Global Equity: Meta Platforms

Meta Platforms plunged approximately 25% on Thursday 3rd February following the publication of its fourth quarter results. We do think that the company is in a marginally weaker position than we perceived it to be in the previous week; growth in the next few quarters, particularly profitability, will also be slower than we were expecting. However, we certainly do not believe that the company is worth 25% less than it was the week before and maintain our position that the market has overreacted, perhaps also displaying signals of general nervousness. 

Revenue was marginally ahead of expectations, which may have disappointed a few investors following Alphabet’s strong beat.  However, to keep everything in perspective, revenue was still up 20% year on year. Sheryl Sandberg, COO observed that the business generated more than $100 billion in annual revenue for the first time.

Meta Platform’s core advertising business remained solid and grew 25% year on year whilst average revenue per person increased 9% and the monthly active people count increased to 3.6 billion from 3.3 billion a year ago. On a user geography basis, year-over-year advertising revenue growth was strongest in Asia Pacific at 31%. Rest of the World, Europe, and North America grew 28%, 20%, and 15%, respectively. Currency was a modest headwind in all international regions. 

Facebook user growth was impacted by a few headwinds in the fourth quarter. In Asia-Pacific and Rest of the World, management believes Covid resurgences during prior periods pulled forward user growth. User growth in India was also limited by an increase in data package pricing. In addition to these factors, competitive services are negatively impacting growth, particularly with younger audiences. 

Clearly Meta Platforms is having to deal with various headwinds simultaneously namely increasing competition (from the likes of TikTok), shift to short form video, very strong comparatives, Apple's IOS changes. Advertisers, Facebook’s own clients, are having their own battles to deal with. Struggling with global supply chain disruptions, labour shortages and inflationary pressures, budgets towards advertising might become increasingly impacted. 

All these headwinds have led management to cautiously forecast first quarter 2022 total revenue to be in the range of $27-29 billion, which represents 3-11% year-over-year growth.

According to Meta Platform’s CFO David Wehner, “the impact of iOS overall as a headwind on Facebook’s business in 2022 is on the order of $10 billion, so it's a pretty significant headwind for the business”. Furthermore, he stated “Google’s search ads business could have benefited relative to services like ours that face a different set of restrictions from Apple. And given that Apple continues to take billions of dollars a year from Google Search ads, the incentive clearly exists for this policy discrepancy to continue”.  We perceive that whilst management have been very vocal about the iOS impact, the tone and impact from these changes have somewhat lessened. Furthermore, we think that this goes a long way in explaining the divergence of results between Alphabet and Meta Platforms.

On the Apple iOS issue, Management highlighted that more progress has been made with larger clients than with small and medium sized businesses. This is because smaller companies need to buy a very small, targeted audience whereas the larger the business, the less the need to personalise the advert. So, whilst this is having more of an impact for the SMBs, management highlighted “over the long run, we believe we have strong benefits for SMBs in using our ad system”. In other words, over time smaller businesses are far more dependent on Facebook, than larger ones. We would have been far more worried had it been the other way around.

As was highlighted in previous management calls, the investment in Reels remains a key strategic focus. It was of comfort to note that the management reported “tremendous growth” in this area and are clearly confident that the relatively low ad load will pick up. This should support Meta’s advertising revenue and act as a growth leaver over time.

On a DCF basis, our fair value estimate is $382 a share, materially higher than the market close price of $237.76. The company is trading at a price to free cash flow yield of 5.8%. Even with the current headwinds, should Meta Platforms’ FCF multiple be at such a discount to the S&P500 year-end median FCF yield of 3.6% or even trade at a discount to the structurally challenged FTSE100 year-end median FCF yield of 5.4%?  

Overall, we think that this does not make sense. Together with Alphabet, the firm dominates the digital advertising space, an area of secular growth. It is hugely profitable, its core advertising business, has nearly a 50% operating margin. It is a founder led business with an enviable track record of generating shareholder value. Its 5-year average Cash return on invested capital is 16.1% whilst its 5-year average Cash return on Assets is 22.2%. It is surely no ordinary company. Meta Platforms is also in a rock-solid financial position. Its PE ratio of 17 (the commonly used valuation metric) does not take into account the firm’s cash position of $16.6 billion, its $31.4 billion of marketable securities nor that it has made high investments which are depressing current earnings, but which should fuel future growth. It is worth noting the metaverse investments cost Meta Platforms over $10 billion in 2021 alone.

Malcolm Schembri
Fund Manager - EPIC Global Equity Fund