Amid the severe economic challenges dimming the confidence of companies and big global advertisers, Meta Platforms is the ailing canary. Investors have been quick to ditch the stock. Last year the social media group lost almost two thirds of its value, leaving the owner of Instagram and Facebook lagging behind all its fellow Faangs (the sector powerhouses that also include Amazon, Apple, Netflix and Alphabet, the Google owner) on three, five and ten-year bases.
At first glance, Meta might look cheap. This time last year its enterprise value stood at 12.8 times forecast earnings before interest, taxes and other charges, a valuation multiple that has averaged 14.6 over the past decade. That enterprise value is now only 6.3, close to a record low.
But the company still seems like more of a value trap than a bargain. External challenges are plentiful. Like Alphabet, it generates almost all its revenue from advertising. A slowdown in spending by big companies on marketing has been painful. During the three months to the end of September, revenue of $27.7 billion was slightly better than analysts had anticipated but was still 4 per cent down on the same period last year.
In addition, Meta has had to cope with the introduction of software changes by Apple last year, which granted iPhone and iPad users the ability to opt out of apps tracking their online activity. That presents two problems for Meta in monetising its platforms: targeting adverts to individuals’ interests is now more difficult; and so, too, is measuring how effective those ads are.
Yet advertisers slashing budgets is not the only challenge. Competition for consumer eyeballs and marketing dollars is another. TikTok has become one of its biggest rivals in the battle for relevance among younger users in particular. Insider Intelligence, the research company, forecasts that TikTok will increase its advertising revenue by 36 per cent this year, outpacing the 5.5 per cent growth it thinks Meta will generate.
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Meta is now pushing Reels, its own short-form video function, to capture a greater share of users’ time online. The problem? There are several: one, Reels is harder to monetise; and two, pushing the short-form video product risks cannibalising revenue generated from advertising on users’ Facebook or Instagram feeds. The shift was one of the reasons behind a decline in the price per ad of 18 per cent during the third quarter. Reels is likely to have cannibalised $500 million in revenue during the December quarter, a position that Mark Zuckerberg, Meta’s founder and chief executive, has said he hopes will become more “neutral” over the next 12 to 18 months.
The upshot? The company warned that overall revenue during the fourth quarter could be as little as $30 billion. Analysts think the sum could reach $31.5 billion, but that would be lower than the $33.7 billion generated during the same period in 2021, putting Meta on course for its first annual decline in revenue since its initial public offering in 2012.
Bet on the metaverse
The decision by Zuckerberg and co to stick with their hefty spending plans, chiefly relating to financing a loosely defined bet on the so-called metaverse, remains a bigger cause for concern. Profits more than halved during the September quarter, which marked the first time in more than a decade that Meta’s earnings have declined by four consecutive quarters.
Some cuts have been made, including reducing office space and laying off about 11,000 staff members in November, but they won’t make much of a dent in the expenditure bill. Headcount expanded by just over 24,000 over the 12 months to the end of September, even as the boom times of the pandemic trailed off.
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Capital and operating expenditure for last year is expected to be between $85 billion and $87 billion, up from costs of $71.2 billion in 2021. This year spending is set to increase again to $96 billion to $101 billion this year, way above the level analysts had forecast.
The metaverse, an immersive world accessed by virtual-reality goggles, is a key source of expense. Over the first nine months of last year, the “Reality Labs” business reported a loss of $9.4 billion, an expansion on the $6.9 billion recorded over the same period in 2021. Hiring more staff and hardware costs associated with the launch of the next version of the Oculus Quest this year is expected to increase the operating losses significantly during 2023.
Meta has a high level of financial protection, with cash and short-term investments worth $41.8 billion at the end of September, but pursuing Zuckerberg’s virtual reality ambitions also diminishes one of the key historic strengths of the company’s business model — a strong level of cash generation. The cash generated by Meta’s businesses was $9.7 billion during the third quarter, only $400 million higher than at the same point in 2019. During those respective periods, capital expenditure has increased to $9.5 billion, from only $3.7 billion in 2019.
Meta, along with Alphabet, is inherently vulnerable to a downturn in global digital advertising demand. The company’s attempts to find other sources of revenue are logical, but the scale of the investment in an area where the potential returns are still unclear — and at a time when the trough for the core, ad-reliant business may not have passed — is likely to prevent investors being more forgiving of the challenges outside of management control.
Regulatory risks are never far away. In December the shares came under renewed pressure amid fears that the social media group could be ordered to overhaul the way in which it processes users’ data in Europe, which could affect how it runs tailored advertising. While the owner of Facebook and Instagram lets users opt out of ads based on their use of other websites and apps, it does not offer that option for ads based on activity on its own platforms. A final decision by European regulators is due shortly. The decision over whether to allow Donald Trump, the former US president, back on to its platforms, which is due at the start of this year, might represent another determining factor over whether Meta wins or loses more advertising dollars.
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While interest rates remain high and consumer spending weak, Meta’s cost line will be in sharpest focus. The technology group will need to go much further in curtailing its lofty ambitions to stand a chance of winning back investors.
ADVICE Avoid
WHY Weak advertising revenue and elevated spending risk placing further pressure on profits
