The story of social media relevance is a fairly recent one going back only a few decades. Predominately the fodder of younger people, that group can be fickle, and when the next hot thing comes along, that could mean trouble for legacy companies. This appears to be happening with Meta Platforms Inc.’s (
META, Financial) key social media platform Facebook, and the culprit this time may be TikTok.
Meta Platforms develops social media and communication platforms that enable people to connect and share content with friends and family through mobile devices, personal computers, virtual reality headsets, wearables and in-home devices worldwide. Key products include Facebook, Instagram, Messenger, WhatsApp and Reality Labs, a virtual reality platform.
Formerly known as Facebook Inc., the company changed its name to Meta Platforms in October 2021. The company was founded in 2004 and currently has a market capitalization of $349 billion.
Reality Labs
Reality Labs is the company’s virtual reality and augmented reality platform that was formed from the original Oculus VR headset business, which was acquired by Facebook in 2014.
The segment’s augmented and virtual reality products, which help people feel connected, include Meta Quest and Facebook Portal. In 2021, the company pumped $12.5 billion into this segment. With only $2.2 billion in revenue, Reality Labs had a large segment operating loss of $10.2 billion. For the first nine months of 2022, the operating loss in this segment was already $9.4 billion and the company mentioned it expects operating losses to grow further in 2023 as it continues to invest heavily in this business. Many analysts and institutional investors are questioning whether this extraordinarily high level of spending is necessary and whether it is hurting Meta’s overall financial returns.
Financial review
Earlier this week, the company reported a miserable third quarter with revenue down 4% to $27.7 billion and operating expenses increasing 19% to $22 billion. This caused a collapsed in operating margins to 20% from 36% in the prior-year period. An interesting advertising-related comment was that ad impressions delivered across all Meta apps increased by 17% year over year, but the average price per ad decreased by 18%. Usage across all platforms only increased in the 2% to 4% range.
For the three months ended Sept. 30, the company essentially broke even on an operating cash flow basis and had to borrow money to repurchase $6.3 billion in stock, at much higher prices than current prices. Capital expenditures more than doubled to $9.5 billion.
The company’s cash position deteriorated to $32 billion and debt increased to $9.9 billion from zero debt at the end of 2021.
CEO Mark Zuckerberg explained further, "Our community continues to grow and I’m pleased with the strong engagement we’re seeing driven by progress on our discovery engine and products like Reels. While we face near-term challenges on revenue, the fundamentals are there for a return to stronger revenue growth.”
Valuation
Analysts quickly lowered estimates for 2023 after the company indicated that expenses will increase to the range of $96 billion to $101 billion, a substantial increase from 2022 estimates of $85 billion to $87 billion. Analyst earnings per share estimates for 2023 are now approximately $8.53, which puts the company selling at about 11 times next year’s earnings. The enterprise value/Ebitda ratio is approximately 7.
The GuruFocus discounted cash flow calculator generates a fair value of $148, which is roughly one-third higher than current price levels. Inputs included next year’s earnings per share estimate of $8.53 as the starting point and a 10% long-term growth rate.
The company does not pay a dividend, but actively repurchases shares. Meta repurchased $44.5 billion worth of stock, which in hindsight was a bad decision as the price was mostly above $300 per share throughout the year.
Guru trades
Gurus who have purchased Meta stock recently include
Tom Gayner (Trades, Portfolio) and
Robert Olstein (Trades, Portfolio). Investors who have reduced or sold out of their positions include
Steven Romick (Trades, Portfolio),
Spiros Segalas (Trades, Portfolio) and
Baillie Gifford (Trades, Portfolio).
Conclusion
Meta is not a technology stock as many believe. Rather, it is a media company that is mostly dependent on advertising, which makes up 95% of revenue. That reality has set in as the stock has retreated 74% from its 2011 highs.
It looks like the competition is catching up with Meta as the TikTok phenomenon continues to expand. Facebook and Instagram are a long way from becoming the next MySpace, but that is always in the back of investors’ minds, particularly if the multibillion gamble on Reality Labs fails to generate meaningful operating income at some point.
However, the steep drop in the share price may provide an entry point for long-term investors.
The large losses in Reality Labs will go away at some point, either through profitable revenue growth or pressure from investors to abandon that segment. It may take several years, but Meta could return to its historically high operating margins at some point.