Two days after the disappointing earnings release, it marks the anniversary of Mark’s bold move from rebrand Facebook in Meta (NASDAQ: META). However, the earnings results reflected that the Metaverse is still in the early stages of its silver linings. The Reality Labs segment is no different from a cash-burning startup, except that it’s backed by Meta’s excellent balance sheet.
It is my conviction that Meta needs to downsize or even abandon its Metaverse business (Reality Labs). Amazon would be a great example. Amazon (AMZN) moved in and out of numerous companies in less than five years. Meta’s core business remains strong and profitable. To restore his leadership status, the move is necessary.
A Quick Earnings Review
Meta delivered disappointing earnings results, leading the stock to plummet a shocking 24.5% on October 27 alone. Below is a summary of Meta earnings data.
|GOAL||Year over year growth|
|total income||$27.71 billion||-4.5%|
|Total expenses||$22.1 billion||17%|
|earnings per share||$1.64||-49%|
|family daily active people||2.93 billion||4%|
|Family monthly active people||3.71 billion||4%|
|Daily Active Facebook Users||1.98 Bill||3%|
|Facebook Monthly Active Users||2.96 Bills||two%|
|R&D expenses||–||Four. Five%|
|Free cash flow||$316 million||-96.8%|
(Above data extracted from the conference call and gurufocus)
There are two segments in which Meta operates: “App Family” and “Reality Labs”. Reality Labs, the focus of this article, generate revenue from sales of hardware, software, and consumer content products. Examples include Meta Quest, Facebook Portal, and related software.
as goal more explained:
Reality Labs virtual and augmented reality products help people feel connected, anytime, anywhere. Meta Quest empowers people to defy distance with cutting-edge virtual reality hardware, software, and content. Facebook Portal video calling devices help friends and family stay connected and share important moments in meaningful ways.
One of the deteriorating factors that brought Meta to such a dire outcome is Mark Zuckerberg’s visionary Metaverse. Revenue at Reality Labs fell for three straight quarters to $285 million, about half the year ago ($558 million in Q3 2021). Quest 2 sales were disappointing after the price hike. The segment’s operating loss expanded to $3,672 million, which represents an increase of 37% year over year.
Reality Labs expenses were $4 billion, up 24% due to active recruiting activities and R&D expenses. Expenses from this segment are about fourteen times its revenue, or one-seventh of the company’s total revenue, and management expects it to rise further in 2023 as headcount increases.
A lesson from Amazon
Meta defines the Metaverse as the next evolution in social connection and the successor to the mobile Internet. To be sure, the Metaverse is visionary and may have an obvious perspective. I like the idea of the Metaverse and have been immersed in Sandbox gaming experiences (SAND-USD). But investors disagree with the company’s venturesome move. Meta shares plunged nearly 70% after the October 28, 2021 announcement.
As the great man Ben Graham wrote in his iconic book “The Intelligent Investor”:
The obvious prospect of physical growth in a business does not translate into obvious returns for investors.
Metaverse may have great prospects in the coming decades, but there are many doubts about the profitability of this segment. Perhaps Mark Zuckerberg has something to learn from Amazon to keep Meta profitable.
The former president of Microsoft in Japan, Naruke Makoto, had a book about the dominance of Amazon. He believes two reasons Amazon prevails are the company’s strong cash flow and the ability to make a decisive move to close unsuccessful deals.
Here is a long list of numerous projects that Amazon entered but ceased development in less than 5 years of operation.
Who still remembers Amazon once it released a Fire Phone? The product had decent specs and tech fans were raving about it.
However, it turned out to be a failure due to its innovative Fire OS (meaning incompatibility with other operating systems) and aggressive pricing strategy. Sales were extremely disappointing despite the price cut, as no one bought the Fire Phone. It cost Amazon about $170 million in operating losses, and $83 million worth of the Fire Phone went unsold.
Something similar was revealed in Mark’s Metaverse but on a larger scale.
The worlds of the Meta horizon struggled to attract and retain users. The platform alone has fewer than 200,000 monthly active users, far short of the company’s goal of half a million by the end of 2022. More than 90% of the world has been visited by fewer than 50 people, and most of the land remains unvisited. There is still a marathon to go if Meta wants to turn it into a platform that is actively used by millions of people, like Facebook, Instagram and WhatsApp.
Also, the headphones are not that affordable. Meta raised the price of the lowest specification goal mission 2 at US$399.99 in July, while the newly launched Meta Quest Pro It costs US$1499.99, which costs more than a 512GB iPhone 14 Pro Max. Without these virtual reality equipment, you will not be able to enjoy the experiences in Horizon Worlds. With headline inflation approaching almost 10%, the public would not show much interest in purchasing this expensive equipment. The effect of the price hike on Meta Quest 2 was reflected in the poor top-line results of the previous quarter. Estimates predicted that more than 10 million earphones were sold, but Meta did not reveal the number of sales.
In the latest conference call, Meta called the Meta Quest Pro a device to enable more people to get their work done in virtual and mixed reality. I think there are several issues the company needs to address before going mainstream:
Lack of economies of scale and competition.
Technological improvement takes years
Ethical issues within the virtual world
Discomfort from using the VR headset
Let’s not forget that there was Friendster before MySpace before Facebook.
Time to quit
As Mark emphasized on the conference call:
Our goal is to grow the operating income of Family of Apps in such a way that, even with our AI infrastructure and investments in Reality Labs, we can significantly increase the overall operating income of our company in the long term.
Application family growth is achievable but difficult to achieve in such a challenging macro context. However, the development is unlikely to erase the losses generated by the Reality Lab segment, which represents around $3.7 billion and is on an upward trend. So Mark’s goal is highly unattainable.
It’s time to quit smoking to protect the hard work over the past decade.
Meta’s core business remains strong and profitable despite the challenges of TikTok and the gloomy economic environment. After falling nearly 70% since the stock gauge turned Meta, the company’s valuation is well below its historical level.
Forward PE, Price/FCL and EV/EBITDA ratios are half their 5-year average. I think Street has discounted Meta’s struggle to maintain profitability and cash flow due to the rapid expansion of the Reality Lab segment.
If Meta downscales or exits its Metaverse business, the company will be a purchase at this attractive valuation. But for now, we will wait and see how things develop.