Alphabet (NASDAQ:GOOGL) and Meta (NASDAQ:META) are two IT behemoths facing macro headwinds in 2022.

Headwinds

Rising interest rates and a sluggish economy have reduced the rate of growth in the digital advertising business.

This is because advertising spending is highly cyclical – it is one of the first things corporations cut back on when times are tough.

Covid-19 has made things more uncertain, as ad expenditure has been lumpy in recent years, reflecting the pandemic economy’s stop-and-start pacing, and this has generated difficult comparables for recent quarters.

However, as the healthcare crisis has subsided, consumer spending and behavior have gradually returned to normal.

People are spending less time on their digital gadgets than they were at the height of the pandemic, thus advertisers’ digital marketing objectives have been scaled back.

Looking ahead to 2023, the absence of large-scale events such as the Olympics, the World Cup of soccer, and the US midterm elections could create more headwinds.

A strong dollar has simply made matters worse by decreasing the dollar value of foreign revenues.

This headwind may be lifting shortly, as the dollar’s strength appears to have peaked.

Meta’s average pricing per ad fell 18% from the third quarter of last year in the three months ending September 30, 2022.

This was countered by a 17% rise in ad impressions, which was driven in part by an increase in daily active users.

Short-term volatility is to be expected, but long-term fundamentals remain appealing.

The long-term picture for digital ad expenditure remains mostly unchanged as the e-commerce business expands and brands seek more imaginative ways to reach their target customers.

Changes in Privacy

There are also micro variables at work.

The introduction of Apple’s App Tracking Transparency framework last year contributed to recent revenue declines.

This severely limited app developers’ access to Apple’s Identification for Advertisers (IDFA) – a unique identifier for Apple’s iOS devices that were widely used to target and assess the efficacy of advertising on a user level.

As expected, a considerable number of iOS users have chosen to opt out of this tracking due to privacy concerns.

As a result, advertisers have found it more difficult to collect data – such as a user’s current interests – analyze advertising success, and display targeted adverts.

As app-based ads grow less effective, advertisers’ returns have decreased, as has the price paid per ad impression on applications like Facebook, Instagram, and WhatsApp.

Alphabet has also suffered as a result of these changes. iOS customers access the company’s programs like YouTube and Gmail in the same manner as they do other apps, so it has the same issue there.

However, it isn’t having the same impact on search, which is Alphabet’s main source of revenue.

Ads that display in Google search results, as well as other web pages that use Google’s search engine, are unaffected by Apple’s latest privacy measures because search ads are primarily targeted using keyword contextual matching – as opposed to direct interest-based targeting employed by most apps.

Sandbox for Privacy

Meanwhile, Google has suggested its own Privacy Sandbox effort, with the claimed goal of improving web privacy.

It plans to phase away support for third-party cookies in its Chrome browser, as well as the usage of Google’s Advertising ID on Android – the Android equivalent of Apple’s IDFA – undermining how advertisers now show targeted advertisements, collect user insights, and analyze ad success.

To replace the current use of cookies and Advertising ID, the Privacy Sandbox plans to introduce “privacy-preserving APIs” such as the Topics API, FLEDGE API, and Attribution Reporting API to enhance ad relevance.

This would allow you to continue to present interest-based advertising, analyze customer trends and behavior, and measure ad effectiveness.

The significant difference in the future is that targeting will take place on the user’s device, with on-device processing designed to keep user data private.

Algorithms will examine users’ activities on their own devices without disclosing their browsing history to marketers.

As a result, unlike Apple’s ATT, Google’s proposed privacy adjustments appear to be both privacy-enhancing and revenue-preserving.

That’s not surprising given Alphabet’s reliance on advertising revenue.

However, Google’s Privacy Sandbox has its detractors, with antitrust charges filed on both sides of the Atlantic.

Advertisers and publishers in both the United States and the European Union have denounced the proposed changes as possibly anti-competitive because it would limit their access to user data while not doing the same for Google’s own search business.

Others have questioned whether the method provides users with significantly more privacy, considering that information about a user’s hobbies may possibly be utilized to obtain sensitive information.

Pressures from Competitors

In other areas, both corporations face stiff competition.

Alphabet and Meta dominate the internet advertising business, but they face increasing pressure to expand their reach and time spent on their platforms.

Facebook’s problems to remain relevant among younger users are well documented, as an aging user base jeopardizes the company’s capacity to grow.

Generation Alpha and Generation Z, or those born after the mid-1990s, spend far less time on Facebook than previous generations and are instead drawn to a growing cohort of younger social media and messaging networks, such as TikTok, Snapchat, and Discord, as well as Meta’s own Instagram and WhatsApp.

As this generation’s spending power expands, brands (and their advertising money) will follow.

Alphabet’s YouTube is also facing stiff competition – and on two fronts. First, consider TikTok in the short video sector, which has done particularly well in recruiting younger consumers.

The corporation is fighting back by creating YouTube Shorts, its own short-form video-sharing site.

However, the short-form video field is saturated – Meta has high hopes that its Reels feature on Instagram will take more market share, while revenue remains an issue.

Second, YouTube confronts ad dollars competition from Netflix, Disney+, and other streaming services. SVOD companies, which have traditionally relied on subscription revenue, have been adding additional ad-supported subscription tiers to their products as consumers seeking cheaper subscription fees face rising cost of living constraints.

YouTube’s bottom line is already feeling the pinch.

Ad income on the video platform declined 2% year on year to $7.07 billion in Q3 2022, the first decline since the group announced YouTube’s own portion of revenues nearly three years ago.

The Google search company, on the other hand, is more resilient, reflecting its bigger moat.

Google’s dominance in search has made its name synonymous with the process of searching for anything on the internet.

There are no signs of Google’s dominance waning, with the company handling 92% of all global search requests in November 2022.

Google Search revenue increased 5% year on year to $39.54 billion in Q3 2022, accounting for 57% of Alphabet’s overall revenue.

Growth Factors

Another bright spot is Alphabet’s cloud business.

Demand for enterprise cloud services is projected to hold up well in the face of a broader IT slump.

Companies are shifting more and more of their workloads to the cloud as part of the continuous digital transformation in order to become more agile, robust, and efficient.

Google Cloud ranks third in the cloud provider market, after only Amazon Web Services (AWS) and Microsoft Azure.

Google Cloud, on the other hand, is growing faster than both of its larger competitors, with a 38% revenue growth rate over the last year.

However, Google Cloud is not yet profitable; the division lost $699 million in the third quarter of 2022.

Meanwhile, Meta is investigating prospects in the metaverse, such as virtual reality (VR) and augmented reality (AR) (AR).

Reality Labs, the corporate successor to Meta’s Oculus brand, recently announced the release of the Meta Quest Pro, a mixed-reality headset capable of blending virtual things into the physical surroundings as well as providing a totally virtual experience.

VR and AR have numerous potential applications, including productivity, socializing, and gaming, but there are still significant obstacles to overcome before they become widely used, including cost, portability limitations, limited field of view, safety concerns, and experience quality.

Expense Management

Alphabet and Meta are both under financial pressure to decrease expenditures.

The strain is especially intense at Meta, which went on a massive hiring binge during the peak of the outbreak.

Over the last three years, Meta has nearly doubled its personnel numbers, with a 94% increase to over 87,000, compared to Alphabet’s 57% increase to more than 186,000.

However, in terms of revenue per employee, Meta retained a lead over Alphabet.

However, that lead has shrunk significantly over the last two years, and given current revenue projections, Meta may even slip behind Alphabet in this category by the end of this year.

Meta seems to have grown too swiftly, failing to anticipate a more difficult macro background and, in a tardy acknowledgment of this, it just revealed plans to lay off 11,000 employees, or 13% of its staff.

Both equities’ valuation multiples have fallen dramatically this year as part of a broader tech selloff.

Alphabet is now valued at 18.9 times its projected earnings in 2022, whereas Meta is only 13.2 times.

However, Meta’s lower multiples come at the expense of slower growth.

Meta’s revenues peaked earlier this year and are now declining. While Alphabet’s revenue growth has slowed, it remains significantly favorable.

Looking ahead, Alphabet’s growth and earnings forecasts appear more appealing as well.

Last Thoughts

While both firms face similar macro headwinds, I believe Alphabet is more appealing due to its more favorable microenvironment.

The group’s overall revenue forecast is brighter since it has exposure to the rapidly increasing cloud sector and because Google’s search business is more resilient.

Although Alphabet’s value multiples are slightly greater than Meta’s, quality and growth always come at a cost.

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