Meta Platforms: Unplug From The Matrix

Summary

• Meta's stock has had an awful year as shares are down more than 70% YTD.
• Shares trade under 10x earnings if the projections are accurate.
• The company is burning huge amounts of cash with Reality Labs as well as with their buyback program.
• I'm a skeptic when it comes to the Metaverse and its potential over the next decade.
• A bet on Meta is a bet on the success of Mark Zuckerberg and his vision for the Metaverse.

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Tech stocks continue to take a beating in 2022, and few stocks display that fact better than Meta Platforms (NASDAQ:META). Most of the market outside the energy sector has struggled mightily this year, and the bullish articles on large tech companies continue to pour in on Seeking Alpha. Today I’ll be explaining why Meta, despite its cheap valuation, is not a buy today.

Investment Thesis

Meta Platforms is one of the best covered stocks on Seeking Alpha, and it seems like I see a bullish article on most days. Despite a cheap valuation where the company is trading below 10x earnings for the first time in its history, I’m still not a buyer here. I don’t believe in the company’s transition to the Metaverse via Reality Labs, and it looks like spending is only going to increase in the next couple years.

Not only is the company burning cash to fund its Metaverse push, but it has also spent billions in the last year to buy back stock at much higher prices while CEO Mark Zuckerberg was selling billions. Many investors point to buybacks at a cheap valuation as a reason to be bullish, but I’m not sure if we will actually see share count decreasing due to the large stock-based compensation expense. While I understand why many authors are bullish on Meta, but I’m not optimistic on the future of the Metaverse, which is why I’m not bullish on Meta today despite its massive selloff.

The Metaverse

The investment case for Meta depends on the success or failure of the development of the Metaverse. While Instagram and Facebook remain advertising cash cows for Meta, the company continues to dump billions of dollars into Reality Labs. The research and development spending looks like it will continue to speed up, and Zuckerberg said as much in the most recent earnings call.

Authors on Seeking Alpha have a wide range of opinions on the Metaverse, and I’m sure you are familiar with most of them. Personally, I won’t be a Metaverse user, no matter how impressive the technology gets. Real life, despite all of its ups and downs, will always be better than the Matrix. Because I don’t believe in Zuckerberg and his vision for the Metaverse and the future of the company, I don’t see any reason to be a shareholder. If the Reality Labs segment was closer to breakeven, it would be easier to argue the bull case for Meta. That’s clearly not the case here. The Reality Labs segment has already lost $9.4B in the first nine months of 2022, which has just started to show up on the financial statements.

The Balance Sheet

Meta has had an impressive balance sheet for as long as I can remember. Cash and equivalents have declined slightly since year-end, and they recently issued $10B of debt in August. While they still have a solid balance sheet, the spending spree on the Metaverse will likely lead to decreasing cash levels as losses from Reality Labs are expected to increase next year. The effects of Reality Labs are far more obvious on the income statement, specifically the segment breakout.

The Income Statement

Overall revenue has stagnated in 2022 ($84.4B vs. $84.3B in the first nine months of 2021) and I wouldn’t be surprised if we see revenue decline in 2023 as the economy slows down and advertising spending slows down. I’m curious to see what happens to the social media user base over the next couple of years as well. I personally don’t use Facebook or Instagram, but I wouldn’t be surprised if we see fewer people using both platforms in coming years.

$1.4B in revenue in the first nine months for Reality Labs (a slight increase versus the first nine months of 2021) led to a loss of $9.4B, up from an already massive $6.9B loss in the first nine months of 2021. While I prefer to look at the first nine months because it provides a wider picture, the most recent quarter for Reality Labs wasn’t pretty either. Revenue was down significantly to $285M in Q3, which is much lower than last year’s Q3 and the first two quarters of 2022. The $3.7B loss for the quarter makes me wonder what results will look like if revenue stays low while the research spending continues to increase. These issues, combined with the massive selloff have led to a cheap valuation, which could turn out to be a value trap.

Valuation

Meta’s valuation has looked cheap for a while, and there hasn’t been any shortage of bullish coverage on Seeking Alpha. There have been numerous articles in 2022 with the opinion that Meta is cheap and the Metaverse will pay off down the road. While I will agree to disagree on the Metaverse, Meta is as cheap as it has ever been if the forward estimates turn out to be accurate.

Price/Earnings (fastgraphs.com)

Shares currently sit under 10x earnings. If you would have told me that Meta would trade at a single digit multiple in 2022, I’m sure many investors (including myself) would have thought you were crazy, but here we are. The company has a market cap of $240B, but I still think the Reality Labs cash black hole will turn into a nightmare for the company. Another cash black hole for Meta has been the company’s buyback program.

Buybacks

While the valuation looks cheap, Meta has also been lighting cash on fire for the last couple of years with their buyback program. They have spent $21.1B so far in 2022, which is on top of $24.5B at much higher prices in 2021. Despite the massive amounts of cash spent on buybacks, the share count has basically been flat over the last five years, a symptom of the company’s large stock-based compensation program.

Shares Outstanding (fastgraphs.com)

Most of the bullish articles I have read on Meta point to the company’s ability to buy back massive amounts of stock at cheap valuations, and I certainly understand where they are coming from. However, I wouldn’t be surprised if the stock-based compensation continues to eat up a good chunk of the buybacks. There is one other piece from the 10-Q that stuck out to me when I was doing my research.

We do not intend to pay cash dividends for the foreseeable future.

We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases.

I get it, people have been investing in the mega-cap tech companies for the high margin growth over the last decade, not the potential for dividends. However, if a company as profitable as Meta has been over the last decade isn’t going to pay a dividend, it’s not going to happen anytime soon. All things being equal, I prefer to own stocks that pay me to own them, even if there is an argument to be made that it isn’t as tax efficient. If I were invested in Meta, I would certainly rather see $45B paid out in dividends over the last two years instead of buybacks to pump up the share price while Zuckerberg was selling a huge number of shares in 2021.

Conclusion

A bet on Meta is a bet on two things: the success of Mark Zuckerberg and his vision for the Metaverse. I don’t see the future for the Metaverse, and I certainly have no plans to plug myself into the Matrix, but I can understand the appeal of a high-tech escape like the Metaverse. While some may disagree with my opinion of the Metaverse, it has become obvious to everyone that Reality Labs will continue to consume a large amount of cash.

While the financials have been impressive in the past, I think Meta’s best years are in the rearview mirror. The biggest reason to be bullish is the valuation. Despite the uncertainty surrounding the company, Meta is as cheap as it has ever been with an earnings multiple below 10x. The other thing that bullish investors often point to is the large stock buyback program. However, if the last five years are any indication, the buybacks will offset the stock-based compensation and not much else.

I am fully aware that this probably won’t be popular with most readers, but different opinions is what makes a market. Meta is down 57% since my last article on the company, where I stated that Meta was cheap for a reason. The comment section was certainly entertaining on that one and I expect that this one will be the same. While I don’t think Meta is a sell because the valuation is cheap (for now), I wouldn’t be buying here either. If you have some tax loss harvesting to do, it might not be a bad time to sell Meta and unplug from the matrix.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.