pcess609
In September, I called Meta Platforms (NASDAQ:META) a mixed bag as the company was seeing a rapid slowdown in growth, amidst tougher comparables and weakness in advertising markets, which in combination with heavy spending on the metaverse created a very tough set-up from an earnings point of view.
Some Perspective
Ahead of the pandemic, Meta posted a 27% increase in 2019 sales to $70 billion, all but a fraction generated from advertising activities. Operating earnings were down 4% on the back of an investment cycle at the time, yet a $24 billion GAAP profit was huge. Net earnings fell a bit amidst higher taxes, as a $6.50 per share earnings number worked down to a 30 times earnings multiple at around $200 per share.
Shares kept on rallying throughout the pandemic and thereafter, with shares peaking around $375 in September 2021, little over a year ago. The company has seen very strong growth in the meantime with 2020 sales up 22% to $86 billion and net profits reported at $29 billion, equal to $10 per share.
Changes to iOS14 and regulatory concerns made that 2021 was set to become a tougher year, but the contrary was the case. Revenues growth even accelerated in with sales up 37% to $118 billion as profits rose in line with topline sales as earnings came in at $39 billion, equal to $14 per share.
Net cash balances fell to $48 billion following some buybacks, but multiples were non-demanding at $230 at the start of the year, as shares already fell from their peak in a meaningful way early this year.
2022 – An Absolute Shocker
After an unexpected strong 2021, the set-up for 2022 was tough as the company originally issued a soft outlook. Originally, the company guided for 2022 expenses to rise 30% to $90-$95 billion, yet the company did not provide a full year outlook. In fact, it only guided for 3-11% sales growth in Q1, with growth hampered by a stronger dollar and tougher comparables, notably.
This would create a tough cocktail on earnings, yet the degree of the earnings shortfall was not yet clear. The reason for that is the investment in the Reality Labs segment, including the augmented, virtual reality and metaverse investments. These activities posted $10 billion in losses in 2021, a number realistically set to rise in 2022.
As it turned out first quarter sales rose 7% to $27.9 billion with operating expenses up by 31%, triggering a 21% fall in net earnings to $7.5 billion, equal to $2.72 per share. Second quarter sales actually fell a percent to $28.8 billion, in part driven by intensifying currency headwinds, as earnings fell 36% to $6.7 billion, for a $10 per share run rate. With shares trading at $150 in September, a $17 per share net cash position translated into an operating asset valuation at $133, for a non-demanding valuation with earnings power seen around $10 per share.
The issue was the third quarter guidance with sales seen down to $26.5-$28.0 billion, on the back of a 6% currency headwind and weaker advertising market. The issue is that even as the full year expense guidance was cut to $85-$88 billion, the outlook was bleak. This came as the expense guidance revealed operating earnings trending at just $8 billion in the second half of 2022, for earnings power close to $5 per share, as that would increase the earnings multiple from 13 times to 26 times earnings.
This observation made me cautious as the world was screaming about a low multiple, yet at least one more pullback was in place.
The Third Quarter Shocker
The latest downfall, causing shares to fall to the $100 market, comes as a response to the third quarter results which painted a bleak picture, as I feared. A 4% fall in sales to $27.7 billion actually looked reasonable, especially given the dollar strength. With expenses up 19%, operating margins fell 18 points to 20% of sales as earnings were cut in half to $4.4 billion after taxes, still a huge number with earnings reported at $1.64 per share, even a bit stronger than I feared in September.
The composition of the results provide some cause for concern. While daily and monthly active user numbers were up in a modest fashion, the composition of revenues is worrisome. The company has resorted to increase ad impressions by 17%, thereby annoying users a great deal, while prices per advertisement were down 18%.
Fourth quarter revenues are seen between $30 and $32.5 billion, despite a 7% point headwind from currencies. Full year 2022 expenses are now seen between $85 and $87 billion, implying a $23-$25 billion cost estimate for the fourth quarter, up from $22 billion in the third quarter. That suggests similar profitability as the current run rate around $6-$7 per share might be maintained.
The preliminary 2023 budget suggests expenses seen between $96 and $101 billion, suggesting another 15% increase in expense in 2023 despite the cost-cutting efforts, as this likely exceeds sales growth by a significant margin, and hence 2023 earnings could continue to fall, if this all plays out. This is the major culprit in my eyes, as the company is managing costs, not cutting them. Continued buybacks, at too elevated levels, make that net cash is down to $38 billion (including equity investments), equal to $14 per share.
This makes that operating assets are valued at just $86 per share and even if earnings power is cut in half from 2021, the resulting multiple remains non-demanding at around 13 times GAAP earnings. The issue is that of the guidance for 2023. Full year 2022 sales are now seen around $115 billion with a 2022 cost base coming in around $86 billion. A similar revenue number in 2023 and $100 billion cost base implies that earnings again could be cut in half.
The major culprit in all of this is self-inflicted. While a strong dollar and soft advertising market are outside of Meta’s control, the Reality Labs segment generates less than $2 billion in revenues with operating losses now trending at $14 billion a year. This reveals the true extent of the bet here at a loss of $40 million per calendar day.
What Now?
The reality it that Meta remains incredibly profitable and has a strong balance sheet, so far the good news. The issue is that a myriad of items, discussed above, makes that the core might come under pressure because of competition, but also because the company is super aggressive in advertising displays, potentially hurting user engagement across the platform over time.
On the other side, the company generates $30 billion operating profits right now and if it for some reason would cut the metaverse project altogether, it could print operating earnings of $40-$45 billion, for earnings far beyond $10 per share. If we back out net cash, we look at a multiple of around 8 times net earnings in that case, a very low multiple.
Right now, blood is really in the streets with shares down effectively 70% from the highs, despite a substantial net cash position. The company is clearly not resilient to the madness of the market, yet the situation is not dire yet and profits will be generated in the meantime. Corporate governance is a major issue with the dual class of (voting) shares, yet the overall valuation argument here is simply too compelling as I am willing to slowly dip my toes into the shares here.
Be the first to comment