Meta Platforms (FB, META): Metaverse or Sharing Pictures with Nana?

TII Rating: ★★★☆☆

Contents


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1. Intro

Thesis

  • Facebook (Meta Platforms) is transitioning from an ever-weakening social network into a metaverse company.
  • This is a Hail-Mary attempt at retaining social media ownership in a changing world.
  • This change is further signified by the leaving of Sheryl Sandberg, COO of Facebook for 14 years. Sheryl was key in turning Facebook into an advertising powerhouse.
  • While their history of ad revenue proved fruitful, it will not carry them forward into the metaverse as Zuckerberg hopes.
  • They have already built some functionality with VR headsets and the like, but people do not want gimmicky out-of-the-box functionality, but worlds teeming with adventure and connection with others who are not in their immediate network.
  • I am calling this transition digital-first network, while Facebook traditionally is a IRL-first network. People are mostly friends with others they met first In Real Life (IRL), while powerful networks create friendships on the internet first (digital-first).
  • Unless Zuckerberg and his team can significantly increase the VR strategy coupled with digital-first connections, Meta Platforms will not be able to support significant advertising revenue in the coming years. Another company will show up and eat their lunch.

Let’s dive in.

Key Stock Information

Price Performance

The recent decline in tech stocks has Facebook hurting since mid 2021. Facebook has a 5 year CAGR of 5.91% compared to the S&P 500 at 11.04%.

Negative price action for a potential stock is great news for any investor, but it can signal some potential problems.

Risk Assessment

LOW MEDIUM HIGH

I am assessing Facebook at a high risk right now due to the nature of the reorganization of the company, notably the transition in focus to Reality Labs, their VR/AR segment.

The old strategy that got them from startup to where they are now is not the same thing that will get them farther.

Advertising revenue might take a hit as privacy concerns become more front stage for users.

Earnings Data

“What will Meta Platforms earn in the future?”

It’s easy to take a guess, but the fact is that with questions surrounding the metrics (Does every account count as an individual user? Why is Instagram suggesting I create a new account?) it’s wise to say “I don’t know” rather than guess.

Here are historical earnings per share and cash flows breakdown:

2. Highlights

Here are the main points where I think Meta Platforms needs to focus in order to continue growth.

Reality Labs and The Big VR Lift

Zuckerberg is placing a huge bet on the metaverse being the main driver for Meta Platforms.

It’s no easy task to shift a behemoth like Facebook and the Family of Apps over to the metaverse.

Here’s the revenue and operating loss for Reality Labs from 2019 to 2021:

Zuckerberg is right to focus early on the metaverse. Things are somewhat smooth right now with growing metrics and Average Revenue Per User (ARPU) increasing:

But as they say, the best time to prepare is before the rains hit.

Zuckerberg’s strategy of making Facebook THE metaverse company is paying off initially.

Here are the brands most associated with The Metaverse:

And the U.S. adults description of the metaverse:


  • The metaverse is simply another word for the internet. It has been over-marketed and overhyped to mean a magical place where people get together on the internet.

    The thing is, we already do this. If you’re reading this report then you’re in the early stage of the metaverse. A more “metaverse” way to interract with this report would be for you and I to discuss it over a Zoom call, or have me show you the report in real-time through VR.

    While I believe that most people underestimate the internet (still), the metaverse is pure hype.

    For Zuckerberg to change the name of the company to Meta Platforms is actually a red flag for me. 🚩

    It’s like a world champion boxer calling themselves the greatest boxer of all time after defending their title multiple times.

    There’s younger, more ferocious, more talented boxers coming for this boxer, and the marketing shenanigans aren’t going to help once the bell rings.

Here is the U.S. adults opinion of Meta as of November 2021. I expect this to shift, as most people do not welcome change.

When leadership of a large company becomes out-of-touch with users, they start evolving away from users. The feedback loop for this is too long for Zuckerberg: Reality Labs is a multi-year bet with no promise of a positive outcome.

Market testing for the VR play is saturated with people who are into VR. In a way this is like being surrounded by “yes men”: they agree with leadership and proclaim “this is great!” while nobody is buying VR headsets.

Mark Zuckerberg wants his iPhone moment, but he’s just the king of connecting grandmas, grandkids, cat videos, and advertisers.

One User, Many Accounts

The next thing I’m extremely cautious of is Instagram nudging users to create a new account.

One of Meta Platform’s main metrics is Daily Active Users and Monthly Active Users. Here’s what I found:

Facebook Inc. is struggling to detect and deal with users’ creating multiple accounts on its flagship platform, according to internal documents that raise new questions about how the social-media giant measures its audience.

An internal Facebook presentation this spring called the phenomenon of single users with multiple accounts “very prevalent” among new accounts. The finding came after an examination of roughly 5,000 recent sign-ups on the service indicated that at least 32% and as many as 56% were opened by existing users. The company’s system for detecting such accounts also tends to undercount them, according to the presentation, which was viewed by The Wall Street Journal.

How Many Users Does Facebook Have? The Company Struggles to Figure It Out – WSJ


  • Meta Platforms is an ad revenue machine on top of a social network. One of the leading indicators of success, then, is how many users the network has, and how much time they spend on that network.

    A user who spends 100 hours on the network is 100x more valuable than someone who spends 1 hour on the network.

    For Meta Platforms to report Daily Active Users (DAUs) and Monthly Active Users (MAUs) is a start, but nowhere needed to accurately depict the value of those users as a leading indicator. 🚩

    “What about revenue?”

    Revenue is a lagging indicator. It shows what already happened, not what will happen.

    What I would like to see is for Meta Platforms to report:

    1. How many hours is each user spending on the family of apps?

    2. How successful are the advertisers?

    Keep in mind, almost every company is deliberately reporting to put themselves in the best light possible. Meta Platforms is no different.

It’ll be interesting to see if Meta Platforms addresses the user issue.

Going Digital-First on a IRL-First Platform

This is a bit of a trickier concept to communicate.

  1. Facebook and Meta Platforms began as a place for people who already knew each other to connect: this is the beginning of social networks.

  2. As the internet became more prevalent, people started forming connections with each other based on vocation, interests, etc. However, these connections were not through Meta Platforms, but LinkedIn and Twitter. Users were not limited by geography.

Zuckerbergs big problem is getting people to use Facebook and the family of apps in a way that embraces digital-first thinking.

Advertisers and User Privacy

Meta Platforms has a new difficult situation on top of all of this.

Users now experience better privacy protection. This is a good thing for users, but it makes it more difficult for advertisers to target specifics demographics and users.

This means less effective ads.

Less effective ads -> less money spent on advertising.

It may seem oversimplistic, but this is the premise for Meta Platforms having a difficult time.

When we combine these tenets: funding Reality Labs, not really knowing how many users there are, and advertisers not being able to target specifics, we get a little storm of difficulty for Meta Platforms to overcome. I think this explains FB’s current drop in stock price more so than the economic environment.

3. Investment Rationale/Risk

  1. I gave Meta Platforms a two-star rating due to its recent decline in advertising revenue over the past quarter. I do not usually put such emphasis on quarterly results, but this is a sign of something wrong with the company, as I mentioned above. The declining ad revenue is the canary in the gold mine. Couple this with the departure of Sheryl Sandberg, who was responsible for much of Facebook’s emphasis on ad revenue, and you get an idea of the leap Meta Platforms is trying to make:

  1. The downside protection here is in the scrappiness of Zuckerberg and his team. While what they are trying to accomplish is a long shot, it is not impossible, and the cash-generation of Meta Platforms is very decent, and at an attractive price based on a single point P/E ratio of 15.04.

4. Business Summary

Meta Platforms has two segments: the Family of Apps (FoA) and Reality Labs (RL).

Family of Apps:

  • Facebook

  • Instagram

  • Messenger

  • WhatsApp

The FoA makes up the entirety of Meta Platforms’ operating revenue and user base.

Reality Labs

Relatively new, this is the segment that Zuckerberg is betting heavily on:

  • “Reality Labs’ augmented and virtual reality products help people feel connected, anytime, anywhere. Meta Quest lets people defy distance with cutting-edge VR hardware, software, and content. Facebook Portal video calling devices help friends and families stay connected and share the moments that matter in meaningful ways.”

  • Meta Platforms currently has the Meta Quest 2 VR headset but is releasing Project Cambria:

  • 2,160 x 2,160 MiniLED Backlit LCD Panels (2)

  • Custom Pancake Lenses (2)

  • 16MP Color Camera for Color Passthrough

  • Eye + Face Tracking (IR Camera based)

  • Qualcomm XR2+ Gen 1 SoC

  • 12GB LPDDR5 RAM

  • 256GB SSD

  • WiFi 6E Support

  • ~5000 mAh battery

  • North of $800 per unit

Note: the above info is not verified. I am not an engineer.

>
“It’s still early but as we build out the experience, the next focus will be on growing the community. We plan to launch a web version of Horizon later this year that will make it easy for people to step into metaverse experiences from a lot more platforms, even without needing a headset. I think the best experience will be on virtual and eventually augmented reality platforms and especially on our platforms like Quest, where in an upcoming release, from the moment you put on your headset you’re going to be embodied with your Meta avatar and ready to interact in Horizon with your friends right from your Quest home.But making this available everywhere will mean you can interact with anyone on whatever device or platform that they want to use. Our other focus for Horizon is building out the metaverse economy and helping creators make a living working in the metaverse. We expect to be meaningfully better at monetization than others in this space, and we think that should become a sustainable advantage for our platforms as they develop.

On the hardware side, Meta Quest 2 continues to be the leading virtual reality headset. Later this year, we’ll release a higher-end headset, codenamed Project Cambria, which will be more focused on work use cases and eventually replacing your laptop or work setup. This premium device will have improved ergonomics and full color passthrough mixed reality to seamlessly blend virtual reality with the physical world.

We’re also building in eye tracking and face tracking so that your avatar can make eye contact and facial expressions, which dramatically improves your sense of presence. It’s also a good example of why we’re developing hardware in addition to the social platforms. We’re bringing Horizon to more platforms, but if you want to be able to make eye contact or have your physical facial expressions just automatically get translated to your avatar in real-time, then our hardware will provide the best metaverse experience, whether you’re playing a game or meeting with co-workers in Horizon Workrooms.

We’ll share more details about Project Cambria in the months ahead as we get ready to launch it. I believe the areas we’ve discussed today are the right places for us to be doubling down on our work. The questions we face are not going to be resolved overnight, but we’ve also faced a number of these challenges before so I’m confident that we can navigate this period while continuing to invest in our future.”

— Mark Zuckerberg, Q1 2022 earnings call

Financial Stability


  • Financial stability is boring in bull markets and lifesaving in bear markets.

    It seems like a lifetime ago that I was preaching the importance of low debt-to-equity and a reasonable quick ratio. Now “growth” companies are feeling the pain of being saddled with debt.

    It’s impossible to predict the future (Nobody predicted the pandemic and the economic response), but a financially stable company can weather almost any storm.

Meta Platforms is a machine. Low debt-to-equity and low quick ratio shows a company that can weather storms, but more important can fund new ventures like Reality Labs and the leap to a true digital-first company.

Segments

Here’s annual revenue since 2011. This is some serious growth.

You might think the United States has the most Facebook users. Think again.

India is the leading country by a wide margin.

But the United States and Canada lead the way with Average Revenue Per User (ARPU).

You can see the slowing of growth in FoA users.

Zuckerberg has seen this coming for a while, hence the large bet on the next era of online connection.

Now notice the gap between monthly active users and daily active users. Not good!

Last look at some fun data: Facebook global audience by age and gender.

If 25-34 is your dominant age group for tech, then there’s trouble. This is one other reason why I am a fan of Roblox as an investment.

It seems that Meta Platforms is coming for them though.

5. Industry and Competitors

Meta Platforms owns a large chunk of the upper echelon of social networks.

The FoA takes up 3 of the top 4 spots:

Notice how the newer social networks take less time to reach 2 billion users.

This isn’t a sign of stronger younger companies, but prevalence of discovery of new social networks.

Margins

6. Leadership


  • If you’ve followed for a while, you know that I’m a stickler for leadership, culture, and the many benefits a deliberate leadership team brings to any company.

    Much of this stems from my time in the Marines, where leadership was the difference between organizational success or defeat.

Mark Zuckerberg

Mark is portrayed as something other-than-human. I think this is why he’s becoming more public with appearances like this one: #267 – Mark Zuckerberg: Meta, Facebook, Instagram, and the Metaverse | Lex Fridman Podcast

While the beginning of the podcast is a little rough, it is telling that Mark is placing emphasis in becoming charismatic. (Not an easy task for an in-the-weeds founder/operator.)

I view this as a great sign that Zuckerberg is becoming more communicative with investors. This is a huge green flag.

One other thing Mark has going for him is the extreme close relationship he has with Facebook and Meta Platforms as its founder.

Many companies are founded by brilliant startup entrepreneurs, but fail to grow and mature without significant leadership change. Meta Platforms does not have this problem.

Zuckerberg has greatly improved Meta Platforms over the last decade with stellar leadership and acquisitions (Instagram, WhatsApp).

Sheryl Sandberg

Sheryl was Mark’s right hand for 14 years. She is responsible for much of Meta Platforms’ growth and focus on advertising revenue. The only problem? Advertising revenue will not be enough in the new era.

People are wanting that digital-first platform that I mentioned earlier, and Sheryl isn’t the one to help Mark usher in this new era.

She was crucial for Meta Platforms’ “stage 1” growth, but now it’s time for stage 2.

Note: Javier Olivan is replacing Sheryl. We’ll see how he helps Meta Platforms transition to a digital-first platform in the coming quarters/years.

Leadership Score: A+

7. Valuation

Meta Platforms has gotten relatively cheaper in the last decade, followed by a large drop in the latest sell-off.

As of today (6/7/22) FB has a P/E ratio of 14.44.

I should also note that FB is down 38% YTD while the S&P 500 is hovering at 0% YTD.

As a value investor I always look at the Price to Free Cash Flow. Meta Platforms, as a mature company, has very reasonable P/FCF. As of the recent sell-off, Meta Platforms has a P/FCF ratio of 13.77. This is extremely cheap however there’s a strong possibility that Meta Platforms will experience decreased revenue as advertisers deal with the added difficulty of privacy challenges mentioned before.

ROIC looks great. I think it will decline for 2022 as Meta Platforms spends the necessary time and capital in deliberately evolving the company.

Lastly, let’s look at Per Share Metrics.

I’m a big fan of seeing just how much I’m paying for revenues and FCF, more so than earnings specifically. I think FCF and ROIC are some of the best ways to measure a company.

You’ll notice that I’m heavily emphatic on valuing where the company is today vs guessing where it might be tomorrow. This is due to the rapid evolution that Meta Platforms is undertaking. It’s a big transition.

Once Meta Platforms has more traction with Reality Labs we’ll be able to tell a little better what the future might hold.

Right now the main question is “Can Zuckerberg pull off this transition before the well dries up?” It’s a very big well, but it’s also a very big transition. We’ll see.

8. Conclusion

Right now it’s cheap because of the ongoing transition. It’s questionable they’ll be successful in this transition, but only slightly.

  • Strong finances

  • Cheap cash flows

  • Great leadership

  • Big transition

I think they will transition just fine, but being early is indistinguishable from being wrong. I also think the smart thing to do here is to wait to see if their Reality Labs segment gains significant traction. Until then I’m giving the business quality a B- and Business Value an A- with an overall stock rating of 3 stars.

Business Quality: B-

Business Value: A-

9. Notes and Appendix

Further Questions

  1. It seems the largest social networks share the same ability for users to generate business. I’d want to dig into this further. With the ability to generate business, platforms seem to explode with the right guidance. This is something I’m very curious about and want to dive into further.

Further Reading:


  • ★★★★★ 5-STARS (Strong Buy):
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    Business combines either exceptional quality and good value, or good quality and exceptional value. Approximately 5% of public U.S. equities fall in this category.

    ★★★☆☆ 3-STARS (Hold):
    Business is average quality, average value, or both. Approximately 40% of public U.S. equities fall in this category.

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