Meta Platforms (META 0.14%) released fourth quarter earnings in early February that left many investors contemplating the company's future. As a result, Meta lost over $230 billion in market value in a day, setting a record for the largest single-day sell-off in stock market history. The drop came after Meta reported an earnings per share of $3.67, missing analyst estimates for only the second time in twelve quarters.
Meta also experienced its first-ever decline in daily active users on its Facebook platform. The company's advertising segment -- which represents the bulk of Meta's top-line -- struggled in the fourth quarter due to Apple's iOS 14.5 privacy update, which continues to serve as a challenge to Meta's ad targeting. However, I think that the most important element to consider from Meta's fourth quarter earnings announcement is its ongoing business transformation that centers around its Reels segment and the metaverse.
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Understanding Meta's transitional phase
As a longtime social media juggernaut, Meta has decided to take its business in several new directions. In the near-term, the company is focused on enhancing its Reels segment, which involves short-form videos similar to what you see on TikTok. Mark Zuckerberg, the company's CEO, stated in the recent earnings announcement that Meta plans to continue prioritizing Reels ahead of core business segments like news feed and stories.
Investors should closely monitor Meta's progress in its Reels segment because currently, Reels monetizes at a slower rate than news feed and stories. According to management, this is because Reels currently show fewer ads than news feed and stories, meaning less revenue is being generated from the segment as of today. Management cited the company's ability to make successful transitions in the past, namely Meta's previous shifts from web to mobile and feed to stories. But as long as Reels isn't monetizing as fast as other core business segments, Meta is at risk of underperforming.
Meta's fourth-quarter earnings announcement also focused on its Reality Labs segment, which involves all metaverse-related business activities. The metaverse refers to a network of 3D virtual worlds where people can interact and connect in a virtual reality. Reality Labs generated a net loss of $10.2 billion in fiscal year 2021. Meta plans to continue its aggressive spending in order to grow the segment moving forward. In the fourth quarter, Meta stated that its investments in Reality Labs were the primary cause of the increase in cost of revenue and research and development, which grew 22% and 35% year over year, respectively.
Meta is expected to experience a similar loss in its Reality Labs segment in 2022, so it's clear that the company has a lot at stake in regards to its long-term vision of the metaverse. The increase in metaverse-related costs will continue to put pressure on Meta's margins and bottom-line, which could lead to more disappointing quarters in the foreseeable future. It's not that Meta doesn't have the cash to fund its metaverse transition. But, the amp in operating expenses intertwined with expected net losses from the Reality Labs segment jeopardizes Meta's near-term financial success without any guarantee that the investments will pay off in the long run. Reels and Reality Labs -- two of Meta's top priorities moving forward -- will continue to present challenges to the company's business in the quarters ahead.
Should investors buy Meta?
Long-term Meta investors must understand that they are no longer investing in a simple social media company, but are placing a bet on the company's Reels business and its vision of the metaverse. I think TikTok has a strong hold of the short-form video space, which makes it difficult to envision Reels succeeding in the long run. The company's tight focus on its Reels segment is quite risky given it's taking attention away from Meta's higher monetizing services.
Above all else, I can't offer my full support of the company's metaverse transition until I see that material progress is being made. Right now, it appears that Meta is aggressively investing in a money-losing business segment that has no clearly defined future. It wouldn't be unwise to hold off on investing in Meta for now, as its transition to Reels and the metaverse adds a significant layer of risk and long-term uncertainty to the company's investment profile.
