By Ee Hsin Kok. Edited by Arjun Chandrasekar.
Overview
In October of last year, Facebook rebranded to Meta. This was done to draw attention to the company’s ongoing investments into the metaverse and to also take attention off an ongoing whistleblower scandal. Around that time, the company had already fallen 16% from its highs, and I wrote an article stating that Meta was an incredibly safe value proposition. Fast forward to today, Meta has fallen even further. It is now down 43% from its highs, and as much as 52% at its low. So is it still a safe value proposition? Or is it a Tech Giant in Crisis?
A Bad Earnings Report
After its initial drop in October of 2021, Meta’s price stabilized and stagnated between $300 to $340 for the next few months. However, following its 2021 Q4 results on February 3rd, the stock took a nosedive, dropping over 26% in a single day to $230.
What was so bad about this earnings report, and why did it cause the stock to plunge 26%? Well, there were three main concerns with this report:
- Daily Active Users failed to grow (First time in company history)
- Metaverse investments had cost more than expected
- Meta lowered future revenue projections
The User Saturation Problem
The first concern that came up in the earnings report, is that daily active users declined. Amidst increased competition from the new social media app TikTok, this was the first time that Facebook had actually failed to increase its Daily Active Users on the platform.
DAUs dropped by 1 million from 1.930 billion users to 1.929 billion. This sparked increased concerns about Facebook’s saturation and the lack of potential for future growth in the social media space.
Costly Metaverse Investments
Facebook has been spending more and more on its Metaverse investments, which have yet to pan out. As a result of this, their operating margins are taking significant hits. Dropping from 46% in Q4 of 2020 to just 37% in Q4 of 2021.
As seen above, Reality Labs (Meta’s metaverse business) lost $3.3 billion in Q4 of 2021, an over 50% increase from its loss of $2.099 billion in Q4 of 2020.
Lowered Future Revenue Projections
Meta also lowered their revenue projections in Q1 of 2022. While analysts had previously been expecting $30 billion, the company said to expect between $27 to $29 billion. Considering revenue of Q1 in 2021 was $26.171 billion, this means Meta only expects 3.1% to 10.8% year-on-year growth (at least in the short term). This is far below analysts’ expectations of at least 15%.
Is the Drop Justified? Is Meta in a Crisis?
All of this brings us back to the main point of this article, finding out if Meta is still a good investment. As mentioned above, there are multiple concerns from the latest Q4 earnings report, but I believe these concerns have been overblown, and the nosedive in Meta’s price is unjustified.
Regarding the first concern of user saturation, this has actually been a problem for a while now. Facebook’s daily active users only grew by 4.5% from 2020 to 2021, and for Meta’s total Family Of Apps (FOA), daily active users only grew by 8.46%. Yet despite this, revenue from the FOA grew by 19.9% from $27.355 billion to $32.794 billion. This was possible because Meta has consistently been able to increase its revenue per user over the years, extracting more and more from each and every user across every geographic location:
The second concern was the costliness of Reality Labs. Meta’s overall operating margins have fallen as a result of Reality Labs making more than $10 billion in losses last year. To make matters worse, the business is also expected to continue losing money for the foreseeable future. The metaverse is a big gamble for Meta, but if we consider the potential for upside relative to the limited downside, it is still a great proposition for the long term.
The limited downside comes from the economic moat of Meta’s FOA. While Reality Labs lost $10 billion last year, the FOA made over $56 billion dollars. Companies usually need to borrow money to invest in new ventures, but Facebook can rely on the massive amount of cash its FOA businesses generate to fund its metaverse investments without taking a big hit if it fails. Conversely, should Reality labs pan out similarly to how AWS did for Amazon, it would be a catalyst for insane amounts of upside and future growth. For context, AWS is now responsible for the majority of Amazon’s operating income.
The third concern is decreased revenue projections in the short term. Meta has cited issues with increased competition from new social media site TikTok, the new Apple Privacy updates decreasing the optimization of their ad targeting, as well as global supply chain issues. However, short-term projections are short-term. Meta has already begun adapting to the growing popularity of TikTok with reels on Instagram; it is inevitable they will overcome Apple’s privacy changes and find new ways to optimize their ad targeting, and global supply chain issues should resolve over time. While short-term growth may be in the high single digits, long-term growth should return to at least 15%.
The Investment Thesis
Meta was a great company a few months ago, and despite a disappointing earnings report, is still a great company today. While it is enduring short-term headwinds, its economic moat and long-term track record of success are undeniable. This is not the company’s first crash – it fell over 50% during its Cambridge Analytica scandal and bounced right back. From a technical analysis standpoint, it is on a strong downtrend and it might be better to hold off buying or adding shares until the trend changes. However, from a pure long-term value investing standpoint, it is significantly undervalued today. A discounted cash flow valuation puts its intrinsic value between $350 to $400, and it’s at an all-time low P/E ratio of 15. Therefore, while anything can happen in the short term, so long as you are willing to hold it for at least the next 3-5 years, you can be pretty confident in Meta yielding a good return.
