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Facebook has successfully overhauled its business before. This time will be harder



Prior to its initial public offering (IPO) in 2012, Facebook was in financial trouble. In the face of slowing revenue growth and soaring expenses, the company has fallen further behind competitors in the transition to smartphones and other mobile devices.


However, the company was able to turn things around in just over two years. Sales increased by 72 percent year on year in the first three months of 2014, and profits more than tripled as the company reorganized to put "mobile first" at the forefront of its operations. Facebook's successful transition has since become ingrained in the company's lore, and it is widely regarded as a major contributor to the company's dominance.


A decade later, the company, which is now known as Meta (FB), finds itself at a crossroads in a similar situation. After reporting declining quarterly profits, stagnant user growth, and a dim revenue outlook for the first quarter of this year, the company experienced its worst trading day ever as a publicly traded company on Wednesday.


As with the company's pivot to mobile, Mark Zuckerberg, Facebook's CEO, has hailed a combination of virtual and augmented reality technologies — collectively referred to as the metaverse — as the breakthrough that will help turn around the company's fortunes. He has even referred to the metaverse as "the mobile internet's heir apparent."


However, there is one significant difference between now and when Zuckerberg's company made its pivot a decade ago: while mobile technology was already a successful platform at the time of Facebook's pivot, the company's vision of the "metaverse" — essentially an immersive virtual world where anyone can interact with friends and strangers via digital avatars — is still years away, if it ever materializes.


More than 100 million smartphones had been sold by 2012, which was the year in which Facebook made the transition from the desktop to the mobile. The International Data Corporation (IDC) predicts that only 9.4 million virtual reality headsets will be shipped in 2021, which are not "the metaverse" but rather "a stepping stone" to it instead. Meta's Oculus VR headset is believed to be the most popular in this market, accounting for the vast majority of shipments. Virtual reality and augmented reality are also still in their infancy as technological advancements (just look at all those legless avatars).


During this time period, Meta's business is under threat on a number of fronts. The number of people who use it is continuing to decline (and aging). Apple's changes to its operating system are posing a threat to the company's core advertising business. Besides that, a string of scandals has thrust the company into the limelight of the regulatory authorities, limiting its ability to acquire its way to continued growth (though it has been gobbling up a number of small companies for its push into the metaverse).


An undefined path to the metaverse


As those issues become more prominent in the real world, Zuckerberg is placing his bets on his ability to pull off another massive transition in the virtual universe. Even he, however, acknowledges that there will be some uncertainty in the future.


Zuckerberg stated during this week's earnings call that "while the direction is clear, the path forward is not perfectly defined" in regards to the company's transition to the metaverse.


That may be an overly optimistic assessment. It is not only unclear where the path will lead, but it is also strewn with obstacles and prohibitively expensive to navigate. Last year, according to Meta's earnings report released this week, the company's AR and VR division suffered a loss of more than $10 billion.


"Meta is putting its core business model at risk in order to satisfy its obsession with the metaverse," said Rachel Jones, an analyst at data analytics firm GlobalData. "Losing money on the metaverse is not a bad thing — the technology is poised to be enormous and provide an abundance of opportunities — but it will take at least another decade to get things moving in this direction."


And that's on top of the years it's already spent attempting to make virtual reality more widely available to the public. When Facebook acquired Oculus in 2014, the company claimed that the headset could serve as a "new communication platform." However, the company has made little progress in comparison to mobile's rapid adoption of the technology.


As a result, despite Meta's high-profile rebranding last year, some of the company's competitors, according to Angelo Zino, senior equity analyst at CFRA Research, appear to be better positioned to lead the transition to the metaverse.


He cites competitors that have more popular existing hardware (Apple), software (Roblox), or simply younger user bases that may be more receptive to the metaverse as examples of such competitors (TikTok and Snap). As an alternative, Facebook is frequently thought of as a place to connect with elderly relatives, who appear to be less likely than younger people to be early adopters of virtual reality and augmented reality technologies.


According to Zino, "If you look at [Meta] today, they truly do have nearly all of the money in the world to throw at this." In contrast, there are many, many other players who are attempting to achieve the same goal as Meta... and I would argue that there are many players who are significantly ahead of Meta."


Mounting problems in the real world


It has been speculated by some Facebook critics that the company's decision last fall to change its name to Meta and invest heavily in the metaverse was intended to serve as a diversion from the company's current problems. If that was the case, this week's investor reaction demonstrated that it was not a particularly positive reaction.


Apple's iOS 14.5 update has stifled Meta's mighty advertising business by making it more difficult to track users across the internet for ad targeting purposes and to track the success of advertising campaigns. Meta's mighty advertising business relies on tracking users across the internet for ad targeting purposes and tracking the success of advertising campaigns. According to Chief Financial Officer Dave Wehner, the company expects to incur a $10 billion loss in 2022 as a result of the changes.


If it continues, Facebook's failure to add new users in the most recent quarter may prove to be a more pernicious trend in the long run. It cited intense competition for users' time from rival apps such as TikTok, which is more popular with younger users, as the reason for its decision. Moreover, with nearly 3 billion users already on the platform, Facebook runs the risk of running out of humans to convert into paying customers.


As Zino put it, "the stagnation of the user base is definitely a threat." After reaching a point where monthly active users come to a complete standstill, it becomes apparent to advertisers.


In addition, Zino believes that Meta's preliminary guidance for the current period — the company anticipates revenue growth of between 3 and 11 percent in the first three months of 2022, down from 48 percent in the first quarter of 2021 — could be a sign that the company is "losing wallet share within the ad space." Meta's total revenue continues to be dominated by advertising revenue, which accounts for more than 99.5 percent of total revenue.


Investors were notified this week by the company that it is placing a significant amount of money into Instagram Reels, the company's version of the popular TikTok short-form video product. Meta executives, on the other hand, have stated that the format has proven to be more difficult to monetize than other products in the past. While Meta tries to sell it to its user base, which experts believe is more mature than the users who watch and engage with similar short videos on TikTok and Snapchat, it's possible that this will continue to be the case.


Meta may have attempted to expand through acquisition at some point in the past, similar to what Instagram did with Facebook in 2012. (Notably, in 2013, it made an unsuccessful attempt to acquire Snapchat.) Indeed, the company generated nearly $40 billion in net income last year and ended the year with $48 billion in liquid assets (cash, cash equivalents, and marketable securities) on its balance sheet. Although the company is now under more scrutiny than it was in 2012, regulators would almost certainly oppose any blockbuster acquisition, which is in stark contrast to the situation in 2012. It is currently defending itself against an antitrust lawsuit arising from its acquisitions of Instagram and WhatsApp, which both went bankrupt several years ago.


All of this adds up to a significant number of challenges that the company must deal with at the same time.


According to UBS analysts Lloyd Walmsley, Chris Kuntarich, and Mary McKennon, who wrote a note to clients on Thursday, "we were struck by the breadth of the company's concurrent priorities (seven?)." As a result, analysts believe that the majority of these will have little impact on "the company's revenue in the near term."


That is to say, Facebook has reached a stumbling block, and there is currently no easy way around it.

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