Meta Is Cheap for a Reason: Shareholders Aren’t the Focus

There is news this morning that Facebook parent Meta Platforms (META) has agreed to settle a class action lawsuit against the firm stemming from the Cambridge Analytica scandal. The firm will pay $750M, which according to Keller Rohrback LLP — the plaintiff’s representative — is the “largest recovery ever achieved in a data privacy class action and the most Facebook has ever paid to resolve a private class action.”

Of course, Facebook, as the company was then known, did agree in 2019 to a $5B settlement with the Federal Trade Commission, while nearly simultaneously settling a case with the Securities and Exchange Commission for $100M over allegations that the firm had misled the public concerning the misuse of user data.

So, About 2023

What investors want to know is not the details of the above mentioned settlement. Everyone seemed to know that some large dollar amount agreement was coming. Investors want to know, as one bad year for the markets and for META ends, is another one in the cards. Is META inexpensive or cheap for a reason?

In October, META posted third quarter earnings that fell well short of consensus on revenue that did beat Wall Street. Earnings have in fact, printed in year over year contraction for four consecutive quarters, and revenue generation in year over year contraction for two. Much of the blame lies in a tougher environment for sales advertising space across the firm’s social media networks since Apple (AAPL) gave consumers using Apple devices a choice in how closely they are willing to allow developers of applications they use to track their activity on the web.

Apple may be a good reason for why this firm’s net income has declined more than 25% over the past two years, but the firm has damaged itself too. Meta Platforms has laid out at least $36B betting on the “metaverse”, which is a virtual reality type environment where people might one day work or play using avatars to represent themselves. A lot of futuristic optimism there, but probably a long way from being commercially sensible.

Structure

Meta Platforms reports performance across two distinct business segments, Family of Apps and Reality Labs. Family of Apps includes all of the social media networks that many of you are familiar with such as Facebook, Instagram and WhatsApp. Reality Labs is where the firm’s metaverse project lives in its entirety. Reality Labs, as you probably already guessed, is where corporate financial performance goes to die.

Year to date through nine months, the Family of Apps segment had driven $83.011B in revenue, resulting in operating income/loss of $31.983B. Year to date through nine months, the Reality Labs segment had driven $1.433B in revenue, resulting in operating income/loss of $-9.438B. Reality Labs was literally a self-imposed 29.5% tax on the firm’s operating income.

Earnings & Fundamentals

Meta Platforms is expected to release the firm’s fourth quarter performance in about a month. Consensus view is for EPS of $2.25 with a range spanning from $1.40 to $2.70 on revenue of $31.55B within a range spanning from $30B to $32.5B. The wide range of expectations tell us that Wall Street is somewhat uncertain in regards to what the firm will post for the current quarter. At consensus, these numbers would amount to earnings “growth” of -38.7% on revenue “growth” of -6.3%.

Free cash flow has become an issue for the firm in recent quarters. Free cash flow for the past four quarters per share runs like this in succession… $4.61, $3.17, $1.71, and $0.12. What’s next? A negative number? The thing is this. The firm is sitting on a pile of cash and the balance sheet is strong. If CEO Mark Zuckerberg wants to keep investing in the metaverse because he truly believes in its commercial future, he certainly has the means to keep doing so for a while.

At the end of the third quarter, Meta Platforms had a net cash position of $41.776B on the balance sheet and current assets of $58.315B. With current assets at $22.687B, the firm has an enviable current ratio of 2.57. Not that it’s anything to worry about with a cash balance like that, but the firm did add almost $10B in long-term debt during the third quarter, which may have been smart considering the interest rate environment.

What I Think

The stock trades at a “below market” 13 times forward looking earnings. This is because Meta Platforms is the opposite of a growth stock. This is a company whose wildly successful core business is probably past peak, while management is choosing to invest not in this core business that provides for the entire firm, but in something seen as either “visionary” or ridiculous. Only time can tell if Zuckerberg is right. He may very well be. Probably not in the short to medium-term however. If the metaverse ends up being the next big thing, that’s a long-term story.

As a stagnant business sitting on a solid balance sheet, if the firm wanted to attract investment, the firm would probably reduce investment in the metaverse, doing what needs to be done to reestablish lost free cash flow and use that created space to initiate a dividend. The fact that this has not been done tells shareholders that they are not the focus.

The stock is down a rough 70% since September 2021, and up about 33% from the November 2022 bottom. Resistance has been met at the $125 level, which just about fills the gap created in late October. There remains an unfilled gap up in the $300’s. We’ll need to see more than a 61.8% Fibonacci retracement of the entire selloff in order to approach filling that space. Let’s zoom in.

There is what looks like an ascending triangle forming here, which would be good for the META bulls. In my opinion, a take and hold of $125 could give you $144.

That said, I am not a fan, and should this stock fail upon its next run at this key $125 level there is a good chance that this is dead money going deep into 2023, especially with the Fed drawing back on the monetary base as the economy goes into recession.

The name is interesting. Its low valuation is really the result of its own decision making. That doesn’t change until META changes.

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