META Research Notes

Your Daily Dose of Stonk Science

Topics: META, metaverse, alternate reality, valuation multiples, social media

Price: F’s in the Chat

$380 -> $115 in a year. Oof. That’s a mega-META L. But you’re an intelligent investor and would never invest in something like this, right? Own the S&P 500 or other tech-focused ETFs? Hmm… maybe you did own part of META.

Technicals

MACD and RSI suggest normal levels of supply and demand, while November was (as mentioned in the last MEMEmail) the time to buy.

Financials

Virtually all of META’s revenue comes from its “Family of Apps”, though its virtual reality business segment has generated $2.3B as of TTM 9/30/2022.

The Reality Labs segment has been a massive issue for investors. META has spent $25.6B on R&D YTD, not including $22.3B of contractual commitments for Reality Labs infrastructure through 2026; I guess they missed the memo, but 2022 is the year for cutting costs, not increasing them.

Products for Reality Labs includes augmented and virtual reality related consumer hardware, software, and content. This segment has lost $9.4B thus far in 2022, largely due to a small user base and lots of R&D spending. Despite these losses, they stated on their most recent 10-Q that “we expect our investments (in Reality Labs) to increase in future periods. If our investments are not successful longer-term, our business and financial performance will be harmed.” I think Scooby-Doo said it best... "Ruh Roh!"

The company has since adopted the trendy cost-cutting fad, including mass layoffs, though it’s likely that META will continue investing in the Metaverse despite warnings from investors.

Frankly, for me, this wouldn’t be nearly as big of a deal if their app segment wasn’t struggling… but it is.

META’s “Family of Apps” includes Facebook, Instagram, Messenger, WhatsApp, and others. Over 99% of revenue from these platforms is generated through advertising revenue, which just happens to have no growth right now. Yay… The big oof is that operating profit for that segment is falling.

Income from operations decreased 28% for META’s apps and 37% for its virtual reality group YTD 9/30/2022 relative to the prior period. META was growing its infrastructure, data centers, and headcount like everything was fine, but everything is not, in fact, fine. I expect profitability for this segment to increase next quarter as a result of layoffs and reduced spending now that META is ✨aligned with the times✨.

Also, here’s a fun tid-bit from their 10-Q: “Substantially all of our revenue is currently generated from advertising on Facebook and Instagram. We rely on targeting and measurement tools that incorporate data signals from user activity on websites and services that we do not control in order to deliver relevant and effective ads to our users. Our advertising revenue has been, and we expect will continue to be, adversely affected by reduced marketer spending as a result of limitations on our ad targeting and measurement tools arising from changes to the regulatory environment and third-party mobile operating systems and browsers.”

In English, they’re saying that they collect your data outside of FB and Insta and use it to target ads at you. They also say they don’t like that regulators are trying to prevent META from using data outside of its apps. Interesting. If you want a science experiment, research a specific shoe on google for a few minutes and then go on Instagram and watch what happens.

Financials

If the Metaverse bet pays off, they’ll control a lot of it. Few companies are as far along in the process as they are. If this Metaverse thing blows up, though, META will have a very hard time recovering.

No offense, but META’s portfolio of brands is dying and they need to do innovate in order to re-assert their competitive edge. If you’ve seen Ready Player One, you can get a good sense of what Facebook... oh wait sorry ✨META✨... is targeting; if that pans out, a few billion dollars will mean nothing relative to that return. In reality, it’ll probably look like what Xbox does right now: a certain demographic using it regularly and most other people not bothering with it because reality > alternate reality.

Valuation: Oh baby

Oh wow… valuations have compressed more than the trash in the trash compactors on the Death star…

It's almost as if Leia, Han Solo, and Luke Skywalker are looking for a good investment in today's economic environment.... Ahhhh... Is it too soon or too real? Maybe both?

Meta's Pre-Covid P/E ratio was 30+. Now it’s 11… 11! An 11 P/E ratio is a bargain for most companies. It’s even more of a bargain for a massive technology company like META!

I would urge you to be cautious, however, as growth estimates have fallen off a cliff. Please notice the forward EPS growth, as well as the PEG ratio below (P/E ratio divided by NTM growth); growth is flat-lining (like my love life *sheds a tear*) and, based on the PEG ratio, you'd be paying way more than you would’ve in the past for META on a price vs. growth basis. By investing so heavily in the Metaverse, META has bet (most) of the farm on the future of the Metaverse, pushing growth out even further and increasing the company's risk.

Though I frequently shy against using forward earnings estimates, I think they provide a meaningful illumination of a very real issue: META’s legacy assets aren’t as relevant or profitable as they used to be, and the Metaverse probably won’t reach economic viability in the near future. Despite preliminary investigations, this isn’t a cheap company.

Liquidation Analysis

Alternatively, if you assume that META gets scrapped and they sell off Facebook, Insta, Whatsapp, etc... you could justify that they are trading at a discount. Here's a comparables data set for META. Small notes: TWTR data is from Q2 2022 (before they were sold), while LinkedIn data is from Q3 2016 (before they were sold).

The number of users on the platform (on a daily or monthly basis) is the industry metric of choice, so the comp set is based on market capitalization per user (daily and monthly).

For all my valuation friends out there, you know that these are not truly comp sets, as TWTR and LinkedIn prices are higher because of an implied control premium associated with these acquisitions. I nevertheless broke the rules for the sake of simplicity and decided to run with it; it'll make it conservative by mixing in public comps, as their valuations will be inherently lower because they don't have a control premium. Also, because LinkedIn and Twitter were sold in different environments (despite having characteristics similar to META in terms of revenue per user), I reduced their weightings to be convservative.

After applying an equal weighting to the daily and monthly calculations, we can compute an implied price per share:

Huh... Fascinating. Disclaimer: there are other factors at play, including varying degrees of revenue per user, growth, and size that buyers would likely factor into their decision. Each of these factors should influence our interpretation of this analysis, but, given the size of META's platforms, as well as their high revenue per user and profitability relative to the comp set, I'd argue that the implied valuation is likely understated.

Maybe META should just sell all its legacy assets and invest it all into the metaverse?

Leverage: Huh?

Debt is $27B relative to cash of $42B. Unless everything blows up in their face, they’ll be fine.

Recommendation: Uhhh... She has a great personality?

META's legacy assets are spinning off enough cash flow to fund the development of Reality Labs and the metaverse, but cash burn is V high and investors hate the idea of spending a lot of money when that is not what's in fashion. That's lowered META's valuation significantly, but it's probably reasonable given how long until the Metaverse becomes a legit thing.

Idk about you, but I don’t like social media and I hate the idea of living in an alternate reality. Even if I thought the metaverse was financially prudent, I wouldn’t invest in it because I would never want to live in an alternate reality. My life isn’t perfect, but that doesn't give me a reason to avoid living it.

If you do decide to invest in META, watch macroeconomic trends surrounding advertising spending, as this will directly impact META’s profitability and its ability to make the Metaverse an (altered) reality.