Third Down and Long for Meta

It’s crunch time football fans! 

We’re headed into the final quarter of 2022. Looking back, it’s been a bad 12 months for TBTF (too big to fail) Tech companies across the board.

Microsoft is down nearly 15% from a year ago. Amazon and Alphabet (Google) are both down around 25%. Nvidia is off over 36%.

(And those losses aren’t even from the highs these companies ultimately put in in Q4 of 2021!)

Terrible numbers, one and all. But not one of them even comes close to the price collapse sweepstakes winner — Meta. The firm formerly known as Facebook is down stomach-churning 58% from a year ago.

A lot of companies are down 60-70% or more this year. But none of those companies held the position that Meta did. After only a brief stint in the “$1 Trillion Market Cap Club,” Meta’s membership was revoked.  Once one of the 10 most valuable companies in the world, its market cap is down over $500 billion!

Ouch.

I’ve written before, when you’re priced for perfection, like so many of the TBTF Tech Club were, you’ve got to be perfect. 

And TBTF Tech had been priced there for far too long. So this bloodbath in the mega-cap really shouldn’t be a surprise. Everything has to correct eventually.

But META’s correction has been worse than the rest of the industry. They’ve had to face specific and unique challenges that have seemingly backed them up to their own goal line.

Right now for Meta, it’s like third and long on their own five yard line with the clock ticking and no timeouts left. Can they stage any kind of a fourth quarter comeback? 

Let’s take a look…

Meta’s First BIG Problem

In a brief cameo from the 2004 movie Iron Man, Jim Cramer, in bashing Stark Industries, said “Look, that’s a weapons company that doesn’t make weapons.” And jumped all over his sell button. (One call he couldn’t get wrong.) 

Meta’s biggest problem stems from much the same thing. It’s an advertising company that can’t sell ad space. Take a look…

In the quarter ending December 31, 2021 Zuck and crew reported $33.7 billion in total revenue. Of that, 97% came from advertising. So what happened?

iOS 15 and Apple’s “Ask to Track” feature. Apple’s new mobile OS required all the third party apps that ran on its platform to ask permission to track their users across other apps.

Turns out people value their privacy. Roughly 84% of Apple users started saying “No.”

This killed Meta’s ability to serve targeted ads to their users… which destroyed their value in the eyes of advertisers. It turned out to be a massive hit to anyone who relied on ad revenue. When their earnings numbers finally came out this past February, Meta set a record collapsing over 26% — and erasing $232 billion in market cap — in a single day. 

And if no longer being able to track a majority of their users wasn’t enough, it turns out the users they had were leaving the platform. In the same report, they noted their active user base had fallen by two million users — the first time the company had ever reported a decline in users.

You can argue Meta’s own culpability in this situation — too many eggs in the ad revenue basket — but the situation is what it is. 

Meta’s Other BIG Problem 

People name their children to honor important people in their lives — parents, grandparents, well-known public figures. Facebook renamed itself to honor what it believes is going to be the future of the internet. 

That next big iteration has come to be known as the “metaverse.” Boiled down, the metaverse is a virtual world where people can participate directly instead of just sitting in front of a computer screen.

And the name change from Facebook to Meta signaled that Zuckerberg was all in on this vision of the internet. 

In their quest to dominate the metaverse, the company spent over $10 billion in 2021 alone. That’s more than ten times what they spent to buy Instagram in 2012. And the spending didn’t stop there. Zuck had been up front about the huge capital investment that developing this new technology is going to require. 

Why such great urgency?

According to some, it’s an existential necessity to the company…

One of the main reasons Zuckerberg is interested in the metaverse, after all, is that he imagines it can give him a way to connect directly with his customers without having to depend on Apple and Google’s phone duopoly.

The problem is, it’s spending a LOT of money without actually knowing what they’re spending it on — i.e. what the final version of this new internet will look like. 

Reality Labs, Meta’s hardware division that is specifically tasked with building “foundational technologies” for the metaverse, has been far from profitable. It has reported billion-dollar operating losses for six consecutive quarters. As of the quarter ending this April: 

The segment has made up less than 3% of Meta’s quarterly revenues, but Reality Labs has made up nearly 20% of the company’s quarterly expenses.

All this creates a lot of risk where investors are concerned.

On top of that, the metaverse itself has been running into some resistance.  According to The Market Ear… 

“Metaverse” has been mentioned on earnings calls less in Q2 than in Q1. But more in 2022 than all of 2021….

And… “Sales volumes and average prices for virtual land have plunged this year, part of a broader slide in crypto and non-fungible token prices.”

This waning interest in the metaverse isn’t what you’d call a disastrous development, especially with all the other global economic $#!% hitting the fan. But the slow down certainly isn’t the most encouraging news either

It’s hard enough taking the lead into the vast unknown, when times are good. But today the challenge bar is especially high. 

(And if you want to dump a little more gas on the fire, you can blame the Fed. Cheap money has always been like rocket fuel to the TBTF Tech sector and the Fed’s unwillingness to move from its current hawkish stance is putting up resistance to a rebound as well.)

So why am I about to tell you…

Meta Is Starting to Look Good to Me

It’s true that Meta’s earnings have taken a beating for the past three quarters:

Source: Ycharts.com

But this shake up in earnings has also brought the market’s valuation of the company down to a somewhat more reasonable level.

The company managed to stop the bleeding in terms of falling revenue with the second quarter showing a (modest) increase. Its earnings expectations have been slashed by over 50% and investors are now paying a lot less (65% less!) for a dollar of sales.

Source: Ycharts.com
Source: Ycharts.com

But Meta’s attractiveness goes beyond simple valuations.

Zuck Gets It

Simply being more reasonably priced, by itself, isn’t cause to suddenly jump on board. (I doubt anyone who bought a discount ticket on the Titanic would say they got a deal.)

A more significant indication that things may turn around for Meta is the fact that Zuck realizes the situation he’s facing, and has started taking some drastic steps to address it. 

He recently made,what could be considered, a startling admission to investors…

“For the first 18 years of the company, we basically grew quickly basically every year, and then more recently our revenue has been flat to slightly down for the first time,” Zuckerberg added.

He’s basically just described the lifecycle of a growth stock. At some point growth stocks can no longer maintain their rapid growth potential (given the size they have grown to) and start to trade more like value stocks. 

Simply acknowledging this fact may give him a better leadership perspective on how to direct the company. For example…

71,970. That’s the number of full time employees Meta was paying at the end of 2021. It has clearly become a significant cost to the company. This is going to get fixed. According to the Wall Street Journal…

The Menlo Park, Calif., company has begun quietly nudging out a significant number of staffers by reorganizing departments and giving affected employees a limited window to apply for other roles within the company, according to current and former managers familiar with the matter, in a move that achieves staffing cuts while forestalling the mass issuance of pink slips.

The reductions are expected to be a prelude to deeper cuts, according to people informed of the company’s plans. While some savings will come from cuts to overhead and consulting budgets, the people said, much of it is expected to come from reduced employment.

This would be the first workforce reduction since the company was founded. And employees aren’t the only assets on the chopping block.

Now we’re getting an indication that cost-cutting doesn’t stop with labor but also it’s the overall corporate footprint. The social media giant is exercising an option to terminate its lease at 225 Park Ave. South in Manhattan, where it occupied more than 200,000 square feet.

That can’t be cheap! They’ve also started redirecting capital from back-burnered projects…

Facebook is shutting down Bulletin, the newsletter platform it launched last year to let writers create and monetize subscription newsletters.

The social-media company, which is owned by Meta Platforms Inc., said publishing on Bulletin will stop in January.

And even the spearhead department of the metaverse effort is seeing cutbacks to refocus its development efforts…

Facebook parent Meta Platforms, Inc is preparing cutbacks in its Reality Labs division to refocus on hardware products and the “metaverse,” Reuters reports. 

So the bad news is, the rampant growth party for Meta may well be over. The good news is, Zuck gets it — and appears to be moving accordingly. 

So What’s the Bottom Line?

So like I said earlier in this letter, it’s third and long for Meta on their own five yard line. The clock is running and they have no timeouts left.   

Can they stage any kind of a fourth quarter comeback?

Well, I’m not adding Meta to the Streetlight Confidential Portfolio anytime soon.

But given the company’s more attractive valuations combined with the fact that the play calling from the top has begun to favor a sound business strategy that addresses the reality of its situation (rather than trying to throw up a bunch of Hail Marys), I’d say Meta is a tech stock to start watching again. 

I’ll keep you posted…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential