The Business Of

Eyeballs | Meta | What Are Their Margins?

Morning All!

So, yesterday we dug into how Meta makes money. And we saw that ~98% of the company’s revenue come from advertising. We saw that Facebook’s monthly active user count has grown from ~766 million in 2011 to ~3bn in 2023. And we saw that the average revenue Meta makes from each of their users has risen ~9x over this period! Which has all led to revenue going from ~$777m in 2009 to ~$135bn in 2023!

But anyway, that’s enough about revenues. Today, let’s switch our focus to margins and start by looking at how Meta’s cost structure is split…

We can see that the majority of Meta’s costs (~73%) come under 2 buckets - ‘cost of revenue’, and ‘research and development’. And this is very similar to what we saw last week in The Business Of Alphabet. ~80% of Alphabet’s costs also fell into ‘cost of revenue’ and ‘research and development’.

However there is a key difference between Meta and Alphabet. Research and development made up only ~20% of Alphabet’s costs. But they make up ~44% of Meta’s! And today we’re going to figure out why this is! Let’s dive in!

Meta Needs Data Centers… But Not As Many As Alphabet, or Microsoft!

Okay, so first let’s start with ‘cost of revenue’ - and what kind of costs come under this bucket for Meta? Well, a big portion of it is data centers! And this again is very similar to what we saw in In The Business Of Alphabet. When Google was founded by Sergey Brin and Larry Page, the company didn’t have massive data centers to power Google Search. They just had a few servers (computers) stored in their garage! However, as Google Search became more popular, and the website needed to store and process more data, Sergey and Larry needed more servers! And they had to build their own massive data centers to house all these servers!

And the same is true for Facebook and Mark Zuckerberg! When Mr Zuckerberg first founded Facebook, the website ran on just one server! However, as more users signed up to Facebook, Instagram, and WhatsApp. And Meta’s data needs grew (more login info to store, more images to process, more friend recommendations to make). They company had to build their own data centers to house all their servers! The chart below shows us Meta’s data center locations has grown from just 2 in 2010 to 22 in 2023. And we’ll get into this data center growth more tomorrow when we look at capex!

But there’s one key point I want us to look at in terms of Meta’s data centers vs Alphabet’s. We’ve just said that Alphabet have data centers for their own products - Google Search, and YouTube. But remember from last week, Alphabet also have data centers for another reason - to manage the data for all their cloud customers! Let’s take HSBC. The global bank has tons of data that need to be stored and processed. But do HSBC have their own data centers to house their servers? No, they use Google’s Cloud services to take care of their data.

And this is the difference. Meta don’t have a cloud computing division like Alphabet. Meta ONLY need data centers for their own stuff - Facebook, Instagram, and WhatsApp. They don’t need to manage data for any cloud clients, like Google Cloud does for HSBC, Twitter and loads of other companies. Hence Meta don’t need as many data centers as Alphabet have. And they don’t need anywhere near as many data centers as Amazon and Microsoft - the leaders in cloud computing!

Okay so we’ve chatted a lot about data centers. Tomorrow we’ll look at the land Meta need for these data centers, the buildings, the servers, the routers, etc. But for today, the question is - how do these data center expenditures actually show up on Meta’s financial statements?

Well, the answer is depreciation! Let’s say a data center costs~$1 billion to build. And Meta estimate the data center’s useful life is 25 years. This means Meta will put ~$40 million in their depreciation costs every year for the next 25 years. And this is what shows up in Meta’s ‘cost of revenue’ line in their income statement. For anyone who needs a quick refresher on depreciation, check out this Investopedia article!

Alrighty so, we know the depreciation of Meta’s data center expenditures make up most of Meta’s cost of revenues. But how big a cost is this? And what does Meta’s gross margin look like?

Well, we can see from the chart below that despite having all these data centers, the company’s gross margin has been incredibly high over its history. Like INCREDIBLY high… at ~81%! To show just how high that is, I’ve put in Alphabet’s gross margin for comparison. And a question to ask is - why is Meta’s gross margin so much higher than Alphabet’s?

Well, there’s two parts to this. First, it’s what we’ve mentioned already. Alphabet need data centers for Google, YouTube, PLUS all their cloud customers. Whilst Meta need data centers only for their own products. Hence, there’s relatively lower depreciation costs for Meta.

But the second part is traffic acquisition costs. Remember, we saw last week that Alphabet spend an extraordinary amount of money to bring traffic to their search engine. For example, in 2021, Alphabet paid Apple a whopping ~$18 billion to make Google Search the default search engine on iPhones and Macs! Now, do Meta have to make such huge traffic acquisition payments? Well, fortunately not!

The Best Paid Employees In The World!

Alrighty, so that’s a good breakdown of the ‘cost of revenue’ we see for Meta. But now let’s come onto the biggest part of Meta’s costs - research and development! And first question - what does ‘research and development’ actually mean for Meta?

Well, the answer is people. And more specifically… software engineers! Across their entire business, Meta employ a whopping ~67k employees in the world. Which of course, is a lot of people. But compared to Alphabet, it’s really not that high! Alphabet employ ~180k employees, nearly 3x more than Meta!

Now, as you can imagine - like we saw at Alphabet - the average salary for a Meta employee is pretty decent. In fact, as we saw last week, Meta rank FIRST in the world when it comes to the highest median salary for employees! The median employee at Meta gets paid an astonishing ~$300,000!

Now, if we took a ‘mean’ average and included bonuses, this ~$300k figure would be even higher! But let’s stick with ~$300k for now. So, how much do Meta pay in total for salaries? Well, it’s a staggering ~$20 BILLION ($300k x 67k employees)! ~$20 billion on salaries - incredible!

Now, similar to what we saw with Alphabet, the highest paid group of employees at Meta are their software engineers. According to this article, entry-level software engineers may ~$179k at Meta. Whilst the more experienced guys and girls make a whopping ~$700k! And as you’d expect, this figure has grown quite strongly over the years as Meta’s revenue has grown. But interestingly, as we can see from the chart below, Meta’s R&D costs as a % of revenue have increased quite dramatically over time. Which means that these costs have been growing faster than revenue!

So, the question is - why? Why are Meta’s R&D costs growing faster than revenue? Have salaries been increasing faster than revenue growth? Have Meta been hiring too many employees? Well, the answer is no! The reason R&D costs have risen quite substantially as a % of revenue is because of share-based compensation. But we won’t dive into this now as we’ll be touching on this in much more detail tomorrow!

Now, one final note on R&D. In the chart below, we can see that whilst ~29% of Meta’s revenue is spent on research and development in 2023. Only ~15% of Alphabet’s revenue is dedicated to research and development. So, what does this mean? Are Meta spending more on research and development than Alphabet? Does Meta hire more software engineers than Alphabet?

Well, the answer is no! Meta has ~20k software engineers. Versus Alphabet’s ~50k. And Meta overall spends ~$38bn on R&D. Versus Alphabet’s ~$45bn. So as we can see, Alphabet spend quite a bit more on R&D than Meta.

So, why is Alphabet’s R&D spend a lower % of revenue? Well, it’s because of Alphabet’s higher revenue figure! Meta’s 2023 revenue figure was ~$135bn. Versus Alphabet’s ~$307bn. And this larger revenue number brings with it strong economies of scale. For those of us who need a bit of brushing up on economies of scale - check out this Investopedia article!

The Social Media King That Advertises… On Bus Stops!

Okay great, let’s move onto the final cost line we’re going to look at today. And that’s sales and marketing. Now, I always find this cost line an interesting one. Because Meta as we know is a giant in advertising. Facebook and Instagram help millions of companies and individuals reach potential customers.

But the funny thing is that Meta ALSO need to advertise. Meta also need to reach users. Both potential users - to encourage them to download their apps. And existing users - to encourage them to use their apps more often! I couldn’t find data for how their marketing budget is split in the US. But according to this article, in 2022, Meta spent ~£89m in advertising in the UK. And in the chart below, we can see that the biggest slice of that ~£89m was used for outdoor advertising!

Now, what on Earth do we mean by outdoor advertising? Well, in the image below, we can see two screenshots. The one on the left shows us Facebook’s ‘More Together’ campaign displayed on 3 outdoor digital boards. And on the right we can see Facebook’s ‘Fake news is not your friend’ campaign on the side of a bus stop!

And this is super interesting, right?! Meta are the kings of social media advertising. And yet when it comes to advertising their own products (Facebook, Instagram)… Meta choose to advertise mainly through another channel!

And whilst this may sound weird at first. It does make sense! Meta’s target audience for their ads isn’t people who are already using Facebook and Instagram. They want to target people who aren’t currently using Facebook and Instagram much. And so where are these people found? Well, not on Facebook and Instagram! This article here gives us some more thoughts as to why Meta and other digital giants are increasingly focusing on outdoor advertising channels.

Now, unlike with R&D, we can see in the chart below that ‘marketing and sales’ costs have been much easier to control for Meta. Over the last decade, the company has steadily reduced the proportion of their revenue going towards marketing. With 2023 seeing ~9% of revenue going towards this cost line!

Fat, Fat Margins!

Alrighty, time to wrap up! We’ve had a good look at Meta’s three main cost buckets - cost of revenue (mainly data centers), research and development (mainly software engineers), and marketing (mainly outdoor advertising and social media advertising).

Now, it’s time to see how Meta’s EBIT margin has coped with all these costs! And as we can see from the chart below, they’ve done pretty well! In 2009, Meta boasted a strong EBIT margin of ~34%. And 14 years on, the company still boasted a super high margin of ~35%!

Now, this mid-30s margin is clearly incredibly impressive. And we’ll be able to confirm that tomorrow when we look at Meta’s position in our TBO EBIT Margin ranking. But some of us may be wondering - why is Meta’s EBIT margin a bit bumpy? And why was there that huge dip in 2012?

Well, it’s because of something we mentioned earlier - share based compensation! And we’ll get into this in more detail tomorrow!

13th Mar 2024

Nigel Jacob CFA