Monday, November 7, 2022

The bull case for META; Eight headwinds; A classic 'kitchen sink' quarter; Analogy with Netflix; Race this weekend

By Whitney Tilson

1) In all five of my daily e-mails last week (Monday, Tuesday, Wednesday, Thursday, and Friday), I analyzed Meta Platforms (META) and the various factors that have caused its stock to crash 76% in the past 15 months – wiping out a staggering $773 billion in market capitalization.

Today I'd like to summarize my analysis and explain why I've concluded that Meta's stock is a pound-the-table buy right now.

In short, Meta has been buffeted by no fewer than eight headwinds that, collectively, have severely impacted the company and its stock:

  1. Apple's (AAPL) privacy measures
  2. The massive rise of TikTok
  3. The end of the pandemic
  4. The strong dollar
  5. Metaverse spending
  6. Artificial intelligence ("AI") spending to address challenges from Apple and TikTok
  7. Reels cannibalizing more profitable segments of Facebook and Instagram
  8. Weak consumer spending, especially in sectors from which Meta draws advertising

In light of this perfect storm, I think it speaks to the extraordinary strength of the business that Meta still managed to report a 20% operating margin and $4.4 billion in net income last quarter.

And here's the key...

As I go down the list, I don't think these headwinds are likely to worsen, and some might even turn into tailwinds – for example, Meta's billions in AI spending might aid advertising targeting and help Reels better compete with TikTok. And the cost cuts announced yesterday could improve margins over time (see this article on the front page of today's Wall Street Journal: Facebook Parent Meta Is Preparing to Notify Employees of Large-Scale Layoffs This Week).

I think the odds of better-than-expected results going forward are especially good given that last quarter smelled to me like a classic "kitchen sink" quarter.

This term applies when a company, knowing it's going to report bad numbers, decides that, rather than try to "put lipstick on a pig" by trying to book some one-time gains and engage in other (sadly, legal) tricks to improve reported earnings by a few pennies, instead takes every possible charge and expense ("everything but the kitchen sink," as the saying goes) to get all the bad news out and set up the stock for easy comparisons going forward.

Kitchen sink quarters are generally quite rare, but are more common when a stock is a) already down a lot... and b) there's a new CEO or CFO who can blame the terrible earnings on their predecessor and also get their stock options struck at the lowest possible price. Sure enough, three months ago Meta announced a transition to a new CFO (Susan Li, the company's vice president of finance since 2016), which took place only last week...

In summary, the year-over-year comparisons for Meta, which have been dreadful for the past year, are likely to, at the very least, stabilize – and there's a good chance they start to improve.

With the stock so universally reviled, I think there could be a rapid rush back into it in light of its cheap valuation and the heavy (25th largest) weighting in the S&P 500 Index. I could see it popping 50% on signs of stabilization, doubling on even the slightest hint of improvement in revenue growth, margins, and spending, and tripling if it actually happens.

2) We don't have to look far to find an analogous situation for how I think things will play out for Meta – just look at fellow FAANG stock Netflix (NFLX)...

After years of astronomical growth, this dominant, global market-leading business faced a confluence of events that caused it to report its first two quarters ever of declining subscriber growth in the first half of this year (sound familiar?).

Investors panicked and Netflix's stock crashed by 77% over a brutal seven months (sound familiar?).

But then the company's turnaround plan, easing year-over-year comparisons, and incredible underlying strengths all kicked in... with the result that Netflix added 2.4 million new subscribers in the third quarter. Investor sentiment turned on a dime and the stock soared, surging 60% in just the past three and a half months.

3) For another bullish take on Meta, I recommend this post by Ben Thompson on his Stratechery blog: Meta Myths. Here are the highlights of the topics he covers:

  • Myth 1: Users Are Deserting Facebook
  • Myth 2: Instagram Engagement is Plummeting
  • Myth 3: TikTok is Dominating
  • Myth 4: Advertising is Dying
  • Maybe True: The Metaverse Is a Waste of Time and Money

4) And here are thoughts from a friend and former student of mine, Angelo Martorell of hedge fund Martorell Capital Partners...

I'm very bullish on Meta.

We can approximately quantify the revenue impact of some of the headwinds you mentioned: 5% to 10% Apple privacy, 5% COVID ending, TikTok perhaps 3%, the dollar roughly 5%, and Reels cannibalization about 4% (Meta is pushing Reels over its news feed, which monetizes at only about 30% as much, though in 12 to 18 months it should reach parity, which is quite remarkable). 

I think there are three big surprises from the latest earnings call:

  1. Engagement is much, much better than I expected. WhatsApp has over two billion daily users, Instagram has a billion monthly users, and Reels is taking market share from TikTok.
  2. Metaverse spending is very high.
  3. Operating expenses will increase about 10%, but with about the same amount of headcount.

Also importantly, David Wehner, the former CFO, timed the buyback terribly and did a terrible job outlining expectations for investors, who didn't know Meta would be investing so heavily in the metaverse, so it makes sense for him to go.

The way I see Meta's metaverse spending is that if the company does create the next computing platform, the upside could be worth trillions in valuation. I don't know what the odds are here, but I'm fine if Zuckerberg gives it a shot for five years (at a cost I estimate at $60 billion) and scraps the project if it doesn't pan out, as Jeff Bezos did with the Amazon Fire Phone.

For what it's worth, there is no other CEO/founder who is nearly as ambitious – the only one I can think of is Elon Musk.

I am pretty certain that in about a year or so Meta will return to 20% growth and expand margins again, which should translate to roughly 30% earnings growth. Why? It's not about the users, it is the usage times monetization. Various verticals are growing 80%+ such as WhatsApp business direct messaging, which is going to be a giant business. And Reels grew 50% in the last six months and that hasn't monetized at all.

Of course we need the headwinds such as weak consumer spending, the strengthening dollar, etc. to stop. But Meta still has triple-digit returns on investment for most businesses. All this is muddled by Apple's privacy changes, so Meta finding a workaround will be huge.

Could I be wrong by a mile? Yes, but I think you still make money.

The most interesting way to look at the valuation in my opinion is that the Family of Apps portion, excluding cash but including related capex, trades at about 6x operating income or 7x earnings. If need be, the company could probably trade at 4x earnings if they cut back spending on growth. That's just insanely cheap.

It's crazy how Meta is one of the most misunderstood businesses by investors due to all the bad press and investors not actually studying the financials and listening to the earnings calls.

Thank you, Angelo!

In summary, I think anyone buying META here will do very well – a double or even a triple over the next few years – but it will likely be a bumpy ride with lots of terrible headlines... so my best advice to META owners is to forget about it and come back in a year.

5) Here I am at the finish of the NYC Marathon:

But no, I didn't run it yesterday – no way an old geezer like me could have done so and recovered in time for a 24-hour race six days later (more later on my upcoming adventure this weekend at the World's Toughest Mudder)!

Rather, on Saturday I ran the pre-marathon 5K race called the Abbott Dash to the Finish Line, which started at the United Nations complex and ended with the last mile of the marathon course. There were more than 11,000 runners!

To protect my heel and not inflame my plantar fasciitis, I wore my cushy Hokas, which are massively slower than my Nike Alphafly racing shoes. Plus I haven't been training much, so my expectations were low...

I was hoping to run a bit under an eight-minute mile, but surprised myself by running it in 24:23, which is a 7:24 pace, good enough for 1,730th place overall (top 16%) and 30th in my age group (55 to 59). Not bad, though far slower than the fastest I've ever run this kind of distance, which was two years ago when I ran a four-mile race at a 6:46 pace.

I posted additional pictures of me near the starting line, where I watched the professional men's and women's heats start, plus a map of the course and my Garmin watch report on Facebook here.

Best regards,


P.S. I welcome your feedback at [email protected].