Thoughts On Meta’s Cost Cuts (NASDAQ:META)

This article was prepared by Navyanshi Nayan in collaboration with Dilantha De Silva.

Meta Platforms, Inc. (NASDAQ:META) stock has fallen nearly 60% this year, wiping out roughly $500 billion from its market value. On Wednesday, Meta’s stock dropped more than 5% after the Wall Street Journal reported that the company plans to cut costs by 10% in the coming months. The cost-cutting measures are rumored to include staff reductions, and the company has begun to remove a significant number of employees through internal business department reorganizations according to the report. Employees from downsized departments are expected to apply for other positions within the company, and those who do not find another position within a certain time frame are subject to termination.

Tracy Clayton, a spokesman for Meta, stated that reallocating resources to company priorities is necessary and that giving former employees the opportunity to apply for other positions within the company is an effective method of retaining talent. However, Meta has given affected employees a limited time to apply for other positions within the company, leaving them frustrated. Because of limited internal positions and high competition for those positions, the short time period is causing barriers to transfer within some divisions. The Journal also reported that employees with proven track records and great performance reviews are being nudged out frequently in addition to those who were unable to find new jobs within the company.

Since the third quarter of last year, the company has reduced its operating expenditure guidance, thereby paving the way to negate some of the impact of rising investment costs on operating margins. In its earnings call last month, Meta announced a plan to gradually reduce headcount growth over the next year, but it has never mentioned that it would reduce the headcount through layoffs. However, many technology companies have adopted restructuring and layoffs to navigate today’s complex economic environment. Tech companies that rely heavily on ad revenue, such as Meta, Alphabet Inc. (GOOG) (GOOGL), and Snap Inc. (SNAP), are facing a slew of economic challenges, including a potential recession, soaring inflation, and rising interest rates, which are affecting ad spending.

Inflationary pressures are putting a strain on advertising spending, and competition has increased for the available ad budget. Meta reported that ad prices fell 14% between April and June. However, the advertising industry is cyclical, which means that companies cut their budgets during economic downturns, and as the economy improves, the advertising industry is likely to return to a strong wheel. The slowdown in ad revenue, therefore, should have been expected all along and is natural. Meta has built a strong ecosystem and serves 3.7 billion monthly active users through its platforms, which will allow the company to attract advertisers back to its platforms once the economy improves.

Companies that have a long history of rapid growth have taken a hit this year as the global economy enters an uncertain period. Google canceled the release of the next-generation Pixelbook laptop and slashed funding for its startup incubator Area 120. Approximately half of Area 120 employees were advised to find new jobs within the company within 90 days. Meta recently closed its Responsible Innovation team as the company believes these resources would be better spent on more issue-specific teams. The team included a good number of engineers, ethicists, and others who worked with internal product teams as well as outside privacy specialists, academics, and users to assist the company in addressing concerns about the potential risks of its products. Although some team members are expected to continue to do similar work in different departments, others are not guaranteed new jobs.

While it appears to be the only effective way for companies to deal with current challenges, Meta’s aggressive employment reduction plans may result in the company losing valuable talent that could prove to be difficult to replace in the next phase of the business cycle. An HBR article titled “Layoffs That Don’t Break Your Company” emphasizes how managers fail to recognize layoffs that are used as a temporary way to cut costs can cause much more trouble in the future. The authors of this research article also highlight that historically, a 1% reduction in the workforce of a company has resulted in a 31% increase in voluntary turnover the following year. Additionally, research has shown that layoffs and ineffective restructuring lead to higher rates of employee turnover and burnout. While having fewer employees may reduce costs, it will also increase work pressure, which could leave a negative impact on innovation.

While the company focuses on the Metaverse, a more immersive version of the Internet that CEO Mark Zuckerberg believes is critical to Meta’s future, Meta’s current business seems to be facing many challenges that need to be addressed swiftly. Aside from the macroeconomic issues, Apple’s major privacy update for iOS 14 last year made it more difficult for social media companies to provide advertisers with detailed demographic information about their users. These changes have reportedly cost the company $10 billion so far. If that isn’t enough, the company is constantly swept up in legal battles. Recently, two Facebook users claimed that Meta is violating Apple’s (AAPL) policies and breaking state and federal privacy laws by allowing third-party unauthorized tracking.

In addition to all this, Meta has reached a point where it no longer has any new effective features to help Instagram thwart the threat of competition. Many new features that were introduced recently received negative feedback from users.

Meta is pushing its metaverse ambition, which has the potential to be a massive opportunity but investments required to make these ambitions a reality are exerting pressure on margins and the company’s profitability. Reality Labs, the company’s division that focuses on virtual reality and Augmented Reality hardware and software, is losing money. The segment’s operating loss in the second quarter was $2.8 billion, 17% higher compared to the corresponding quarter last year. The company’s spending in Metaverse is skyrocketing, and with its ad-business slowing in the current economic climate, its margins are likely to trend lower in the coming quarters.

Despite all this, there is reason to believe that Meta’s cost reduction measures fundamentally differ from that of a struggling company. At the end of the June quarter, Meta had more than $40 billion in cash and short-term investments, so the company certainly is not facing a liquidity crunch. This forces us to believe that Meta’s cost reduction plans have more to do with reorganizing and reshaping the business to thrive in the long run amid the changing business model of the company.

We are keeping a close eye on how this cost reduction plan will impact the company’s business. For the time being, we will remain long META stock as we find the company deeply undervalued today as highlighted in our previous articles.