Facebook Inc. (FB, Financial) reported second-quarter earnings on July 28, beating analyst estimates for both revenue and earnings. However, in after-hours trading on Wednesday, shares tumbled as much as 5% as the social media giant said it expects year-over-year revenue growth rates to decline sequentially in the next few quarters due to pandemic-related challenges.
The company reported earnings per share of $3.61 against $3 per share expected by analysts. Regulatory pressure remains a continuous threat to Facebook, and the recent decision by Apple Inc. (AAPL, Financial) to update privacy terms and conditions is a hit to its expected profitability as well. Even after factoring in these challenges, the company seems to be on track for double-digit growth over the next several years as a result of its strong competitive advantages.
Second-quarter earnings recap and outlook
The company reported revenue of $29 billion for the second quarter, a 56% increase year over year. This is the fastest rate at which revenue has grown since 2016, highlighting that Facebook is a high-growth company despite its massive size and scale.
Average daily active users came to 1.91 billion in the quarter, up 7% compared to the prior-year quarter and in line with analyst expectations. As of June 30, there were 2.9 billion monthly active users, and the average revenue per user came to $10.12, an increase of 44% year over year. Facebook reported a net income of $10.39 billion and free cash flow in excess of $8 billion, once again highlighting the cash-rich nature of the business.
Commenting on the company’s efforts to expand its revenue streams and the overall performance in the second quarter, CEO Mark Zuckerberg said:
“I’m excited to see our major initiatives around creators and community, commerce, and building the next computing platform coming together to start to bring the vision of the metaverse to life. In the coming years, I expect people will transition from seeing us primarily as a social-media company to seeing us as a metaverse company.”
Exhibit 1: Revenue by user geography (in millions)
Source: Investor presentation.
Chief Operating Officer Sheryl Sandberg said the success in the last quarter came on the back of the ongoing digital transformation in every corner of the world, which is a favorable macroeconomic trend that is likely to persist for a long period of time.
The company expects advertising revenue growth to be driven primarily by increases in advertising prices throughout the remainder of the year. Even though Facebook had a very strong second quarter, Chief Financial Officer David Wehner highlighted the possibility of a slowdown in growth, saying:
“In the third and fourth quarters of 2021, we expect year-over-year total revenue growth rates to decelerate significantly on a sequential basis as we lap periods of increasingly strong growth. When viewing growth on a two-year basis to exclude the impacts from lapping the COVID-19 recovery, we expect year-over-two-year total revenue growth to decelerate modestly in the second half of 2021 compared to the second-quarter growth rate. We continue to expect increased ad targeting headwinds in 2021 from regulatory and platform changes, notably the recent iOS updates, which we expect to have a greater impact in the third quarter compared to the second quarter. This is factored into our outlook.”
Although Facebook expects revenue growth to slow due to the reopening of the economy, it has already taken several strategic steps to remain at the top of the social media industry, and these decisions will likely to reward shareholders in the long run.
For instance, Facebook is now planning to place a greater emphasis on content creators as well as its e-commerce and computing platforms, which Zuckerberg described as "building blocks" for the future of the internet and the company in a conference call with analysts. The company is already testing a payment mechanism for content creators, and such an incentive model could attract high-quality creators to the platform in the coming years. As more creators join the Facebook platform, the company is starting to focus its resources on developing monetization tools for them so that they can make a living from their work as well. In addition to video features, the company has launched Live Audio Rooms, Podcasts and Bulletin to focus on other types of creators, such as writers. The company has decided to pay more than $1 billion to creators for using Facebook and Instagram features through the end of 2022, and it will make the content tools available free of charge for creators through 2023.
In terms of e-commerce, WhatsApp payments are now available in Brazil and India, and the company plans to introduce new payment tools, such as QR codes, to Messenger in the United States. The company is planning to make Facebook Pay available on third-party websites as well, which could be a decisive moment for the company.
Facebook is redefining its ad business as well, with an increased focus on the privacy of users. Commenting on the changing ad business, Sandberg said:
“The digital transformation is a long-term trend that isn’t going away. By focusing on innovation in these four areas, we will continue to help businesses of all sizes make the shift online and reach customers with privacy-safe personalized advertising.”
In a conference call, Zuckerberg talked about the company’s goal to develop the Metaverse, a virtual social environment. He believes that virtual reality will be the next big thing in tech:
“Metaverse is a virtual environment where you can be present with people in digital spaces. You can kind of think about this as an embodied internet that you're inside of rather than just looking at. I see our focus here as a continuation of our work to build technology that brings people together. In many ways, the metaverse is the ultimate expression of social technology. Some of the experiences I've dreamed of building since well before I started Facebook are only starting to become possible now. If you look at the investments we've made over the years, you can see this vision gradually starting to come into focus, and you can see why we're so excited about it. In addition to being the next generation of the internet, the metaverse is also going to be the next chapter for us as a company.”
Facebook is certainly moving in the right direction to retain its market leadership for a long period of time, and this could pave the way for the company to earn economic profits in the foreseeable future.
Regulatory pressure and child safety concerns are major challenges for Facebook
The social media giant continues to remain under regulatory and political pressure. Earlier this month, the Biden administration criticized Facebook for failing to do enough to counteract misinformation on its platform that discourages people from getting vaccinated. In a response to these comments, Facebook said:
“We will not be distracted by accusations which aren’t supported by the facts. The fact is that more than 2 billion people have viewed authoritative information about COVID-19 and vaccines on Facebook, which is more than any other place on the internet. More than 3.3 million Americans have also used our vaccine finder tool to find out where and how to get a vaccine. The facts show that Facebook is helping save lives. Period.”
The company also faces regulatory pressure from the Federal Trade Commission along with 48 state attorneys general for its monopolistic position in the social media industry. Although the case was dismissed by a federal court, the FTC has until Aug. 19 to improve its argument and refile the case.
Facebook faces problems related to child safety on its platform as well. On July 27, the company announced changes to its Instagram platform, stating that users under the age of 16 (or 18 in some regions) will be limited to “private accounts” as publicly available profiles can be easily targeted by perpetrators. However, some activists argue that it will not aid in the reduction of child abuse or exploitation because there is a greater chance that adolescents will not reveal their true age. Even in the case of private accounts, the control is in the hands of the user who chooses whether to respond to harmful messages, in which case Facebook will not be held liable. The problem for Facebook now is to figure out better ways to make it a safer platform for minors.
Takeaway
Facebook continues to dominate the social media industry, and its expansion into virtual reality provides the company with a new growth stream. The company's biggest challenge, for now, is to find some middle ground with regulatory authorities, which is easier said than done. Despite some challenges, the social media platform seems well-positioned to grow, which makes the recent pullback in stock price a good opportunity for growth investors to invest in the company.
