Meta Earnings: Strong Q3 and Promising AI Developments

• Ad impressions and average price per ad increased 7% and 11% year over year, respectively. The firm saw broad-based strength, with ad impressions and prices growing across geographies.
• More than 500 million people are using Meta’s chat assistant within its applications. We were encouraged to see management call out improvements in user engagement stemming from increased usage of the chat assistant.

The bottom line: We maintain our USD$560 fair value estimate for wide-moat Meta, and we continue to view the firm as well positioned to leverage AI to improve user engagement and user monetization. With Meta’s shares trading slightly down after hours, we view them as fairly valued.

• While Meta’s investments in GenAI have raised eyebrows, we reiterate our belief that their true value will manifest itself in Meta’s core advertising product. We believe ad campaigns on Meta can derive greater value using GenAI tools, which Meta can capture via its potent monetization engine.
• At the same time, we expect near-term margins to remain pressured as Meta’s capital expenditures flow through its income statement as depreciation charges and it continues to spend heavily on AI talent.

AI-Powered Ad Opportunities

As we have previously outlined, we really like Meta’s AI opportunity as it relates to the firm’s ability to invest within its economic moat, which is built in the digital advertising space. On that front, we liked management’s additional commentary on Meta’s GenAI-infused ad and creative features for ad agencies and creators to improve their ad targeting and creative processes.

As we highlighted in our Alphabet earnings note Oct. 29, digital platforms that possess scale can attract creators by rolling out GenAI features that can improve the creative process of making and editing photos and videos. These features include being able to edit videos by giving Meta’s Llama-powered GenAI tools text prompts or changing backgrounds on pictures. As more creators use these tools, we expect user engagement to increase, enabling Meta to monetize increased viewership via ads.

From the advertiser’s perspective, Meta’s GenAI tools could potentially unlock better ad targeting. We saw some glimpses of these improvements as management cited that more than 1 million advertisers used GenAI tools to create more than 15 million ads on Meta’s platforms in the last month, with these ads resulting in a 7% increase in conversions. Going forward, the effectiveness of GenAI-enabled ad targeting tools could be a material differentiator between which platforms advertisers dedicate a larger portion of their spending.

Beyond providing better tools to creators and advertisers, Meta is also leveraging AI to better curate its content feeds across Facebook and Instagram. AI-led improvements with content-recommendation led to an 8% and 6% increase on time spent on Facebook and Instagram, respectively.

Growth in Threads and Reality Labs

We see Meta’s Threads as a growth lever the firm can pull to increase its ad inventory over the next few years. While the firm doesn’t expect Threads to materially contribute to fiscal 2025 sales, we remain confident in Meta’s ability to monetize Threads successfully over time as the application scales. Management highlighted continued strength in user growth, with more than 275 million monthly active users, as well as increased user engagement.

While hardware sales are not a material contributor to Meta‘s top line, we were impressed by sales from this segment, classified as Reality Labs. Reality Labs sales grew 29% year over year to USD$270 million. While the Reality Labs sales growth was robust, primarily driven by the success of Meta’s Ray-Ban AR glasses, the segment’s profitability remains challenged. Reality Labs’ operating loss for the quarter was USD$4.4 billion, up from a USD$3.7 billion loss in the year-ago quarter. We don’t expect Meta’s Reality Labs to be profitable over our explicit five-year forecast. We do, however, model the unit to reduce its operating losses as it scales, creating less of a headwind to Meta’s overall profitability.

The operating income for Meta’s Family of Apps, or FoA, unit, which includes its application lineup, was USD$21.8 billion, with the segment’s operating margins up 200 basis points year over year to 54%. As we look ahead, we are expecting FoA operating margins to decline sharply over the next few years as the firm’s capital expenditures flow through its income statement as depreciation charges.

While Meta didn’t lay out its capital expenditure plans for the upcoming fiscal year, it did foreshadow a material increase from 2024 levels. Assuming Meta’s capital expenditures for fiscal 2024 are USD$39 billion, which is the midpoint of management’s updated guidance range, we expect a further 19% increase in capital expenditures for fiscal 2025 followed by a smaller 12% increase in fiscal 2026.

For the upcoming fourth quarter, management expects sales to be between USD$45 billion-USD$48 billion, with total operating expenses to be in the range of USD$96 billion-USD$98 billion. Both outlooks are consistent with our model, and we don’t foresee Meta having any issue hitting these targets.

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