Meta Platforms: A Mixed Bag (NASDAQ:META)

Early this year, mid-February to be exactly, I wondered if Meta Platforms, Inc. (NASDAQ:META) was starting to look interesting already. The company had seen a huge selloff on top of the market woes at the time, as the company was bracing investors for a tough year, as investors feared reduced relevance from its once-so-dominant platform and Meta’s investments into the Metaverse.

The fundamentals revealed strong appeal, yet the concerns about the future weighted too heavily on me in order to see appeal and have conviction. Shares were down to $230 at the time, a 40% pullback from the September 2021 highs, which actually marked an outperformance versus many other names.

Some Perspective

Ahead of the pandemic, Meta (at the time still called Facebook, of course) posted a 27% increase in 2019 sales to just over $70 billion, with 99% of revenues generated from advertising activities. The company actually saw operating earnings down 4% despite the spectacular increase in sales, on the back of huge investments, yet a $24 billion GAAP profit was still highly compelling.

Net earnings fell 16% amidst a higher tax rate, as an $18.5 billion profit came in at $6.43 per share. A net cash position of $55 billion was equivalent to $19 per share. Trading at $200 at the time, the operating assets traded at 31 times earnings, a huge multiple.

Shares rallied in 2021 as the company saw sales up 22% to $86 billion in 2020 as operating margins expanded and with effective tax rates down, net profit of $29 billion effectively came in at $10 per share, while net cash rose to $62 billion. The impact of changes to iOS14, stringent regulatory demands and headwinds in Europe meant that 2021 was set to become a tough year.

As it turned out, 2021 was much stronger than anticipated, with sales seen up 37% to $118 billion as profits were up 35%, keeping up with revenue growth and not resulting in the margin reversal feared at the start of the year. Earnings came in at $39 billion, close to $14 per share. Aggressive buybacks made that net cash fell to $48 billion. At $230 per share, operating assets were valued at around 16 times earnings, as 2021 earnings came in far stronger than guided by management at the start of the year.

2022 – A Shocker

After warning for dismal 2021 results, and 2021 turning out to become a very strong year, 2022 was really set to become a more challenging year. The company guided for 2022 expenses to rise 30% to $90-$95 billion. The company guided for just 3-11% sales growth in the first quarter, on the back of the pandemic being on its retreat, tough comparables, and currency headwinds. The cocktail of slower growth and high expenses was setting the company up for real earnings headwinds.

The other headwind are the investments not made into the core Facebook, Instagram, WhatsApp and Messenger business, but the Reality Labs segment. This augmented and virtual reality business did post a doubling of sales to $2.2 billion last year, yet a $10 billion operating loss reveals huge losses, as investors get the creeps of the investments made into the metaverse.

At 16 times earnings, the unleveraged balance sheet looks enticing. Even if earnings would fall, multiples looked reasonable, yet the market was still in a stronger point at the time, as secular headwinds were building up which includes more consumer scrutiny, regulatory actions, the impact of privacy watchdogs, consumer groups and competition. Moreover, the continued losses into the Metaverse still had to be paid off, so this balancing act made me cautious.

A Further Pullback

Since February, shares have lost another third of their value, now trading at their lows of $150 per share. First quarter sales rose 7% to $27.9 billion as expenses were up 31%. This made that operating earnings were down a quarter. All this triggered a 21% fall in net earnings to $7.5 billion, still a very decent result with earnings of $2.72 per share still coming in at a run rate of $11 per share.

With the company guiding for second quarter sales between $28-$30 billion, despite intensifying currency headwinds, and the company cutting the full year expense outlook by $3 billion to $87-$92 billion, this looked reasonable.

Second quarter sales of $28.8 billion were down a percent compared to the year before, in part the result of intensifying currency headwinds. The company managed to limit the increase in expenses to $22 billion, with operating earnings down a third and net earnings down 36% to $6.7 billion, for a $10 per share run rate. Net cash balances of roughly $46 billion works down to $17 per share here, which implies that at $150 per share, the operating assets trade at just $133 per share. With earnings power down a third and still trending at $10 per share, the resulting earnings multiple of 13 times is very much non-demanding by all means.

The devil is in the guidance, as third quarter sales are seen down to $26.5-$28.0 billion, driven by weaker advertising revenues, slower than anticipated growth in virtual reality and a massive 6% currency headwind. To combat slower growth, the company sees total expense for the year at $85-$88 billion, indicating that despite the cut in the expense guidance, investors should brace themselves for a tough second half.

With expenses to date coming in at $40 billion, that suggests a $45-$48 billion expense base in the second half of the year, as $53-$56 billion in revenues (based on the third quarter guidance) reveals just about $8 billion in operating earnings, which translates into a number equivalent to the second quarter earnings numbers, with earnings now running at just $5 per share a year. If this is correct and indicative going forward, valuations are seeing little protection from earnings power, with shares trading at 26-27 times operating assets.

What Now?

Right now I am still performing a balancing act on Meta. The earnings fall projected this year has arrived yet few would have predicted earnings to fall from about $13 per share to $5 per share, as this almost matches the share price decline. Obviously this triggers interest, yet current multiples are still quite high, but I likely expect surprises to the upside, at least in the cost expense.

Risk related to the outlook include very steep earnings pressure, regulatory concerns, increased costs from moderation efforts, and fading popularity of platforms, but fortunately the company has many brands under a single roof. The bright side is a strong balance sheet and strong earning power (in normal times) as any reversal in profitability could unleash great appeal, or depress earnings multiples further. A gradual buying of the dip here seems warranted, although it is time for Meta to demonstrate some strength here.