When it rains it pours! Mark Zuckerberg would attest to that. Shares of Meta Platforms (Meta) have been in a downward spiral from the time the company reported its December Q 2021 results early this year. Since end of last year, headwinds one after the other (company-specific and broader macro-driven) have played out at different levels to dent investor optimism in the stock.
So, is the story over? Far from it, for reasons we explain below. Trading at a PE of 8.6 times one-year forward EPS, 4.3 times one year EV/EBITDA, the risk-reward is strongly skewed to the upside from current levels for reasons mentioned below. Meta remains one of the foremost technology companies in the world. . Hence, investors can buy the shares with a long-term perspective. Investors who have already bought at higher levels can make use of the correction to bring down their average cost price. There are risks in the near term as to where the shares will find a bottom and investors must be ready and have the mindset to look past it. However, given market volatility and ongoing macro issues, a minimum three-year perspective is required on the stock.
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What has been happening?
From its all-time-high levels of $384 reached last year, the Meta shares are down 78 per cent. Amazon is down 52 per cent from peak, Alphabet is down 45 per cent, Paypal is down 77 per cent. Netflix is now down 62 per cent after cratering to as low as 77 per cent from peak. The list is big and high, with bluechip global technology stocks down in the range of 25-80 per cent from peak. While this time the declines have been outsized, extreme volatility is par in US Tech stocks as we explained in our Big Story on US Investing in our bl.portfolio edition dated Feb 28, 2021.
. Tech rout, including Meta’s spiral, can be explained by three reasons. One, is the broader macro factor impacting the entire global tech sector. Significantly higher interest rates in the US versus the past decade and global slowdown take their toll. Two, the company had to deal with iOS privacy changes that impacted targeted advertising, resulting in much higher than anticipated negative impact to its revenue. This impacted not just Meta but all its peers as well. The third is the most important factor that has spooked investors. Aggressive investments in its Artificial Intelligence discovery engine (aimed at improving user experience in its core business) and Reality Labs business. Meta’s futuristic bet on metaverse/augmented and virtual reality. Zuckerberg believes metaverse will be one of the most dominant tech themes of the future and wants to position Meta as a leading player in this space with control over the ecosystem. For long he has regretted inability to control the ecosystem on which Facebook operates and its dependence on desktop and mobile operating systems dominated by rivals. .
At bl.portfolio we had recommended a buy on Meta shares after it had declined 40 per cent from its all-time highs to $237. The shares are down 62 per cent from those levels. At that time we had noted the valuation was reasonable based on long-term fundamentals of the company. The decline since then is more than what we had anticipated, driven by the slowdown impact and investor pessimism being higher than expected. However, this being a cyclical slowdown that impacts advertising-dependent companies more, Meta too has been hit. To that extent, recovery can also be better than anticipated when the cycle turns. Much of the long-term thesis on the company remains intact. Its attractive valuations apart, here are five reasons why the stock is a buy at current levels for long-term investors.
One, despite all the negative headlines surrounding prospects for Meta’s core business – Family of Apps (Facebook, Instagram, WhatsApp, Facebook Messenger), the performance and engagement metrics continue to remain strong. In the recently concluded September Q, daily active person (DAP – unique users across Family of Apps) increased to 2.93 billion — up 2 per cent QoQ and 4 per cent Y-o-Y. For its core Facebook app, daily active users (DAUs) increased to 1.98 billion — up 1 per cent Q-o-Q and 3 per cent Y-o-Y. This growth comes of a higher Covid/digitisation base effect and contradicts the talk of saturation and user fatigue in Facebook. Further, the company, in its call, noted strong traction and progress in engagement and monetisation in Reels (Facebook and Instagram video product that competes with Tik-Tok). Further, its Whatsapp and Messenger products continue to have very high engagements and are still under-monetised.
Two, financials can see a turnaround over the next few years as the macro cycle turns. For September Q, Meta reported revenue of $27.71 billion. While this was down 4 per cent Y-o-Y it was impacted by strong dollar besides the economic slowdown. On a constant currency basis, revenue was up by 2 per cent. The slowdown in revenue has been seen across peers, including Alphabet, and is not unique to Meta.
Operating profit declined by 46 per cent to 5.6 billion, due to high investments in AI and Reality Labs. Operating margins came in at 20 per cent versus 36 per cent last year. Excluding Reality Labs, operating margin would have come in at around 36 per cent (previous year 45 per cent). The decline in margins (excluding impact of Reality Labs) versus previous year is driven by company’s investments in core business Artificial Intelligence discovery engine and other initiatives. The company noted in its earnings call that it intends to deliver operating income growth beyond 2023 and rein in expenses accordingly. Thus the declining profit trend can see a good reversal once company is past its investment phase next year.
Three, Meta, along with Alphabet, continues to dominate the digital advertising ecosystem and it will be hard for competitors to displace it for the foreseeable future. According to a digital advertising report, in 2021, Meta had 23.7 per cent (and growing) share of digital advertising revenues worldwide (behind Alphabet’s 28 per cent) with other competitors way behind in single digits.
Four, with a very strong balance sheet Meta has ample capacity to give a tough challenge to any emerging competitor in its core business as well as in metaverse. The company is expected to end CY22 with net cash of 37 billion (16 per cent of current market cap). Free cash flows are also strong at $15 billion for the year and can see a strong rebound beyond 2023 once the investment phase is over.
Five, upside potentiality from Reality Labs investments is completely ignored at current levels. Current valuations are assigning negative value to Reality Labs as earnings are compressed due to losses booked from these investments and the stock trades at a low PE of 8.6 times. The worst case scenario is that these investments become sunk cost (factored at current levels) and best case scenario is company achieves its long-term objectives in this space. This makes the risk-reward skewed to the positive side.
