Meta Platforms Beats Earnings: I'm Selling (Rating Downgrade)

Meta Platforms, Inc. (NASDAQ:META) just released its first quarter earnings and easily beat analyst estimates on revenue and earnings. Revenue came in at $28.6 billion, up 3% (a beat) and diluted EPS came in $2.20, down 19% (also a beat). The company reported $6.9 billion in free cash flow ("FCF"), which shrinks to $3.9 billion if you subtract the $3 billion in stock-based compensation ("SBC") reported for the period.

Meta’s earnings release was in line with what I personally expected. My own revenue expectations were not as low as those of the market, as I thought that numerous stories about Instagram Reels’ popularity pointed to positive revenue impacts. Basically, Reels is Meta’s video service that competes with TikTok. Meta made it a priority last year to gain share lost to TikTok last year, and Reels’ engagement gains confirm that that’s happening. More time on Instagram means more ads can be shown: whether Reels themselves are “monetizing well” or not, that extra time on the platform means extra ads.

Other aspects of Meta’s Q1 release were not as good as what was seen in the core advertising business. Reality Labs’ revenue came in at a mere $339 million, which was down 51.2% from the same quarter a year before. The “other revenue” category declined as well.

Overall, Meta’s first quarter release was pretty good. The stock rapidly shot up 9% after hours when it came out, and justifiably so. Stocks are valued based on the cash flows that investors expect, and Meta delivered far more than expected. Nevertheless, I sold all my Meta shares earlier today. I think $250 is a reasonable valuation for META and the stock is already pretty close to that level. For this reason, I consider Meta Platforms, Inc. a hold at today’s prices.

Earnings Recap

In its first quarter earnings release, Meta Platforms, Inc. beat the analyst consensus on both the top and bottom lines, delivering:

• $28.6 billion in revenue, up 3%.

• $2.20 in EPS, down 19%.

• $6.9 billion in free cash flow, down 18.8%.

• $13.98 billion in cash from operations, down 0.5%.

• $3 billion in free cash flow after subtracting SBC.

Overall, it was a decent quarter. Profits declined, of course, but the positive revenue growth points to the possibility of future profit growth if costs can be kept in check. CEO Mark Zuckerberg announced another round of cost cuts near the end of the first quarter; those cuts won’t make it into earnings until next quarter. So, there is some tentative cause to believe that margins could be better in Q2.

One sour point in Meta’s first quarter release was the performance of Reality Labs. The segment did just $330 million in total revenue, a 51% decline from the same quarter a year before. Despite Meta’s initiatives to reduce costs, the company is still spending over $3 billion a quarter on it. It would be difficult for Mark Zuckerberg to just throw in the towel on the metaverse since he has invested so much in it and even re-named his company to reflect his ambitions in the space, but at this point, Meta’s VR segment is looking like a real money pit – one that’s not growing, at that.

Valuation

Now for the reason why I sold my Meta Platforms, Inc. stock:

The valuation.

At $100, Meta Platforms looked like a true value opportunity, with a fair value estimate under the assumption of 0% growth that was far higher than the stock’s price. Today, that’s not the case.

At today’s price, Meta trades at:

• 26 times earnings.

• 4.8 times sales.

• 4.3 times book value.

• 10.6 times operating cash flow.

• 36 times free cash flow (this multiple calculated by the author, the rest from Seeking Alpha Quant).

Meta Platforms, Inc. stock is nowhere near as cheap as it was back in the days when people spoke of it as a value stock. In fact, its free cash flow multiple is among the highest in big tech! Now, that’s largely due to one particular quarter in which there was hardly any free cash flow at all due to a big jump in CAPEX spend. If you normalize it, then the FCF multiple is close to the earnings multiple, which is to say slightly high but not overly high.

Another thing worth noting about Meta’s valuation is that it no longer has a fair value estimate above the current stock price at an assumption of 0% growth. Meta’s free cash flow per share was $6.51 in the trailing 12 month period. If you discount that amount at the 10 year treasury yield (US10Y), you only get a $183 fair value estimate, and that’s not even including a risk premium. Meta now needs to grow in order to be worth its current stock price, and it’s not growing earnings as of the most recent quarterly release.

Risks and Challenges

As we’ve seen, Meta Platforms is a pretty profitable company. It’s not “growing” exactly, though it could see its earnings growth ramp up in future quarters due to the cost cuts, as happened recently with Alibaba Group Holding Limited (BABA) (OTCPK:BABAF). Nevertheless, there are real risks and challenges with this stock. Being pretty much neutral on Meta Platforms stock at today’s prices, I will highlight some risks to those going long as well as risks to those going short.

• Risk to longs: lingering fallout from Apple Inc.’s (AAPL) App tracking transparency policy. When Meta Platforms released its fourth quarter 2021 earnings, CFO Dave Wehner said that Apple’s data restrictions would cost Meta $10 billion per year in lost revenue. The results we’ve seen in the ensuing period seem to have confirmed that. Meta Platforms has delivered several quarters of negative revenue growth and shrinking profits. The most recent quarter’s sales growth was a mere 3%. There is very little evidence that Meta has been able to simply “grow past” the effects of Apple’s privacy changes, as its revenue growth remains slow to this day (though it is above-consensus).

• Risk to longs: a future recession. The past 16 months have seen Meta’s revenue growth go from high double digits, to negative, to just barely positive (in the most recent quarter). All this occurred in a period without a formally declared recession. If a recession were to occur, then Meta’s revenue would likely take another hit, causing earnings to decline even more. While it’s encouraging that Meta is now committed to getting costs under control, it is not cutting costs to an extent that it could maintain its margins on falling revenue. So, a large hit to Meta’s revenue in a recession is a real risk.

• Risk to shorts: continued cost discipline. Much of the reason why Meta stock has been rallying lately is Mark Zuckerberg’s newfound commitment to cost discipline. Zuckerberg spent much of 2022 reducing headcount and generally trying to improve margins as much as he could. The end result was that Meta, although not growing, still has some of the highest margins in big tech. If Meta continues to report such high margins, then its stock is theoretically worth something, even if it doesn’t grow. So, shorts will want to keep in mind the fact that Meta is a very profitable company. More quarters of strong profitability could cause some issues for short sellers.

• Risk to shorts: a nationwide TikTok ban. There are few things that would cause a swifter rally in Meta Platforms shares than a TikTok ban. TikTok, as you might know, is the Chinese social media app whose features overlap somewhat with Instagram and which competes with Instagram directly for advertiser dollars. Meta has cited TikTok as a competitive threat in several earnings calls and investors seem to have taken its word on this. TikTok was recently banned in the State of Montana, and on Federal Government devices. If the Federal Government ever banned TikTok outright – it has already done hearings to explore the possibility of doing so – that would mean less competition for Meta, and likely more profits. So, a TikTok ban is a big risk to anybody short Meta stock.

The Bottom Line

The bottom line on Meta Platforms, Inc. is that it’s still a very profitable company with an admirable competitive position. Its user counts are still growing, its margins are still sky-high, and its revenue growth recently swung back to being positive. There are some issues within the business, such as the continued unprofitability of Reality Labs, but those things can be forgiven when you consider the company’s overall positive trajectory.

The real problem with Meta Platforms, Inc. is that the stock has gotten fairly pricey. At 26 times earnings, this is definitely not the deep value opportunity it once was. Meta Platforms, Inc. certainly isn’t the most expensive big tech stock out there, but it’s not the cheapest either. Personally, I’m content to exit my position in Meta Platforms stock.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.