpassed revenue growth due to the margins of our incremental revenue being significantly higher than the 50% overall gross margins for the entire company. This incremental revenue is generated predominantly from our leading social and payment platforms, which have already been built and had their costs covered. We now consider gross profit growth as a key proxy and, frankly, a better proxy than revenue growth for our organic growth given this shift in terms of the revenue mix.”

Last quarter, the operating margin of 27% increased from OPM of 20% in the year ago quarter yet decreased 400 bps from the previous quarter. The operating profits were $41.4B RMB or $5.8B USD.

The adjusted operating margin of 32% was up from 27% in the year ago quarter and is up 11-points in two years. This is down QoQ 400 basis points.

Per management regarding this efficiency: “We further enhanced our operating profit growth from gross profit growth through operating leverage. First, we streamlined operations and prudently reduced aggressive marketing expenditures. We perceive these measures as a less recurring strategy. Second and more importantly, we are committed to operational efficiency and disciplined resource allocation, which includes thoughtful staff distribution and effective marketing expense management. This approach ensures a focused organization and a lean cost structure moving forward.”

  • The net margin of 18% for profits of 27.9 RMB doesn’t comp well against a one-time event in the year ago quarter, which had led to a net margin of 74%, but the 18% is in line with previous quarters. 
  • The adjusted net margin of 28% compares to an adjusted net margin of 21% in the year ago quarter. This is down 200 basis points QoQ.

Cash Flow:

Operating cash flow last quarter was RMB $54 billion or USD $7.6B, up 52% YoY. This represents an operating cash flow margin of 35% up from a margin of 25% in the year ago quarter.

Free cash flow of RMB $34.2B or $4.8B was up 48% YoY and represents a free cash flow margin of 22% up from 16% in the year ago quarter. Some quarters have a higher FCF margin than others, with Q3 and Q1 reporting a FCF margin of 33% and 35%, respectively.

The company has RMB 403.3B or USD at $56.9B in cash. This is up from USD 45.9 in the year ago quarter. The company has debt of RMB 348.6B or USD 49.2B for net cash of RMB 54.7B, which calculates to net cash of $7.72B USD.

Last quarter, the company spent RMB 7.5B in capex, which was up 33% YoY.

The fair value of shareholding in listed investee companies was RMB 550.7B or USD $77.8 billion. This has been trending upward but is a risk to have this much exposure to other companies.

The carrying book value of unlisted investee companies was RMB 337.3B or USD $47.6 billion. This has been flat over the past few quarters.

Dividends and Buybacks

Tencent pays an annual dividend and recently increased this by 42% to HKD 3.40 per share, which has a current exchange rate of $1 = $7.84. This would equal USD $0.43. Also, according to the last earnings report: “we intend to at least double the size of our share repurchases, from approximately HKD49 billion in 2023 to over HKD100 billion in 2024.” This equals roughly USD $12.7 billion.

Per the earnings call: “We believe this commitment to return at least HKD 132 billion or US $16.9 billion to shareholders during the year is well supported by our free cash flow, which was US $24 billion for the full year of ’23, along with our gross cash position of US $57 billion and our investment portfolio of US $126 billion.”

Key Metrics:

The Online advertising revenue segment reported RMB 39.8B up 21% YoY. This compares to 15% growth in the year ago quarter. This represents 19% of revenue with a gross margin of 56.8%. The gross margin was up 12.6 points year-over-year.

Fintech and Business services were up 15% YoY for RMB 54.4B compared to a decline of (-1%) YoY to RMB 47.2 billion in the year ago quarter. This represents 35% of revenue. Gross margin in fintech and business services is at 43.9% which was up 10.3 points year-over-year.

Revenue from value-added services (VAS) which includes international games, domestic games, communication and social, and also digital content, was down 2% YoY to RMB 69 billion and was also down 2% in the year ago quarter. Revenue from music-related and game-related livestreaming services decreased while revenue from the video accounts streaming service, music subscriptions and mini-games increased. This segment has a gross margin of 53.7% and was up 3.9 points YoY.

Despite the puts and takes in the segment, management stated the following highlights: “Our mini-games platform increased gross receipts by over 50% year-on-year. Our number of major hit games in China achieving both high DAU and substantial monetization increased from six in 2022 to eight in 2023 and in connection with games achieved double digit revenue growth and rose to 30% of games revenue.”

Management also stated they expect games to improve “from the second quarter of 2024.” There is also a popular game on desktop expected to launch on mobile in the second quarter called DnF mobile.

  • Combined MAU of Weixin (mainland China) and Wechat (global app) is 1.343B up 2% YoY
  • Mobile Device MAU was down (-3%) YoY to 554
  • Fee-based VAS registered subscriptions was up 6% YoY to 248

Additional metrics:

  • Tencent Video had 117 million paid subs. Long form video subscription revenue increased 1% year-on-year, driven by higher ARPU, while their video subscriptions declined slightly to RMB 117 million.
  • Tencent Music had 107 million paid subs. Music subscription revenue increased 45% year-on-year on 21% growth in subscription count and 20% growth in ARPU.

Some highlights this past quarter include management stating: “Weixin Search has now achieved over 100 million DAU, up over 20% year-on-year, and Weixin Search content QV grew over 30% year-on-year. Our search revenue grew multiple times year-on-year in 2023 as we ramped up monetization on this under-monetized asset.”

Later it was also stated: “Weixin video accounts on the content consumption side, time spent increased over 80% year-on-year in the fourth quarter driven partly by DAU and mostly by time spent per user.”

Risks:

There are some risks associated with Tencent stock that are important to keep in mind, especially since United States stocks do not carry the same level of risk. The first is United States-China tensions, the second is that Tencent’s financials are unaudited, and third that Tencent is an over-the-counter stock which means the stock is not traded on an exchange.

Valuation:

Tencent trades at a PS ratio of 4.5 and a 4 EV/Sales which is in line with three year averages yet is low on a 5-year average basis. The 3-year median is 5 and the 5-year median is 6-8 EV/Sales

The company trades at a Fwd PE Ratio of 12 based on next year’s earnings compared to a 15 Fwd PE Ratio on a 3-year basis. However, the forward PE Ratio on a 5-year median is 30.

Price to FCF is 28.7 and has primarily traded higher except in 2022. The stock has traded as high as a 50 Price to FCF, but this is the absolute max it’s traded in the last few years.

Earnings Call:

AI driving Ad Revenue increase:

Per the earnings call:

“Moving to online advertising, our ad revenue was RMB 30 billion in the fourth quarter, up 21% year-on-year, benefiting from upgrades to our ad tech platform and more advertising revenue and video accounts. We generated increased ad revenue from all major categories except automotive with notable step-ups in revenue from internet services, healthcare and consumer goods categories. We refined our ad targeting by utilizing more real-time data in the AI powering our ad tech, enabling us to match target users with more relevant ads in a more timely manner across both our owned and our ad network properties.We refined our ad targeting by utilizing more real-time data in the AI powering our ad tech, enabling us to match target users with more relevant ads in a more timely manner across both our owned and our ad network properties.

Our video accounts ad revenue more than doubled year-on-year despite maintaining a very low ad load, due to increased video views and upgraded ad targeting. Weixin Search increased its revenue several-fold year-on-year in the quarter on growth on commercial queries and RPM.”

Later it was also stated:

Moving to communications and social networks, for Weixin video accounts on the content consumption side, time spent increased over 80% year-on-year in the fourth quarter driven partly by DAU and mostly by time spent per user, benefiting from our enhanced content recommendation engine […] Our video accounts ad revenue more than doubled year-on-year despite maintaining a very low ad load, due to increased video views and upgraded ad targeting. Weixin Search increased its revenue several-fold year-on-year in the quarter on growth on commercial queries and RPM.”

More on Artificial Intelligence

“Our Tencent Hunyuan foundation model is now among the top tier of large language models in China with notable strength in advanced logical reasoning. Our upgraded advertising AI model enables us to deliver better ad targeting and higher revenue.”

“In 2023, we also made notable progress in core technologies, especially those involving AI that will serve as our growth multiplier going forward. After deploying leading edge technologies such as the mixture of experts, or MoE architecture, our foundation model Tencent Hunyuan is now achieving top tier Chinese language performance among large language models in China and worldwide. The enhanced Hunyuan excels particularly in multi-turn conversations, logical inference, and numerical reasoning, areas which have been challenging for large language models. We have scaled the model up to the trillion parameter mark leveraging the MoE architecture to enhance performance and reducing [indiscernible] costs, and we are rapidly improving the model’s text-to-picture and text-to-video capabilities.

We are increasingly integrating Hunyuan to provide copilot services for our enterprise SaaS products, including Tencent Meeting and Tencent Docs, and we are also developing new gen-AI tools for effective content production internally. More generally, deploying AI technology in our existing businesses has begun to deliver significant revenue benefits. This is most obvious in our advertising business where our AI-powered ad tech platform is contributing to more accurate ad targeting, higher ad click-through rates and thus faster advertising revenue growth rates. We also see earlier stage business opportunities from providing AI services to Tencent Cloud customers.”

Technical Analysis

If we analyze the bigger trend in Tencent (TCEHY), there are two interpretations on the pattern in play.

  • The Blue Count has the large correction that started in February of 2021 was actually a correction within a larger uptrend. This pattern would be playing out in 5 waves, and the current breakout would be the start of the final 5th wave higher. If this is in play, we will push past the $72 resistance, breakout to new all-time highs and then target the $115 – $140 region.
  • The Red Count has the larger 5 wave pattern ending in February of 2021. This would imply that we are in a larger degree corrective bounce, which should take us to the $58 – $72 region, and potentially higher. We would be in the final push of a B wave, which is a 3 wave move.

If we zoom in on this move, what is worth noting is that both counts suggest a move to the $58 – $72 region.

From current levels, this is a 35% – 65% move. How TCEHY reacts in this region will determine if the more bullish blue count is in play. For any immediate entry, our stops would be between $39 – $36. If we catch the trend correctly, these stops would move higher with price.

Conclusion:

Similar to our analysis on Baidu, we foresee China’s push for domestic tech to be a force to contend with when it comes to AI. We could not be clearer that United States stocks are richly valued at the moment, and it’s quite difficult to find a good deal on tech in this market. Should we look toward China for alpha, it would be brief and a decision based on technicals. This means a position ranging from 1 day (should the setup fail) to a couple of months maximum. The weekly webinars and trade alerts are especially informative in this case, which is why the analysis is not shared with subscription tiers that do not have access to these Premium benefits. China is risky, Tencent is not audited, and is an OTC stock, and there are geopolitical tensions to navigate. With that said, the likelihood is high that we will attempt this half-court shot, so keep an eye out for the trade alert.

Knox Ridley, Beth Kindig, and the I/O Fund Analysts, contributed to this analysis

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The Magnificent 7 Are Falling Like Dominos; Only 3 Remain

Posted on by io-fund

This article was originally published on Forbes on Feb 29, 2024, 09:34pm ESTForbes Forbes on Feb 29, 2024, 09:34pm EST

The Magnificent 7, defined as Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia and Tesla, have seen a “magnificent” run fueled by AI optimism over the past fourteen months. The Magnificent 7 returned more than 106% in 2023, doubling the Nasdaq 100’s nearly 54% gain and significantly outperforming the S&P 500’s 24% gain. At first glance, it may appear that the Magnificent 7 are continuing their outperformance of the broader indexes in 2024.

However, like dominos falling, these market generals are topping out and diverging from the broad market. First Tesla in July of 2023, then Apple and Google in February have topped, and now Microsoft is not making a new high with the broad markets’ most recent run higher.

Beth's Twitter Post on the Magnificent 7

Source: TwitterSource: Twitter

The Magnificent 7 of 2023 have now become 2024’s Magnificent 3: Nvidia, Meta and Amazon. Of these, Nvidia’s saw a stellar start to the year as shares have gained nearly 60% YTD due to the GPU leader’s beat-and-raise quarters.

The Magnificent 3: Nvidia, Meta and Amazon

Source: TradingView

There are two reasons why this matters – which we also outlined in our analysis “Five Stocks (Not Seven) Can Lead to New Highs” from October – that “a handful of these stocks [the Mag 7] can push the bigger markets higher,” but now we’ll need more than just three to keep the rally going.

First, these 7 stocks hold a significant weighting within the indexes. It will be difficult for a sustained push higher to continue if these FAANGs do not participate, considering their outsized weighting.

  • The Mag 7 comprises more than 40% of the Nasdaq 100 and more than 29% of the S&P 500.
  • MSFT, GOOGL, AAPL, and TSLA account for about 18% of the S&P 500 and about 25% of the NASDAQ-100.
  • For reference, just Apple and Microsoft combined hold a larger weighting in the S&P 500 than Berkshire Hathaway, JP Morgan, UnitedHealth Group, Visa, Exxon, Mastercard, Johnson & Johnson, Procter and Gamble, Home Depot, Costco, Merck, and Chevron combined. If these companies collectively all stalled, it would be a major warning sign. Yet, Apple and Microsoft are both stalling.

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Secondly, when the cycle leaders start to underperform, it tends to mark the start of a trend change. The FAANGs have been the undoubted leaders of this bull run, and we are now seeing them start to trend lower against the indexes. More times than not, the leaders on the way up, tend to be the leaders on the way down.

In today’s bull cycle, this leaves Nvidia, Meta and Amazon as the three remaining generals making new highs with the markets.

NVDA, META, AMZN Chart

Nvidia, Meta and Amazon are the three remaining generals making new highs with the markets. Source: TRADINGVIEW

Combined, the trio account for approximately 15.8% of the Nasdaq 100 and 10.8% of the S&P 500. Nvidia’s post-earnings surge, in which the chip giant added nearly $250B in value, helped the S&P 500 add more than $2 trillion in market cap as it boosted other AI and tech stocks in general. Should the trio begin to follow in the path of the four fallen dominos, setting a high and drifting lower, the market may be at risk of giving up some of its newfound gains, similar to what we had discussed in our analysis “Apple Can’t Save This Tech Rally” at the end of January. In this, we outlined how both the bull and bear cases for the market “are calling for a level of volatility in 2024 that will, at least, retrace the rally we’ve seen since November 2023.”

Concentration Risk Elevated

To an extent, the narrow leadership of this market stemming from the Magnificent 7’s AI-powered gains has raised warning bells for some investors, as the market’s concentration has surpassed levels seen in the dot-com bubble. To be clear, my firm is a pioneer in building an AI portfolio, and a selloff would be a buying opportunity. However, narrow leadership is a problem not to be ignored, and this is best illustrated by the chart below:

Historical Top 7 Stock Weightings in S&P 500 Index Since 1999

Source: CME

As mentioned earlier, the Magnificent 7 account for more than 29% of the S&P 500, more than the 21% concentration of the top 7 stocks in the S&P 500 seen in 1999 and 2000 — keep in mind that Tesla is no longer one of the top 10 largest stocks in the S&P 500, so the concentration of the top 7 today is above 30%. This also marks a dramatic increase from the 14% concentration seen a decade ago.

What this means is that as the Magnificent 7 as a whole continue to outperform – the seven have already gained more than 22% YTD in 2024 – they will continue to cover up the turbulence in the broader market that is brewing under the surface. For example, at the end of February, the Nasdaq 100 and S&P 500 are up nearly 9% and over 7%, respectively, while the equal-weighted S&P 500 has gained just over 2%.

Magnificent 7 vs Nasdaq and S&P

Source: TradingView

This concentrated dominance has helped the S&P 500 push to new highs, more than 6% above its 2021 high, while the equal weight S&P (orange) has yet to reclaim that 2021 high, sitting about 100 points lower. The influence of the Magnificent 7 is clearly visible — the S&P 500 has a 26 percentage point outperformance of the equal-weight index, returning 81% versus 55% over the past five years; this gap has widened throughout 2023, from 8 percentage points in April to 14 percentage points in July to 20 percentage points in October.

S&P 500 Level% Change

Source: YCharts

I/O Fund Portfolio Manager Knox Ridley outlined in our analysis in October, 5 Stocks (Not 7) Can Lead To New Highs that “a handful of these stocks [the Mag 7] can push the bigger markets higher, and even potentially make another high in the NASDAQ-100.” The setup was that the indices were “due for a sizable bounce over the coming weeks – months, which we believe will be led by a handful of Big Tech names.” Now that we are at new highs, we think we will need more than just three of the Mag 7 to keep going.

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more hereLearn more here.

Valuations Relatively Intact

Though the recent momentum-filled surges in AI favorites including Super Micro and Nvidia have some investors drawing parallels to Cisco’s ascent in 2000, valuations for the Magnificent 7 are relatively intact.

Tesla is struggling with earnings growth as price cuts bite margins, while Apple’s growth headwinds are leading to minimal earnings growth; on the other hand, Amazon is showing strong earnings leverage from improvements in its margins, Google is trading at a near 30% discount to its year-ago PE of 30x, and Nvidia is eerily cheaper now than it was when it had bottomed in October 2022 in the low $100 range.

Magnificent 7 Forward PE Ratio

Source: YCharts

Compare this to Cisco, given the parallels being drawn, which traded at more than 150 times earnings at the peak of the dot-com bubble – or more than twice as high a multiple as the most expensive of the Mag 7 of today.

We discussed on Fox Business News this week that keeping an eye on valuation is important for determining which stocks to buy on dips. The impact AI has had is very visible on the top line with blowout quarters from Nvidia, and on the bottom line with blowout quarters from both Nvidia and Meta. However, AI’s impact on valuations is being overlooked as these valuations are low and setting up a new buying opportunity should the broad market present weakness.

Conclusion

We will continue to track how the Magnificent 3 perform over the next few weeks, and whether Meta, Nvidia, and Amazon will continue to lead or if they will follow the trend of the remaining four in underperforming versus the broader indices.

When these cycle leaders start underperforming, it usually marks the start of a trend change. The FAANGs undoubtedly have led this bull run since 2023. We are now looking for what will lead the market next, and most importantly, when.

If you own AI stocks or are looking to own AI stocks, consider joining us for our next broad market webinar. Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, manage risk, as well as revealing our various long-term game plans regarding stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.

I/O Fund Portfolio Manager Knox Ridley and I/O Fund Equity Analyst Damien Robbins contributed to this report.

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.

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Social Media Stocks: One Metric Shows Meta’s Clear Leadership

Posted on by io-fund

This article was originally published on Forbes on Jan 11, 2024,05:24pm ESTForbes Forbes on Jan 11, 2024,05:24pm EST

Social media stocks Meta (META), Pinterest (PINS), and Snapchat (SNAP) enjoyed strong gains in 2023 as the broader ad market stabilized and fundamentals improved. 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, less than 1% shy of search ad spend.

This upbeat ad market forecast leaves investors questioning if more upside awaits social media stocks in 2024. In this analysis, we dig into Meta’s leadership in the space, some improving trends at Pinterest, and how Snapchat has weaker ARPU than its peers.

Meta’s strength in ARPU and cash flow generation stands out here, setting it clearly apart from Snapchat and Pinterest – it can maintain spending 30% of gross profit on R&D while driving significant cash flow growth.

Ad Pricing Recovers While Impressions Remain Strong

Ad impression growth remains strong for Meta and Pinterest, while ad pricing is in the initial stages of a recovery after declining for multiple quarters as companies optimized budgets through much of 2022 and early 2023.

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Meta: Ad Impressions Remain Strong

Meta reported 31% YoY growth in ad impressions in Q3, a second straight quarter with growth above 30% YoY after a string of growth in the teens in 2022. Impression growth was driven by APAC and Rest of World, Facebook’s two largest and fastest growing geographies for daily active users. DAUs rose ~6% higher in both regions to top 1.57 billion combined, equivalent to 75.5% of Facebook’s global DAUs.

Ad pricing declined (6%) in Q3, adding further confirmation that pricing bottomed in Q4 2022. The decline was driven by that strong growth in impressions in APAC and Rest of World, as the two are Facebook’s lowest monetizing regions with ARPU less than half of global ARPU. Meta said that “overall engagement on Facebook and Instagram remains strong,” and Reels “continues to grow and drive incremental engagement.”

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 Ad Impressions & Ad Pricing Growth, YoY

Source: Meta

Pinterest: Pricing Remains Depressed

Pinterest reported similarly strong trends in ad impression growth while pricing also remained depressed. Pinterest said in its Q3 earnings call that it has “been able to drive increases in both total impressions and in ad loads simultaneously,” thus driving impression growth of 26% YoY. This marked a significant 10 percentage point increase from the 16% impression growth from Q2 and Q1.

Pricing declined (12%) in Q3, an 8 percentage point sequential improvement from a (20%) decline in Q2. Pinterest chalked up the improvement to “industry-wide demand stabilization” and its “AI-fueled ad stack efficiencies.” However, a double-digit decline for ad pricing is weighing on strong impressions growth, as Pinterest has struggled to meaningfully improve ARPU this year.

Snapchat: Growth Still in Single Digits

While its peers are reporting high double-digit impressions growth, Snapchat’s growth remains in the single-digits, reporting just 7% YoY growth in Q3. This marked a slight 2 percentage point acceleration over Q2, though it remained below the growth levels seen throughout 2022, a stark contrast to both Meta and Pinterest who have witnessed double-digit percentage point accelerations.

Pricing is nearing an inflection, recovering to just a (5%) decline in Q3 compared to an (18%) decline in Q1 as impressions growth continues to outpace demand.

Snapchat Ad Pricing & Ad Impressions, YoY Growth

Source: Snapchat

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more hereLearn more here.

Meta & Pinterest ARPU Accelerating

Meta and Pinterest both are demonstrating accelerating ARPU in core geographies, whereas Snapchat is struggling to improve monetization of its user base, with ARPU in core geographies declining. All three displayed solid double-digit ARPU growth in Europe, a dominant factor in global ARPU growth in Q3.

  • Meta’s global ARPU increased 19% YoY to $11.23, aided by 34% YoY growth in Europe to $19.04. US & Canada ARPU rose 14% YoY to $56.11, marking a solid acceleration from 7% growth in Q2.
  • Pinterest’s global ARPU rose just 3% YoY to $1.61, aided by 5% YoY growth in US & Canada $6.46. Europe’s ARPU rose 26% to $0.91 in the quarter.
  • Snapchat’s global ARPU declined (6%) YoY to $2.93, as North America ARPU fell (4%) YoY to $7.82 as monetization struggles persist. Europe mirrored peers with double-digit growth, at 15% YoY to $2.11.
Meta Pinterest, Snapchat Global ARPU, Q3 2021 - Q3 2023

Source: Company Filings

Over the past two years, Snapchat’s ARPU weakness is visible. Global ARPU is down (16%) relative to Q3 2021, compared to a 12% increase for Meta over the same period. Pinterest’s ARPU is trending relatively in line to 2022’s levels, and looks relatively weak, sitting around half of Snapchat’s ARPU with slow growth reported in Q3. Meta’s ARPU has accelerated through 2023 and is on track to potentially reach a record level in Q4.

R&D Expenditure Trends Highlight Meta’s Leading Position

Snapchat lags both Pinterest and Meta with weaker impressions growth and declining ARPU. That is the key shortcoming in Snapchat’s growth story: an inability to effectively monetize its user base to generate GAAP-profitable growth.

R&D expenditure trends highlight both Snapchat’s inefficiencies, while clearly demonstrating Meta’s ability to maintain high R&D spend and be a cash machine.

Meta, Pinterest, Snapchat R&D to Revenue

Source: Ycharts

Snapchat is putting more than 44% of its revenue into R&D, compared to 36% for Pinterest and nearly 30% for Meta – the three have all increased R&D expenditures as a percentage of revenue since 2022, for the development and deployment of AI and ML features as well as other product innovations. Snapchat’s primary R&D investment is augmented reality, both to increase user engagement – more than 60% of DAUs interact with AR features – and to drive increased ROI and click-through rates for advertisers.

However, the real issue for Snapchat — what sets it apart from Pinterest and Meta and the reason it will struggle to reach and generate GAAP profitable growth over the medium term – is that it is spending around 80% of its gross profit dollars on R&D.

Meta, Pinterest, Snapchat R&D to Gross Profit

Source: Ycharts

Essentially, Snapchat is spending a disproportionately high amount on R&D relative to peers while failing to increase ARPU and monetization within its user base. This is creating a downward spiral for GAAP profitability from operations, with GAAP operating margin below (30%) in each quarter in 2023 and below (22%) for seven straight quarters.

What sets Meta apart is that it can maintain a high level of R&D spend – at more than 33% of gross profit in Q3 and above 36% YTD through Q3 – while remaining a cash cow with strong operating cash flow and free cash flow growth. Meta’s operating cash flow margin rose to nearly 60% in Q3 as it generated $20.4 billion in OCF during the quarter. Meta is on track to deliver nearly 50% growth in OCF in 2023 to nearly $75 billion, assuming OCF margin in Q4 stays in line with Q3’s level. Free cash flow totaled $13.64 billion in Q3, a 40% margin, while YTD free cash flow was $31.51 billion, a 33% margin.

Valuation

Snapchat’s 90% rally in Q4 has taken its valuation on an EV to revenue basis nearly in line with Meta and Pinterest, though Snapchat is much more expensive than the two on an EV to operating cash flow basis.

Pinterest, Snap, Meta EV to Revenues

Source: Ycharts

Snapchat is trading at nearly 5.9x EV/revenue, compared to 6.7x EV/revenue for Meta and 7.5x EV/revenue for Pinterest. Forecasted revenue growth rates for the three currently sit in the teens: 13.4% for Snapchat, 16.5% for Pinterest, and 13.0% for Meta.

In terms of EV to operating cash flow, Snapchat trades at a high premium given it sees inconsistent growth in OCF – it currently trades at 71.1x OCF, versus 38.5x for Pinterest and 11x for Meta. Pinterest’s operating cash flow growth has also been lumpy, though its cash flow generation remains stronger than Snapchat’s. Meta is significantly cash flow positive, and may deliver nearly 50% growth in OCF in 2023 to nearly $75 billion.

Pinterest, Snap, Meta EV to CFO

Source: Ycharts

Conclusion

Bullishness on social media stocks has risen rapidly – Meta leads the tech universe with the most analyst buy recommendations heading into 2024 with 41, and bullishness on Pinterest has reached 2021 levels, with approximately 70% of analysts giving it a buy rating.

Pinterest Analyst's Bullishness

Source: Bloomberg

Meta’s ability to drive significant growth in multiple key metrics sets it apart from Snapchat and Pinterest as a clear leader in the social media sphere. The Facebook and Instagram parent continues to witness strong growth in ad impressions as pricing recovers, driving ARPU higher, while its superior margin profile allows it to spend 18x more than Snapchat on R&D while generating substantial cash flow.

Pinterest’s ARPU is relatively in line with 2022’s levels, but single-digit growth raises red flags as ARPU is much lower, around half of Snapchat’s and less than one-tenth of Meta’s. Snapchat is struggling to effectively monetize its user base, and is spending substantially more of its gross profit dollars on R&D without seeing material benefits to growth.

I/O Fund Equity Analyst Damien Robbins contributed to this analysis.

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.

Recommended Reading:

FAAMG Stocks Trading At Precarious Valuations

Posted on by io-fund

This article was originally published on Forbes on May 10, 2023,07:45am EDTForbes Forbes on May 10, 2023,07:45am EDT

The mega-cap stocks that are known as FAAMG reported earnings recently. These names are driving the market higher, especially Microsoft and Apple. In fact, the percentage of Microsoft and Apple’s combined weighting in the S&P 500 has never been higher.

The S&P 500 weighting is according to market cap, which is price times float. The longer buying happens in these two names, accompanied with selling in other areas of the index, the percentage weighting becomes stretched to unhealthy extremes. This is not characteristic of a burgeoning bull market; instead, it is the type of behavior we usually see at market tops.

Also worth noting, since the February top, we are seeing a strong rotation into Big Tech while aggressive selling is taking place in other areas of the market. Take a look at the market cap weighted NASDAQ-100, which has over40% weighting into the FAAMG stocks, compared to the equal weighted NASDAQ-100.

Nasdaq 100 Equal Weighted

Source: I/O FUND

While the NASDAQ-100 has made a series of higher highs, led mostly by the FAAMG names, the equal weighted index has made a series of lower highs. We are seeing similar price action in small caps as well as most economically sensitive sectors. This is typically not the sign of a healthy market.

FAAMG Stocks Trading at Precarious Valuations

As you’ll see below, there’s little room in FAAMG valuations compared to their 5-year historic averages. Apple and Microsoft both trade above their 5-year median on the top line and bottom line whereas the others are getting quite close given the low growth rates and macro uncertainty. The only exception is Amazon.

Microsoft is leading on valuation at 10 compared to the FAAMGs that are at 7 or below. Most are within range of their five-year average valuation except Amazon at 2.0 today compared to an average valuation of 3.6.

FAAMG Valuations

Source: YCHARTS

Amazon has a P/E ratio of 247.79, compared to 32.96 for Microsoft, 29.22 for Meta, 28.13 for Apple, and 23.32 for Alphabet. The FAAMGs are trading within range of their historical valuation except for Amazon with a five-year average P/E ratio of 93.48.

FAAMG PE Ratio

Source: YCHARTS

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FAAMG Earnings Overview:

There were some puts and takes in the most recent earnings reports. Despite price telling us we could be nearing a top, there are some fundamental signs that FAAMG stocks may be overstretched in the near term.

Below, you’ll find that consensus points toward a bottom for FAAMG stocks yet it will require consensus materializing in the coming quarters in order for the stock price action to hold. In other words, the market has front run the rebound in growth and now we must wait and see if this rebound unfolds.

Alphabet: Search is Resilient

Alphabet’s revenue grew by 2.6% YoY or 6% in constant currency, for a total of $69.8 billion, primarily helped by the resilience in Search and the momentum in Cloud business. Although this is marginal growth, below you can see that Alphabet is expected to accelerate in revenue growth over the next few quarters from 2.6% to an expected 9.4% in Q1 of next year.

Alphabet Qly Revenue YoY

Source: SEEKING ALPHA

Operating margins were soft at 25% of revenue compared to 30% last year. Net income declined (8.4%) YoY to $15.1 billion. This resulted in EPS of $1.17 compared to $1.23 for the same period last year.

Alphabet Qly EPS

Source: YCHARTS

The drop in profits was mainly due to $2.6 billion in charges related to the reduction in the company’s workforce and office space, and was offset by $988 million in depreciation from servers and network equipment.

Google Cloud revenue grew by 28% YoY to $7.45 billion and reported its first profitable quarter bringing in $191 million operating income.

Microsoft: Top Line and Bottom Line Beat

Microsoft’s revenue grew 7.1% YoY and 10% in constant currency to $52.9 billion. Management’s revenue guidance for next quarter is $54.85 billion to $55.85 billion, representing YoY growth of 6.7% at the mid-point. Similar to Google, a noticeable acceleration is expected in the second half of the year.

Microsoft Qly Revenue YoY

Source: SEEKING ALPHA

Azure grew by 27% and 31% YoY in constant currency and came in at the higher end of management guidance of 30% to 31%.This is down from 38% growth in constant currency last quarter. Next quarter will also mark a deceleration with management guiding to 26.5% in constant currency. This includes 1% from AI services.

Growth Rates for Cloud IaaS

Source: I/O FUND

Operating income grew by 9.8% YoY to $22.35 billion. The net profit margin was 34.6% compared to 33.9% in the same period last year which resulted in EPS of $2.45 compared to $2.22 in the same period last year.

Microsoft Qly EPS

Source: YCHARTS

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Meta: Back to Positive Growth

The company’s revenue grew by 2.6% YoY and 6% on constant currency to $28.6 billion. This is a positive as Meta’s revenue has declined YoY in the last three quarters.

Management’s revenue guidance for the next quarter is between $29.5 billion to $32 billion, representing a YoY growth of 6.7% at the mid-point. Analysts expect revenue to grow 7% YoY to $30.84 billion.

Meta Qly Revenue YoY

Source: SEEKING ALPHA

The operating income declined by (15%) YoY to $7.2 billion as total expenses rose 10% YoY. The operating margin was 25% compared to 31% in the same period last year. The net income declined by (24%) YoY to $5.7 billion, resulting in EPS of $2.20 compared to $2.72 in the same period last year.

Meta Qly EPS

Source: YCHARTS

The company recorded $1.14 billion in restructuring charges related to layoffs, facilities consolidation, and data center. Excluding these charges, the operating margin would be 4% higher and EPS would be $0.44 higher.

Amazon: AWS is Slowing

The company’s revenue grew by 9.4% and 11% YoY in constant currency to $127.4 billion. Analyst consensus is for growth of 8.2% next quarter.

Amazon Qly Revenue YoY

Source: SEEKING ALPHA

The operating margin was 3.8% compared to 3.2% in the same period last year. Net Income was $3.2 billion or $0.31 per share compared to a net loss of ($3.8) billion or ($0.38) per share in the same period last year.

The net income included a pre-tax valuation loss of ($0.5) billion from the investment in Rivian Automobile compared to a pre-tax valuation loss of ($7.6) billion in the same period last year.

Amazon Qly EPS

Source: YCHARTS

AWS revenue grew by 16% YoY to $21.4 billion. This is lower than the 20% growth in the December quarter and a remarkable slowdown from the 37% in the same period last year.

Management discussed in the earnings call that April AWS revenue growth further decelerated to 11%. This is due to the ongoing tough macro environment, causing customers to optimize their cloud spending in the recent quarter.

The company’s CEO, Andy Jassy, also highlighted cautiousness in the enterprise customers. “In AWS, what we’re seeing is enterprises continue to be cautious in their spending in this uncertain time. Customers are looking for ways to save money however they can right now. They tell us that most of it is cost optimizing versus cost cutting, which is an interesting distinction because they say they’re cost optimizing to reallocate those resources on new customer experiences.”cost optimizing versus cost cutting, which is an interesting distinction because they say they’re cost optimizing to reallocate those resources on new customer experiences.”

Notably, despite the market rewarding Microsoft’s report, cost optimization is not isolated to one hyperscaler and investors can expect to see more evidence of optimizations in future reports.

Apple: More Buybacks to Appease the Street

Apple’s revenue declined by (2.5%) YoY to $94.84 billion. Management commented that they expect YoY performance to be similar to the March quarter. Analysts expect revenue to decline (1.7%) YoY to $81.53 billion in the next quarter following these comments.

Apple Qly Revenue YoY

Source: SEEKING ALPHA

iPhone sales grew by 1.5% YoY to $51.3 billion. Mac revenue declined by (31%) YoY to $7.2 billion. iPad revenue declined by (13%) YoY to $6.7 billion. Wearables, home and accessories revenue was flat, and the services segment revenue grew by 5.5% YoY to $20.9 billion.

The operating margin was 29.9% compared to 30.8% in the same period last year. The operating expenses of $13.66 billion were lower than management guidance of $13.7 billion to $13.9 billion, which the market saw as a positive.

Net income declined by (3.4%) YoY to $24.2 billion with a net profit margin of 25.5% compared to 25.7% in the same period last year. EPS came in at $1.52 and remained unchanged from the same period last year.

Apple Qly EPS

Source: YCHARTS

Apple returned $23 billion to the shareholders through dividends and equivalents of $3.7 billion and $19.1 billion in share repurchases. The board also authorized an additional $90 billion share repurchase and increased the quarterly dividend by 4% to $0.24 per share.

Analyst Comments:

Deutsche Bank analyst Benjamin Black raised the firm's price target on Alphabet to $125 from $120 and kept a Buy rating on the shares. He noted, “The company reported solid Q1 results with the biggest takeaway being the stabilizing growth trends at Search and YouTube, which beat Street expectations.”stabilizing growth trends at Search and YouTube, which beat Street expectations.”

Wedbush Securities analyst Dan Ives said in a research note. "It's clear that in Redmond's enterprise backyard the company is gaining more market share on the cloud front with many enterprises making this transformational shift on the shoulders of Microsoft,"gaining more market share on the cloud front with many enterprises making this transformational shift on the shoulders of Microsoft," He further said, "Cloud growth and the overall outlook for the June quarter was solid and much better than feared given recent noise in the market and will be music to the ears of investors this morning digesting results."Cloud growth and the overall outlook for the June quarter was solid and much better than feared given recent noise in the market and will be music to the ears of investors this morning digesting results."

BMO analyst Keith Bachman upgraded Microsoft (MSFT) shares to outperform. He stated that he now has "higher conviction" that any headwinds to Azure are likely to moderate by the end of the year, while opportunities in artificial intelligence can help the longer-term. "While the stock is not inexpensive, we think the durable growth opportunities warrant a premium valuation."

RBC Capital analyst Brad Erickson raised the firm's price target on Meta Platforms to $285 from $225 and kept an Outperform rating on the shares. Brad said, “The company's Q1 results were better-than-feared and the simple three-fold bull case – dominating engagement vs. competition, restoring lost signal post-IDFA, and cutting costs – is increasingly coming into view.” RBC believes that further upside is still achievable for Meta on engagement share gains and the ongoing conversion improvement eventually leading to incremental spend.

Citi analyst Ronald Josey raised the firm's price target on Meta Platforms to $315 from $260 and kept a Buy rating on the shares. “With engagement rising, newer advertising products attracting incremental spend, and a more streamlined organization, Meta's momentum in Q1 can continue.”“With engagement rising, newer advertising products attracting incremental spend, and a more streamlined organization, Meta's momentum in Q1 can continue.” the analyst tells investors in a research note.

Conclusion:

We have Buy levels we are targeting for FAAMG stocks, which we share with our premium research members each week as the stocks progress. We believe our target buy levels will set us up for gains in FAAMG stocks when the next bull cycle begins. We provide in depth macro and individual stock analysis so that readers can better understand why we buy/sell. In this market, we frequently take gains.

Right now, we do not believe FAAMG stocks are in a buy zone. Instead, some are trading higher than their 5-year median on valuations despite a weaker macro backdrop and fundamental weakness. The market is front-running the anticipated revenue rebound. Most of this rebound is based off low comps, and there could be soft growth in the future for some of these names.

You can learn more here including information on our next webinar, this Thursday at 4:30 pm Eastern, where we review our positions live.

Equity Analyst Royston Roche contributed to this article.

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Meta Stock: The rising expenses and Capex are worrying

Apple’s Stock In Focus: More Profitable Than Banks

Google Stock: Search Is On The Precipice Of Multi-Decade Disruption

Netflix Stock Will Be A FAANG Again

Meta Stock: The rising expenses and Capex are worrying

Posted on by io-fund

Meta shares nosedived 25% after the company's recent Q3 results. Meta's expenses are rising and the company is seeing softer revenue growth and softer margins. The slowing advertisement revenue has forced the company to look for new investments and the market is doubting when or if these investments will pay off.

Perhaps most importantly, the increase in expenses and Capex has plummeted Meta's cash flow margin in the most recent quarter. This is a material change to Meta’s story as the company was the leading FAANG stock on free cash flow yet reported a sudden, drastic reversal in Q3.

Below, I discuss the company's recent results in a detailed analysis below.

Meta’s Revenue is Slowing

The company’s revenue in Q3 fell by 4% YoY to $27.71 billion and was up 2% on a constant currency basis. The company managed to beat the consensus estimates by 1.2%. This is the company's second consecutive quarter of declining revenue.

CEO Mark Zuckerberg attempted to address concerns in his opening remarks yet the market was not buying it, “We now reach more than 3.7 billion people monthly across our Family of Apps. And while we continue to navigate some challenging dynamics of volatile macro economy, increasing competition, ad signal loss and growing costs from our long-term investments, I have to say that our product trends look better from what I see than some of the commentary I have seen suggests.”I have to say that our product trends look better from what I see than some of the commentary I have seen suggests.”

While the company does not fully acknowledge the change in business model that we discuss in our analysis “Facebook Stock: A Permanent Change To The Business Model” results show that the company is struggling with growth. The management expects growth to return next year as Mark Zuckerberg said, “We are still behind where I think we should be, but we believe that we will return to healthier revenue growth trends next year. That said it’s not clear that the economy has stabilized yet.”

Management’s guide for next quarter is $31.25 billion at the mid-point of the guidance, representing a YoY decline of 7.2% and the guide includes 7% foreign exchange headwinds. Analysts expect revenue to decline by 6.1% in Q4 and 1.6% in Q1 2023. The consensus estimates suggest that revenue growth is expected to return in Q2 2023.

Softer Operating Margins

In addition to revenue declining, the sell-off was also fuelled by a declining operating margin. Operating income fell 46% YoY to $5.66 billion. The Family of Apps segment operating income was $9.3 billion and Reality Labs operating loss was $3.7 billion. Total costs and expenses rose 19% YoY to $22.1 billion.

The company has seen a significant drop in the operating margin. Operating margin was 20% compared to 29% in Q2 2022 and 36% in the same period last year. It is significantly lower than the company’s historical period as seen in the chart below.

Chart: Meta Platforms Operating Margin

Source: YCharts

The management expects total expenses to be $86 billion at the mid-point of the guidance for the full year 2022, which represents YoY growth of 21%. This includes $900 million in additional charges for consolidating the office facilities that the company expects to record in the fourth quarter. I estimate the operating margin for Q4 to be 23% which would be significantly lower than the 37% in the same period last year.

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Meta Capex

For Q3, Meta had capital expenditures, including principal payments of financial leases of $9.52 billion, up 109% YoY.

YTD 2022, the Capex is $22.8 billion, and the management guidance for the full year 2022 has been revised to $32-$33 billion from the previous range of $30-$34 billion.

This represents YoY growth of 69% at the mid-point of the guidance. Doing the math suggests Q4 Capex will be about $9.7 billion, up 75% YoY and up 1.9% QoQ.

Chart: Meta Capex in $B

Source: Company Investor Relations

Dave Wehner, CFO of the company said in the earnings call, “Turning now to the specific CapEx outlook for ’22 and ’23. We expect 2022 capital expenditures, including principal payments on finance leases, to be in the range of $32 billion to $33 billion updated from our prior range of $30 billion to $34 billion. For 2023, we expect capital expenditures to be in the range of $34 billion to $39 billion driven by our investments in data center servers and network infrastructure. An increase in AI capacity is driving substantially all of our capital expenditure growth in 2023.”For 2023, we expect capital expenditures to be in the range of $34 billion to $39 billion driven by our investments in data center servers and network infrastructure. An increase in AI capacity is driving substantially all of our capital expenditure growth in 2023.”

Turning now to the specific expense outlook for ’22 and ’23, we expect 2022 total expenses to be in the range of $85 billion to $87 billion updated from our prior outlook of $85 billion to $88 billion. This includes an estimated $900 million in additional charges in Q4 related to consolidating our office facilities footprint that we expect to record in the fourth quarter of 2022. We anticipate our full year 2023 total expenses will be in the range of $96 billion to $101 billion. This includes an estimated $2 billion in charges related to consolidating our office facilities footprint.”

Chart: Meta Platforms Operating Margin Quarterly

Source: YCharts

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The Bottom Line

The increasing expenses, particularly in the reality labs segment, have weighed on the company’s profits. The management expects the reality labs segment losses to continue in the next year and investors don’t seem confident the company’s spend on the metaverse will materialize into growth or profits for some time.

On the other hand, the company has been investing heavily in cloud infrastructure and artificial intelligence. The increase in Capex reduces the company’s free cash flows. This is a concern since Meta led Big Tech on a strong free cash flow margin in the past. The free cash flow margin was 1% in the recent quarter and down significantly from 37% in the December quarter.

The company’s net income fell 52% YoY to $4.4 billion. EPS of $1.64 compared to $3.22 for the same period last year. The company’s net profit margin was 16% compared to 23% in Q2 2022 and 32% in Q3 2021.

The company has cash and marketable securities of $41.78 billion at the end of Q3 2022. The debt was $9.92 billion.

The operating cash flow was $9.69 billion (35% of revenue) and free cash flow was a meagre $173 million (1% of revenue) in the recent quarter. The difference between operating cash flow and free cash flow is the high Capex.

Chart: Meta Platforms Profit Margin Quarterly

Source: YCharts

Conclusion:

Meta Platforms was once a stock market darling for its solid revenue growth, strong profits and cash flow. Times have changed, and the company is now struggling with slowing ad revenue. It’s not only the increased expenses and capex that are an issue, rather a clear path to monetization that goes with it.

If you’d like more information regarding how the business model has changed, please reference the articles below.

Facebook Stock: A Permanent Change to the Business Model

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.

Snap: Bad Management Team … & WTH is Really Going On.

Posted on by io-fund

I couldn’t be more disappointed with Snap’s management. Not only the lack of guidance but the lack of willingness to describe exactly what the issue is with their business.  

In the call, the management said they are seeing 9% growth to-date this quarter yet are modeling revenue to be flat year-over-year. This is an absurd comment to not substantiate. Why would August be 8% growth, October 9% growth and the holiday season be negative growth, which in turn weighs on October’s progress? I’m not sure which is worse, was this a flippant comment they made and we will see 9% or higher growth come next quarter? Or, are they really seeing such a serious headwind that November and December will greatly decelerate? I believe I have identified the serious headwind with no help from Snap’s management team, which I detail below. 

Here is one comment that was made on the call regarding the expected revenue deceleration during the holiday season:

“By the end of August, when we shared 8-K about the restructuring, the quarter-to-date revenue had improved to about 8%, and so that implied things accelerated a bit. With the full quarter number at 6% this quarter, obviously, things slowed down into about the low single digits in September, so. And then we’ve seen things move up a bit in the beginning of this quarter with the early weeks being at about 9%.”

Here they try to spin the December quarter:

“It’s Derek speaking. I’ll take the first part of that and then hand it up to Evan. I think first, just stepping back for context on Q4. Even flattish year-over-year revenue growth is about a 15% step-up on a quarter-over-quarter basis. So, we are expecting revenue to grow seasonally at a pretty good clip. So, the issue that we’re seeing here is that if you look back to a year ago, we grew at over 40% year-over-year in the prior year. And many of the really significant macro impacts that we’ve seen over the course of this year weren’t impacting the business nearly as much as they were a year ago.”

To add to the absurdity, they have relied on excuses such as Ukraine, macro for brand advertisers or Apple’s changes. This doesn’t explain why November and December would weigh on October as both are consistent (not variables) throughout Oct-Dec.

Here, an analyst calls out that it doesn’t totally add up:

“Just on the brand side. I think many are curious kind of why brand will suffer so hard going into a seasonally strong period. Is this more macro-related? Is it — given some of the restructuring, is that having some impact?”

This was the answer, which was not a good one: “And certainly, with the performance that we saw from the brand portion of the advertising business in Q3 gives the — sort of informs our expectation of the decel to move through the rest of the quarter.”

So, I’m sitting here wondering why a 19% DAU growth isn’t translating to higher revenue growth and trying to sift through the garbage being stated on the call. Following strong DAU growth for many quarters, management is providing a 6% growth rate this quarter and “maybe” a 9% growth or “maybe” a 0% growth rate. Something is very wrong here.

Furthermore, how can the 19% DAU growth not give them more confidence in terms of the revenue they can drive next quarter?

Because I’ve worked around mobile global UA, I believe the answer to this question is that Rest of World user growth greatly weighs on this company’s business model. This is the only true explanation that makes sense to me. If the majority of the user growth is in the $0.90 ARPU to $1.00 ARPU, then this is going to pull down revenue. This also means that next quarter — even with strong DAU growth — the company cannot accurately guide because ROW cannot monetize high enough to support YoY growth.

I pointed this out in the analysis here for our Re-Entry when I stated: "My interpretation is that DAU will outpace revenue growth because DAU growth will come from Rest of World where users are monetized at a lower rate than North America and Europe. This has been the trend over the past year in Snap’s key metrics."

It’s one thing to have advertiser falloff and softer ARPU in North America in the $8.00 ARPU range (which you’ll see below has not occurred!!) and another thing to have even nominal falloff in a region that is at the $1.00 ARPU range, because the majority of the user growth is occurring here, then it only requires small decimal points to drag down overall ARPU quickly.

My regret is believing management when they said it was “platform changes” or “Apple’s ATT” or “macro headwinds. Excuse my language in this write-up, but instead here is the total garbage investors were offered:

“Operationally, our advertising business has become a lot more technically complex over the past few years as advertisers are working to better measure and optimize their campaigns. That means that we need to drive increased coordination across our sales, engineering and product teams, which is one of the reasons I’m so excited to have Jerry leading these teams as our COO. I’ve already observed a significant change in the way that our teams are working together, and I’m really pleased to see the focus on our advertising customers driving everything that they do […] We saw about an 8% increase in impressions year-over-year in the quarter, which is really a function of daily active users and engagements.”

My note: again, this doesn’t address why there would be a deceleration in Nov/Dec and why they can’t guide. The company had 19% DAU growth and 8% growth in impressions and they can’t give a guide? Very strange.

They said eyeballs are doing well again:

“So, at a very high level, both in the U.S. and globally, viewership is up. And so that means that our overall opportunity is expanding if we can continue to increase folks’ depth of engagement. And that’s really important, of course, for advertisers who really value the reach that we provide.”

Here’s a question where Snap could have been more forthright:

“Ross Sandler:

I just wanted to throw the macro question out. So, it sounds like it’s mostly brand advertising that was weak in 3Q, and it seems like that’s the area that’s forecasted to really drop off as we kind of go forward here in 4Q. So, could you just maybe elaborate a little bit on what you’re seeing? What’s — we can obviously see what’s going on with the macro broadly, but specifically to like rest of this quarter, what commitments you’re looking at that would cause those growth rates to kind of dip into the negative?

And then, related to one of the prior questions, you’re growing your DAUs almost 20% and impressions 8%. So, it seems like we’ve just got a demand problem here, not a supply problem. Can you just talk to that a little bit? Thank you.”

I’ll save you the answer they gave which was evasive and focused on “restructuring, “advertisers can turn performance based advertising off very quickly” and “future of AR”

There were moments where they brought up EMEA and APAC, but this was buried and not discussed as a direct answer to the issue:

“And the third thing is bringing top talent to our three president roles for the Americas, APAC and EMEA. One of them Ronan Harris is going to join us next week. This will ensure that we’re improving our focus on customers in every region and getting closer to the customers’ needs. I think these priorities will set Snap up to be successful in this current environment.”

And then again, it was their last comment before closing the call:

“I think one thing I’m watching specifically is on the sales side. We’ve got these president roles. Ronan Harris is joining a bit later this month as our President of EMEA. We will also have an APAC President and an Americas President, and we’ll be putting folks into those roles as soon as we can. And in addition to that, we’re also thinking about how to better organize our sales teams to go to market in a way that best serves our customers. And we’re sort of thinking about Q1 as the time line for that.”

Yet, if this is what’s going on — and it’s my speculation that it is — the management did nothing to connect these dots and continues to rely on many other trivial excuses that don’t add up to the 6 month variability we are seeing (July-Dec).

I believe they are not connecting the dots because it signals something systemic (not that it matters given the severity of the selloff – they could have not shown up to the earnings call and the stock would probably be doing better today).

It’s systemic because the very regions they can grow DAU will, in turn, weigh on their revenue.

I’ve noted the ROW could be a concern in our previous write-ups, but now that I’ve gotten more information on just how disconnected DAU growth is from revenue growth in Q3, and now in Q4, I feel fairly confident we are looking at company struggling to keep up with previous ARPU that had a higher mix of North America and European growth.

Below is Snap’s overall ARPU. Quick glance shows that it’s declining YoY for Q2. It declined again for Q3 Average revenue per user was $3.11 in Q3 2022, compared to $3.49 in Q3 2021 (not pictured below).

In fact, we can see further evidence of this as ROW declined (9%) and North America only declined (1%).

This makes my bullshit detector go off even more with the Apple excuse because iPhones are not used in ROW regions, instead these regions primarily use Android. Android has not gone through the privacy changes (yet) that Apple has.

If Apple was the issue, North America would have fallen off in ARPU by more than (1%) bc this is the highest concentration of iPhone users. Europe’s (5%) also contributes but the Apple excuse is debunked bc Q3 2021 was when these changes occurred and the YoY would be more drastic in North America if Apple was contributing.

If we look at Q2, another big miss in the earnings report, we see the same pattern. North America was up 8% debunking the Apple issues and ROW is down (11%). This creates a (4%) drag on ARPU.

You can see the largest comp for ROW is approaching, which is Q4’s $1.12. All quarters have a high comp in Q4 but you can see the other regions have been doing a decent job of keeping pace.

On a side note, the company states Russia falls within Europe revenue, so the (9%) in the $1.00 region is also not satisfied by the Russia-Ukraine war excuse. Europe (the Ukraine region) up 2% last quarter in Q2.  

So now, it starts to make sense that Snap is not confident about the holiday season as the drag is coming from ROW.

Obviously, I’m incredibly disappointed because the company used the Apple ATT excuse and my understanding is this should be something they can overcome as Snap does not use third party data.

On another note, I firmly believe the company is not selling off due to margins but rather the opaque issues with revenue. This company is going to become FCF positive between $1 billion to $1.5 billion next year and this is well understood. Scanning the analyst notes today, they were encouraged by the bottom line in the report. Not one mentioned ROW revenue, however, despite it’s clear decline in ARPU.

It’s easy to glance at the margins and draw a quick conclusion that the company is very unprofitable, but the well-publicized budget cuts across the board has resolved this issue for the most part.  

The market is forward-looking and as soon as next quarter, the shift toward profitability will begin. In fact, the company beat on the bottom line across the board on top of moving toward greatly improved operating income next year. If anything, this was a positive as market expected ($105) million FCF and company reported +$18 million FCF.

If it were the bottom line, it’d be much more straight forward. Instead, I feel the management is dodging the real issue as to why DAU growth does not translate to revenue growth. The longer the DAU strength continues and the longer the revenue weakness continues, the more of a red flag it has become.

Management is responsible for discussing the real issues with shareholders and ROW should have been directly called out in this earnings call and the previous earnings call.

Even worse, to have so many different storylines that don’t add up … Apple, Ukraine, Macro, Brand Ads – during the holidays nonetheless — supposed to get worse from Oct to Dec …? It simply doesn’t sit right.  

Conclusion:

I had posted this on the forum in the comments and it sums up my thoughts:

“Snap is pulling levers to not burn cash and will have a 20% FCF positive margin, maybe 25%, and this is well understood at this point. Some people point towards SBC which at $700M net (minus buybacks) is 14% of annual revenue. Not the worst I've seen — cloud is certainly much higher with some favorites in the 30% SBC range.

I believe it's the disconnect between user growth and revenue growth that is causing the selloff, and I think it's important to identify the issue bc Snap will be FCF positive moving forward around $1B to $1.5B — so will Snap's new cash profile (which is widely understood to show up in Q4 and beyond following the layoffs and the shutdown of ancillary products with one-time related costs recognized in Q3) fix the issue? If so, it's a buying opportunity.  

I don't think this is a buying opportunity bc what we have is a major disconnect on DAU growth from revenue growth. Why can't the company post a higher growth rate given the 19% DAU growth — usually audience precede revenue growth. If this isn't fixed and the FCF issues are fixed, it may still be problematic business model.” 

This write-up was intended to describe what I truly think the problem is with the business model, with no help from management. This correlation would have been much easier to see if Snap had not created many smoke screens to deter from the real issue.  

I believe institutional analysts are in the same boat, where Snap’s narrative and excuses has distracted them from looking more deeply at the issue. You can sense on the call, they can’t quite grasp it. It’s not terribly difficult to put together – it’s simply a matter of searching for it, which no one is doing because management is feeding so much garbage on the call.  

The conclusion is we are out of the stock with a serious and lingering concern about this management team.

 

Knox Ridley on Why Meta Platforms (FB) Tumbled After Earnings

Posted on by io-fund

I/O Fund’s Portfolio Manager Knox Ridley spoke to Nicole Petallides from the TD Ameritrade Network. He rightly predicted that Meta Platforms (Facebook) would be under significant pressure and Snap would be a winner. Here’s an overview of the discussion.

Why did Meta Platforms shares fall?

I/O Fund has followed Facebook’s business model for the past 3-4 years. We had warned our readers that the company’s business depends on Apple. Most people think that Facebook is an ad company with about 2 billion daily active users (DAUs). They monetize that data and do ads which is accurate. However, most people do not realize that the growth that has made them the powerhouse was because of the third-party data from Apple. Our stance is that Apple owns the real estate on iOS, and everyone else is renting.

“The reality is that Apple built the ecosystem and it’s theirs to monetize as they see fit. In this equation, consumers matter too, and data should not have been collected without permission in the first place.”

Apple changed the landscape by altering IDFA, a unique id within your iPhone that allows advertisers to track your behavior. So, Facebook combined this data and their data and sold the most valuable consumer data. We knew that Apple would take away this data and the Wall Street Analysts ignored this critical risk. I/O Fund's research process, which gives importance to the company's technical aspects like the products, is the clear winner in the long term.

Will you buy Meta stock?

The story of Facebook has materially changed. Everyone likes to focus on the financials like the cash flow and the balance sheet. However, to identify the winners in tech investing, you need to understand the product very well.

In the case of Facebook, the product that has helped to get the cash has been changed materially. They have mentioned in their earnings call that the impact of the iOS changes will be around $10 billion. This is a significant chunk of revenue. Few investors are buying the dip due to the Metaverse. We believe that it will take a few years before Metaverse can be effectively monetized and also Facebook’s history of entering new businesses is not that great. So, we will not be buying the dip.

Often, Wall Street Analysts find it difficult to differentiate companies that will outperform as they don’t have the technical knowledge to understand the products. This distinguishes our company from the competitors as we successfully manage a tech-focused portfolio.

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Will Snap be a winner?

We started to cover Snap on our premium website in July 2019. We noticed the strong app sessions for Snap and the company's plans to monetize the millennials' data that was less known to the broader market, particularly the launch of Audience Networks in 2019. We had also pointed out that Snap is the best platform for Millennials and Gen Z audiences.

We believe that Snap will become one of our bigger positions. What differentiates the company from Facebook is that they don’t monetize third-party data. So they will not be affected much by IDFA. When Facebook got hit, we tried to determine if the problem was with the company or the Ad-Tech industry. We tried to study various earnings reports like Google and Microsoft and then we realized that it was the Facebook problem. The market mispriced Snap. It has an affluent customer base of Millennials and Gen Z that the company can easily monetize in the long term. They also reiterated that the company could grow by 50% year-over-year going forward.

To conclude, Wall Street’s confusion over the tech that runs each company, primarily Facebook and Snap, led to a buying opportunity for I/O Fund members as Portfolio Manager Knox Ridley issued a buy alert on Thursday, February 3rd at $24.95, leading to a 58% gain in one day.

The I/O Fund can make big calls in the face of market confusion for two reasons. The first is our lead tech analyst Beth Kindig’s direct experience in tech unrivaled in the markets. She can confidently make calls the market disagrees with because she understands the tech driving the revenue. Secondly, I/O Fund Portfolio Manager, Knox Ridley, is one of the best portfolio managers in a tech-focused fund, who guides the entry and exits, and previous audits prove this.

The I/O Fund is a team of analysts who share their research publicly as they build a portfolio of 20 stocks. Our team has record results for a retail Fund and we also have four-digit gains on some of our free newsletter coverage. You can learn more about our premium service by clicking here or sign up for our free newsletter here.by clicking here or sign up for our free newsletter here.

Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.