Meta Platforms (FB.US) is big business, with the highest gross margins of any of the big US tech giants. However, it is vulnerable to the publication of the results for reasons related to the growth of users. Something we have already seen with Netflix.
In fact, Meta lost all of its Russian users in the first quarter, as did Netflix. While Netflix beat earnings estimates by a wide margin, it wasn't enough to save it from Wall Street's reaction to the loss of users.
All those investors who have followed the Meta Platforms (FB.US) stock recently, may notice that it has been correlated with Netflix (NFLX.US). After the latter posted a net user decline of 200,000 during the first quarter, it plunged 36% in a single day, and Meta went with it. While Meta's drop was much less pronounced than Netflix's, it was significant. On April 20, Meta shares fell 8%, even though there was no major news about the company on that date.
So we wonder why Meta had this behavior. Being that their businesses have nothing in common: one is a paid subscription service and the other an advertising platform that also sells virtual reality headsets. Investors may have sold Meta because Q4, when both Netflix and Meta posted bad numbers and sold off quickly, and it was still fresh in their thoughts.
But there is another more material factor that could be at play: The user counts.
While Meta and NFLX have completely different business models, they are similar in that they both publish data about their users, including global user counts, in their results reports. In the past, this was a great metric to highlight because it could show company growth in periods when financials fell short of expectations. But in 2022 it is becoming a liability. This year, services like Netflix, Facebook and Instagram lost all their Russian users in one fell swoop. The US government asked them to limit some features to comply with the sanctions, eventually being banned entirely by the Russian government. The ban hit Netflix hard in the first quarter, taking away 700,000 users. Meta will have Russian losses pictured in its own Q1 report and, in fact, the gross number of them will likely be higher than Netflix's by far.
The average investor has always been very enthusiastic about FB shares and even to this day, they still are for the business it builds. However, “wherever you go, do what you see”. The sell-off in their previous report was a buy of the moment just one day later. And the same thing will probably happen again this week when the data is known at the close of the session on Wednesday.
Meta Platforms: competitive position
What is the market waiting for? Best prices. Largely due to the company's competitive position, which has weakened somewhat in recent years. However, it's hard to pass up Meta's outstanding free cash flow performance, even though the company now has more competitors than ever, and that may be justifying a somewhat lower share price.
Currently, Meta's competitive position right now is good. It ranks second in the online advertising industry after Alphabet (GOOGL.US), and is well ahead of third-place firm Amazon (AMZN.US).
Source: Statista
Looking at the image above, Meta has a very high market share, indicating a strong competitive position. However, there are two events that may change that fact in the future.
- Changes to Apple Application Tracking Transparency ("ATT") (AAPL): which requires mobile marketers to seek consent from users to track them. Specifically, marketers will need to seek user permission to track them on apps and websites owned by companies other than Apple.
- The rise of Tik Tok.
ATT is a long-term headwind that is projected to cut $10 billion from FB's revenue this year. It's a big part of why CFO David Wehner projected first-quarter revenue to grow between 3% and 11%. Apple's ATT policy forces FB to ask iPhone users if they want their data to be tracked with that "Ask app not to track" phrase. That includes data about things like web browsing and physical location. Such data is crucial to the operation of FB ad targeting. Without it, FB can't show ads to users based on the websites they read or the dates they visit.
Unfortunately, not many people opt for tracking as only 25% of FB users on iPhone agree to be tracked. That's higher than the subscription rate when ATT first launched (11%), but still not great. Not only do these changes make FB ads less attractive, but they also send advertisers to other platforms that don't require this kind of data as much, like Google Search.
The rise of TikTok is another long-term headwind for Meta. Tik Tok is a short-form video app that is very similar to Instagram. It is currently #2 on the app store above any of the Meta apps. It's hard to say exactly how much ad revenue Meta is losing to TikTok. The app is similar to Instagram but not identical; being more focused on video, while Instagram focuses on still images. Still, the two apps cater to a younger, image-conscious audience, meaning they're competing for every potential click.
How much money it will cost Meta ATT and TikTok remains an open question. While ATT has set a goal of $10 billion, TikTok has not commented on it. However, it's quite reasonable to assume that it's costing Meta some revenue, as its audience is pretty similar to Instagram's.
Financials
Related to Meta's competitive position is its financial position. Meta's most recent quarter was a slight bust but caused a sell-off due to poor guidance for the upcoming quarter.
In the fourth quarter, Meta delivered let's remember:
- 33,670 million dollars in revenue, 20% more.
- $12.85 billion in operating income, down 1%.
- 10,280 million dollars in net income, 8% less.
- $3.67 in diluted BPA, 5% less.
It wasn't a bad performance overall. Revenue exceeded expectations and revenue slightly decreased. Also, the net margin was very healthy, 30%. However, the loss of profit combined with guidance of just 3% to 11% for the first quarter sent shares of Meta down 26% in a single trading day.
The question is whether FB can return to positive earnings growth with ATT and TikTok in the picture. Given the huge increase in Metaverse spending, 11% revenue growth for the first quarter would imply a decline in net income. Unless Mark Zuckerberg reins in those expenses, FB's profits are likely to decline again.
Of course, the balance of FB is beyond question. With $48 billion in liquidity and no long-term debt, the company can afford to get through several bad quarters. Your long-term debt-to-equity ratio is literally zero!
But in this environment of high interest rates, investors are analyzing earnings releases like never before, at least in these last two years, and the fact is that Meta's first quarter results are at risk of being worse than of the previous quarter. So short-term downside in reaction to the Q1 release is a very real possibility.
Why is Meta at risk of getting the Netflix treatment?
So far, we've broken down a few reasons why Meta's Q1 results might be a bit disappointing. Its spending on the Metaverse has increased, its competitive position has decreased, and Apple is taking a $10 billion bite out of revenue. It is a recipe for disadvantage.
Meta risks being treated like Netflix, i.e. subject to a "this company is going out of business" type of sale.
What explains it?
The one quality that Meta and Netflix share, despite their completely independent business models, is the following: User count report.
Netflix and Meta are similar in that they both report user counts prominently in their earnings releases. Until recently, that was a positive thing, but this season it can be a drag.
When Netflix released its results, it reported a large increase in earnings per share and only a small loss in revenue. EPS growth was negative, but only slightly. Overall, it wasn't such a bad report.
So what made investors nervous?
Most likely is user growth. In the first quarter, Netflix lost users for the first time in its entire history. It lost 700,000 users in Russia, where it closed its operations, resulting in a net loss of 200,000.
NFLX's subscriber count, not its finances, most likely caused the stock price to crash the day after the results. But that doesn't explain a 36% selloff. A sale of that magnitude would typically come after something unprecedented happened, and the first net loss of users in a company's history would fit the definition of "unprecedented." Not only did NFLX lose 200,000 users in the first quarter, it will see a loss of more than 860,000 subscribers in the second quarter, based on the company's own guidance that the industry would lose 2 million this quarter. Those are some scary numbers, and they will continue to be scary as long as Russia is out of the picture.
Which brings us back to Meta
Meta, like Netflix, will release the number of users in your post. Daily Active Users ("DAU") are among the company's most viewed metrics and attract outsized media coverage. Typically, Meta reports very strong user growth, particularly internationally. But in the next release, Meta, like Netflix, has to deal with the Russia factor. In response to Western sanctions on Ukraine, Russia closed Facebook and Instagram within its borders. Russia was 1.4% of Meta's global user base before the ban. Thanks to the shutdown, Meta will likely need to report a decline in global users in its next report. If investors react to that the same way they did to Netflix's declining user base, the stock could quickly lose value.
Meta shares fell immediately after the Netflix report, so it could be that the possible global loss of users is already priced in. However, another round of sales should not be ruled out. In this increasingly fragile economy, investors are feeling nervous, and you never know when even a "sort of" earnings release will trigger a sell-off.
Background
While the report should be positive overall, global user growth is likely to be the worst in company history. And the market is looking for the best position after its results are published. However, fundamentally it would again be a great entry point.
Why?
Because the sale that is being discounted would not have a “rational” justification, basically. As we saw with Netflix, investors will sell shares due to declining user numbers, even if the results themselves are good. In this value-hungry market, investors are seemingly looking for any excuse they can find to dump technology for energy, or transportation, or whatever the current value sector is in vogue.
What they seem to be missing is the fact that this year's tech sell-off has created value opportunities in the tech space. At today's prices, Meta is trading at just 13.3x earnings and 8.7x operating cash flow. He also has $16 billion in cash, a figure that rises to $47 billion if short-term liquid securities are included. Its gross margin is a staggering 80%, and its return on equity is one of the highest of any big tech company. Meta is, simply put, a highly liquid and financially stable company that has enough cash in the war chest to weather any crisis. If the expected correction comes, will you buy more or go short?
Technical Analysis
Mark Zuckerberg's company doesn't look good either, from a technical point of view. It seems that investors are seeing similarities in the behaviors of both companies, both NFLX and Meta. Even the percentage variations are similar.
Therefore, while a bounce could happen, we prefer to watch the glass bottom towards previous lows, coinciding with the lows of the coronavirus pandemic in 2020, at $136.
Darío García, EFA
XTB Spain
