Derick Hudson
This article will be short on math, long on a logical solution (thought experiment) to Meta’s (NASDAQ:META) metaverse problem. I propose a simple solution that aligns interests of various parties current within ownership structure of META.
My simple proposition is that the massive metaverse investments do not belong under the umbrella of META. It is clear public markets are placing no value on the metaverse project. In fact, it appears to me that the market is placing a sizable negative value on the spend, essentially assuming the returns on this investment will be negative, and that the investments will continue for a meaningful time. I do not think that is entirely irrational.
On the other hand, I believe market participants are excessively negative on the long-term prospects of the family of apps side of the business. I imagine that as more evidence emerges regarding durability of the advertising dominant platforms, shareholders will forgive the large capex and AI investments being made currently as we may determine those eventually become significant competitive advantages.
Given the disparity in the two issues, what follows is a short suggestion to solve the conundrum. My basic thesis is that Mr. Zuckerberg should not hold the remaining shareholders of META hostage to his metaverse ambitions.
Gaining alignment of interests
1. META should announce cessation of huge metaverse investment. Presumably the market will place a positive valuation on the $15 billion in annual spend on META as it flows back to operating income.
2. It is not hard to imagine META shares rebounding aggressively on an announcement like that. As evidence, look at how significantly the market reacted to concrete evidence of expense control efforts after recent job cut announcements.
3. Mr. Zuckerberg holds a large percentage of outstanding META shares. If he chooses to invest large sums of money into an uncertain metaverse future, he should fund it himself in a different structure.
By my math, if META shares rebound to just $200 upon regained discipline, his net worth would run around $75 billion. He could fund $5 billion per year from his own stock liquidations. To limit loss of control of META, pair that with a sizable buyback out of restored FCF and make a meaningful dent in shares outstanding.
Granted, that is smaller than he is currently throwing at it, but he could pair that with outside investors in the private markets with a more aligned interest than META shareholders have demonstrated.
4. I would still advocate for, and be in support of, outsized current capex/AI spending to enhance the competitive positioning of the family of apps business. It seems that this category of spend is almost obligatory given loss of ad efficacy signal widely reported regarding the changes Apple made recently. However, can you imagine if Facebook/Instagram can replicate the signal loss with in-house AI accomplishments? That effectively eliminates the absence of platform control to which so many attribute the metaverse ambitions.
Assuming the metaverse project is indeed a black hole, this eliminates the damage to shareholders who thought they were investing in a capital light, cash flowing social media enterprise.
Should the metaverse project be a wild success… well then perhaps I’m wrong along with many others grumbling about the project’s expenses. That would be ok.
From Mr. Zuckerberg’s perspective, if he truly believes in the successful future of this endeavor, then my proposal would actually concentrate his interest in the new metaverse entity proposed. Presumably he could own a much larger stake in it funded as suggested than his slightly less than 15% stake in META.
There are, of course, many means of separating the two disparate businesses. I suspect, and indeed hope, that the comment section will teach me some things in this area. I would even be okay with a spinoff of Reality Labs assets to current shareholders complete with a limited one time lump funding from Facebook. At least then losses will be known, measurable, and most importantly finished. And in that situation shareholders could elect how to proceed for themselves.
I know many will hash this out in deeper detail than I have done in this article. This is a relatively bare-bones model of what I feel should be done. It is nothing more complicated than altering structure to align interests of all parties. I simply propose that Mr. Zuckerberg’s grand notion should not be funded indefinitely through a controlled enterprise despite the other owners (who own 85%+ economic interest) disagreement with the spend. I am aware that the dual class ownership structure permits these types of anomalies, but I make my thoughts public, nonetheless.
In closing, let’s take a glancing look at valuations and potential valuations should anything like my proposal take place.
META has just shy of 2.7 billion shares out. Using round numbers, market cap is $305 billion and there is $33 billion of cash on the balance sheet yielding a rounded $270 billion enterprise value.
On a trailing 12 month basis, Operating income including the Reality Labs division losses still equals $35 billion. That yields a multiple on operating income of less than 8x.
If you add back Reality Labs operating losses dollar for dollar to the operating income line, you get a rounded $48 billion of operating income despite all the noise about Tik-Tok etc. That means META currently trades at an EV/operating income of 5.5x the core family of apps business. Even if you are a subscriber to the low-to-no growth future for family of apps, that is dirt cheap. In fact, I believe personally that the multiple of the overall enterprise is too cheap even with Reality Labs losses, though I have great respect for arguments to the contrary.
I posit that META is worth at least 10x operating income even if a somewhat stagnant business in current condition. That creates a stock price of $150 with no change. Eliminating the Reality Labs losses, or significantly reducing them, gets you quickly to valuations of $200 per share or more. And should current investments in AI/capex to harden core family of apps business prove successful and recede, that too would flow directly to bottom line. In short, there are scenarios under which this company is worth a couple of multiples of current price. I believe current prices also already reflect all of the metaverse waste and little to no prospects of resumed growth at core apps business. I view that as a decent risk/reward. Nothing in investing is guaranteed, but weighing the probabilities seems to have a higher right tail than left presently.
I am under no delusion that any of what I prescribe above will actually take place, but I find the thought experiment valuable, nonetheless. It paints a picture of just how cheap this company is on a core basis and alludes to some valuation thoughts should discipline be reinstated even within META ownership structure as it stands.
It allows a clearer head to imagine where profitability may go even if Mr. Zuckerberg simply scales back spend within current context. Is that likely? That is a judgment for each of us to make as we make our own investment decisions. The recent layoff announcement felt a bit like a “got religion” moment. Much of the current opex and capex bloat is actually in support of family of apps and presumably will recede as work in that department achieves intended results. Do we have any guarantee of this? No. But it does seem more likely than it did 30 days ago.
This article spends no time on other items that are significant to the future at META including the proposed ban of TikTok in the U.S., likelihood of success of AI efforts to gain back advertising signal loss, current advertising pullback writ large and META’s positioning within the market when this ad market inevitably resumes normal spending patterns, etc. I welcome a lively discussion below.
Thanks for reading. I have not penned any articles in quite a long time. I hope readers will understand this is intended to be though-provoking and as such includes no hard-hitting financial models etc. I hope to participate in a collegial chat below.
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