Meta Is Soaring (NASDAQ:META)

Kameleon007

Article Thesis

Meta Platforms (NASDAQ:META) reported its fourth quarter earnings results on Wednesday afternoon. The company showcased a hefty earnings decline, but that was expected. Overall, there were some positives as well as negatives in the quarter, which we'll dive into in this article.

What Happened?

Meta Platforms reported its fourth quarter results on Wednesday. These are the headline numbers:

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While revenues beat estimates, the company missed profit estimates widely. Somewhat surprisingly, the market reacted positively to these results, sending shares up by 10% in after hours trading at the time of writing. Shares are volatile, however, thus this could change.

The Good, The Bad, And The Ugly

Let's start out with a major problem for Meta: Its sales are declining. Tech companies are oftentimes seen as growth investments, and rightfully so, as the tech industry saw revenues grow considerably in recent years. In Meta's case, the company experienced rapid business growth for many years, but that has ended, at least for now:

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Quarterly revenues came in at $32.2 billion, which was down 4% year over year. That was a worse performance compared to the first nine months of the year, as revenue had been flat throughout the third quarter on a year-over-year basis. Even that is not a great result for a company that has grown at a hefty pace for years, of course. There are several factors at play when it comes to explaining Meta's revenue decline. First, currency rates remain a headwind for the company -- Meta generates a significant portion of its revenue outside of the US, and with the US dollar strengthening over the last year, the revenues that are generated in Europe, Japan, etc. are worth less once denominated in USD. This was a 6% headwind, thus revenue would have been up 2% at constant currency rates. Will this be a headwind forever? I don't think so:

The US dollar has stopped strengthening towards the end of 2022, and has actually been pulling back in recent weeks. If that trend does not change materially, currency rates will be less of a headwind in Q1 and Q2, and will stop being a headwind in Q3 and Q4. In fact, if the dollar index remains where it is today, this year's Q4 could actually see a currency rate tailwind, as the US dollar is weaker today relative to the October-December time frame last year. Investors can thus expect that at least one of Meta's headwinds will be waning soon, unless there's a big reversal when it comes to the US Dollar's performance.

Growth of 2% at constant currency rates still is significantly weaker than inflation, of course, meaning currency-neutral revenues still declined in real terms. The good news is that neither ad impressions nor Meta's user count were a problem - both were up year-over-year. Pricing was a weakness, however, as Meta generated, on average, 22% less per advertisement across its platforms relative to the previous year's quarter. That can be explained by the fact that businesses were less willing to pay top dollar for ads - the current economic slowdown and the potential recession we could see this year has made businesses more focused on keeping costs in place, which is why Meta and other social media companies can't earn the same amount per ad they used to earn during the 2020-2021 time frame, when massive stimulus payments and cheap money made advertisers pay very high prices per ad impression. With money being tighter during the current economic phase, it's not too surprising to see businesses become more cost-focused, thus the decline in revenue per ad had to be expected.

The bad news is that Meta itself didn't become tighter with money - while many of its customers successfully reduced their costs by paying less per ad impression, Meta itself ramped up its spending and saw its expenses soar. Meta's total costs and expenses rose by 22% year over year on a reported basis. That's in stark contrast relative to the reported 4% revenue decline - META spent way more money while generating less revenue. It's pretty clear that this is bad for profitability and thus for shareholders. Ideally, a company grows its costs less than its revenue, while it's OK if both move in line with each other. But when expenses soar while revenues dip, that results in a hefty margin hit. Not surprisingly, Meta saw its earnings drop massively, as net profit declined by 55% year over year. While net profits still came in at $4.7 billion, which is equal to $19 billion annualized and thus still a really strong result in absolute terms, the trend is clearly unfavorable: If Meta were to see its revenue dip by another 4% over the next year, while expenses rise by another 22%, the company would report a net loss of around $500 million for Q4 of 2023. I believe that this is very unlikely, due to several factors, but the example shows that Meta clearly has been moving in the wrong direction in the recent past. The first factor for why I believe that things will be better a year from now is the aforementioned currency impact, which should turn from a headwind to a tailwind one year from now if things remain as they are today. On top of that, the company will focus more on bringing down its operating expenses going forward - recently announced job cuts will help with that, while other measures, such as less business travel and cuts on employee perks, will positively impact Meta's profitability as well, all else equal. Here's a noteworthy statement from the company's earnings release:

Headcount was 86,482 as of December 31, 2022, an increase of 20% year-over-year. Our reported headcount includes a substantial majority of the approximately 11,000 employees impacted by the layoff we announced in November 2022, who will no longer be reflected in our headcount by the end of the first quarter of 2023.

All else equal, Meta's headcount could drop by up to 13% when the company reports its next results. The actual reduction will likely be less than that, as some new employees will be hired over the same time frame, but it's pretty clear that the headcount reduction will be significant. Another important item from the earnings release is the following statement:

We anticipate our full-year 2023 total expenses will be in the range of $89-95 billion, lowered from our prior outlook of $94-100 billion due to slower anticipated growth in payroll expenses and cost of revenue.

This suggests that expense growth will be less pronounced relative to previous assumptions, which naturally is a good thing. The midpoint of the guidance implies that expenses will grow by 4%-5% in 2023, relative to FY 2022. That's a lot better than the massive expense growth we have seen last year.

Overall, there are thus some signs of improvement when it comes to margins and profitability, but I still believe that the company clearly has a lot of work to do in this area, and some investors will likely remain on the sidelines until they see a clear improvement in Meta's actual reported results - so far, these improvements are only seen in forward-looking and thus somewhat uncertain statements.

Looking at capital allocation, we see two important themes: Meta's growth investments and its shareholder returns. Meta continues to spend heavily on capital expenditures, as those totaled $9.2 billion in Q4. That was actually up from the Q1-Q3 average of $8 billion per quarter, thus Meta has not been cutting its investments in the fourth quarter. Since some of this spending is used for the Metaverse business that's so far not generating any profits, it seems questionable whether this massive spending is in shareholder's best interest. That being said, Meta's founder Mark Zuckerberg clearly sees a lot of value in this business, thus investors that believe in his vision may be happy to wait a couple of years to see how this venture works out in the long run.

On top of spending heavily on capital expenditures, Meta also has been spending heavily on buybacks in the recent past. Buybacks totaled $7 billion in Q4 alone, and since the company announced a new $40 billion buyback authorization, we might see even more buybacks in the current year. Of course, not all of the company's buybacks are actually resulting in a share count decline - some of those buybacks are offset by the company's share issuance to management and employees. Over the last year, the company has spent $28 billion on buybacks, which is equal to 7% of the company's market capitalization. The share count has only declined by 3% over the same time frame, thus Meta's share count roughly declines by one share for every two shares that the company buys. In terms of effectiveness, Meta's buybacks thus aren't great, but if there were no buybacks, the share count would rise meaningfully over time, thus Meta's buybacks are still better than the alternative - shareholders would be diluted constantly without buybacks. Thanks to a $40 billion cash position, Meta can continue to spend heavily on buybacks in the foreseeable future, and I believe that there is a good chance that they will do exactly that.

Takeaway

Meta's reported revenue performance was pretty bad, but the good news is that currency rate headwinds will be less impactful going forward. We might actually see currency rate tailwinds in H2 of 2023.

Ad impressions are strong, but the economic environment results in less revenue per ad.

One of the biggest headwinds over the last couple of quarter, expenses being out of control, held true in Q4, but there are clear signs of improvement, thus things could be better in 2023.

Overall, there's some good things and bad things in the report -- based on the market reaction, most investors chose to focus on the positives. Meta trades at 19x net profit estimates for 2023, which is not overly expensive, but which isn't as cheap as it was at some points in 2022. I hold a position in META but will likely not increase that position in the near term, while I continue to wait for the Metaverse spending and cost reduction efforts to play out over time.