Buried in the vortex of topics around Meta’s September quarterly report is one core question. Can the platform successfully shift engagement and monetization away from Stories and toward Reels? Answering this question is more important than understanding the slowdown in ad spend ahead of recession, navigating the continued impact of IDFA, modeling the tightening of costs or understanding how leadership changes will impact the company’s priorities. If history repeats itself, Meta will eventually get the Reels formula right and return to growth. Maybe even with the help from a surprise TikTok ban in the US. Investors including ourselves should be prepared, and patient, because the transition will likely take a year or two to unfold.
Why is Reels so important?
Reels is important because short-form video is at the center of engagement growth. TikTok is a force that Meta has never had to compete with in the past. While exact numbers are not available, I estimate that global TikTok DAUs have increased from about 0.3B at the start of 2020 to 1.1B today. That compares to Meta’s DAUs increasing from about 1.7B to 2.0B during the same period. While a large portion of engagement comes from short video, its monetization has under-indexed given the user demo is largely below 30. That said, those users are getting older and spending more money and will be the center of the ad spending bullseye in the next five years. In short, to win in social advertising over the next five years, you need to have a large audience for short-form video.
Can TikTok be caught?
I believe they can be caught. This is in part because of the strength of the network of its two biggest competitors, YouTube Shorts and Meta Reels. Meta has never had first-mover advantage, but always found a way to catch up and surpass competitors with vertical growth. Instagram was never a competitor, but would have been if left alone. Snapchat was copied by Facebook in the form of Stories, essentially draining Snap of its growth potential, and now Meta faces TikTok. Comments from the Google earnings call indicated that momentum in its short-form video product, Shorts, is “encouraging.” Meta’s comments indicated that Reels is a net positive for overall engagement, up 30% QOQ. Some of that progress is attributed to Instagram filling its feed with Reels content, tricking users to view Reels. Call it a trick or smart marketing, it appears TikTok is slowly losing ground.
There’s also the wildcard of a potential TikTok ban in the US. I don’t think it’s as much a long shot as others believe. In 2020, TikTok was banned in India for geopolitical reasons. This could also happen in the US as distance grows between the superpowers, which could stoke concerns that the Chinese government will tweak TikTok’s content algorithm to influence public opinion. Essentially, TikTok is a weapon in modern information warfare. And, there is precedence with both YouTube and Facebook banned in China. My guess: There is a 50/50 chance that TikTok is banned in the US after the next presidential election.
Can Reels result in reaccelerated revenue growth?
First, Meta needs to build Reels engagement which appears to be on track. Next, they need to make money. Today, Reels is cannibalizing Meta’s overall revenue given that advertisers are not ready to make the jump from static ads to video. That will come over time. For some context on the Reels revenue ramp, it is currently on an annual revenue run rate of $1B. While this is small compared to the company’s $120B annual revenue, it’s encouraging given the product was launched in September 2021. Ramping short-form video into a $100B+ ad business will take time. The headwind will likely last a year and, in the back half of 2023, we should start to see stability if not an uptick in ad revenue growth.
Beyond five years, there’s the metaverse
While Reels adoption is today’s central question, the key question five years from now will be the impact of the shift to the metaverse. I believe that the metaverse is coming and that it’ll have a profound impact on how much time we spend online (I know, it’s hard to imagine spending more time online). I envision multiple forms of the metaverse including some 2D and some immersive. Either way, Meta will have a seat at the table which opens new revenue growth opportunities around advertising, commerce, work and play.
I was nervous going into Google earnings. For the past month, I’ve been expecting cautionary September guidance from big tech, with Google and Microsoft results being the first real test. Google’s June quarter was essentially inline with expectations but a little light on YouTube revenue which, in my opinion, was more than offset by slight outperformance in search. As is the case with every quarterly report, the takeaway is embedded in the outlook. Google’s management chose to describe their outlook as “uncertain,” which is more bullish than it might sound.
Don’t fall into the trap
The trap in this environment is to view results more positively than they really are. Tech investors are at risk of falling into this given what they’ve been through in 2022. The answer to the question—were Google results positive or negative?—requires us to decode their outlook.
Google side-stepping the question is a positive
As for the September outlook, the company outlined three factors that they summed up as broader uncertainty: tough comps, FX headwinds and the macro. CFO Ruth Porat went on to say she’ll leave the modeling up to the analysts.
I believe that Google actually has high visibility on two of the three factors that they outlined: tough comps and FX. The third factor, the macro, is the definition of uncertainty. What caught my attention was when Mark Mahaney asked which verticals can we infer are weak. SVP & Chief Business Officer Philipp Schindler side-stepped the question, only saying there have been pullbacks on spending in YouTube and on the Google network by some advertisers in Q2. That was obvious given it was in the reported numbers.
It’s game theory, but I believe that Google’s business is doing just fine. It sounds like brand advertising is soft, and that’s why YouTube missed. That softness is more than offset by strength in search, which is gaining ad dollar market share. Management knows there’s little upside in saying things are stable, so they protect themselves with the “uncertainty” language in case things really tank. Then, if things do worsen, they can say—I told you so.
Google will still be the O₂ of the Internet
As an investor in Google, I breathed a sigh of relief after decoding the outlook. That doesn’t mean shares of $GOOGL are in the clear. The macro could, and maybe will, worsen. Even so, the company has shown when other businesses stumble—Walmart, Snap, GM, to name a few— Google marches on because they continue to be the oxygen of the internet.
- Search. The most important metric, Search revenue, was slightly better than expected at $40.7B vs $40.3B. Search continues to innovate. The company continues to invest heavily in AI, with 8 mentions in the prepared remarks, especially related to AI-powered multisearch. Search is also a good barometer of consumer health, and was driven by travel (expected) and retail (surprising).
- YouTube Shorts. Management indicated that momentum in Shorts is “encouraging,” and passed on giving additional commentary in the Q&A. What jumped out at me is that the product got a call out on the prepared remarks. TikTok has competitors.
- Profit CEO Sundar Pichai reiterated his comments from earlier this month that they will be slowing hiring, describing it as a more “disciplined” approach. This should have a positive impact on 2023 earnings.
From Doug’s blog, The Deload:
There are 1,170 unicorns and more than half of them probably won’t make it.
It’s no secret that 2021 was a boom time for all forms of capital, but late-stage venture was particularly strong. In 2021, a total of 842 companies raised more than $100 million in a single financing round, up 153% y/y.
Source: Pitchbook NVCA Monitor
Meanwhile, large scale exits also grew. In 2021, the number of $500 million+ exits was 99, up 106% y/y. However, the pace of big exits doesn’t seem to be following the pace of big financings.
One way to consider this is to divide the number of $100 million+ financings per year by the number of $500 million+ exits. That ratio was 8.5:1 in 2021, the highest of the past 15 years. Mega financings/mega exits averaged about 3:1 between 2006 and 2017.
Source: Pitchbook NVCA Monitor
If 2021 had adhered to a ratio inline with the average of the past 15 years, we would have seen 55% fewer $100 million+ financings in 2021.
There’s half of your unicorns disappearing.
Of course, number of mega exits is a trailing metric but I do think it’s telling. Allocators — VCs and LPs — need to see a path to monetize the vast amount of capital earmarked for large private financings.
Some of the large increase in late-stage capital shifts what had previously been returns captured by public markets (small and mid cap tech) to private markets. But more of it seems to be inefficient capital allocation to companies that will never generate fundamental performance to generate great returns given high private valuations. In a way, private investors are capturing returns that used to go to public investors, but they’re also destroying alpha in the process by over-financing losers as well.
The new world order in late-stage capital creates three kinds of companies: