Image: Facebook’s free cash flow generation remains robust. Image Source: Meta Earnings Presentation Q4 2021
By Brian Nelson, CFA
We like simple ideas — underpriced investment ideas with moaty characteristics, net cash rich balance sheets, tremendous free cash flow generating potential that are tied to secular growth trends over the long haul.
The company formerly known as Facebook, now Meta Platforms (FB), has had all these things going for it, but it is no longer a simple idea. That doesn’t mean we’re abandoning ship, however. No story is perfect.
Nevertheless, we’re putting Meta Platform’s fair value estimate under review following its fourth-quarter 2021 results, released February 2, and while we expect shares to still come out underpriced following our model update, the number of headwinds against the social media giant continue to mount.
Here are just a few:
1) Expected revenue growth in the first quarter of 2022 of just 3%-11% on a year-over-year basis, a range fully below the consensus number
2) Growing competition from the likes of ByteDance’s video app TikTok and the need to compete using Reels, which monetize at lower rates
3) A capital spending profile that has simply exploded due to investments in the metaverse, data centers and the like, to the tune of $29-$34 billion in 2022 alone
4) Headwinds from Apple (AAPL) iOS changes when it comes to running effective advertising campaigns
5) Massive negative publicity from the Wall Street Journal’s ‘The Facebook Files’
6) Antitrust scrutiny surrounding some of its prior deal-making practices nearly a decade ago
Facebook used to be a clean(er) story, but the company is now against the ropes and is being hit from every direction. It’s difficult to handicap and quantify these headwinds within the valuation context, but from a cash-based standpoint, it boils down to slowing revenue growth due to iOS headwinds and negative sentiment, tighter margins as it deals with competition and policing its platforms, and slower free cash flow growth due to significant capital spending plans – with negative tail risk from legal issues arising from privacy and antitrust concerns.
The pressure seems to be getting to Zuckerberg and company, as its fourth-quarter 2021 results could have been better, with the social media giant missing bottom-line expectations, despite a solid beat on the top line. Quarterly revenue jumped 20%, but due to a 38% increase in total costs and expenses, operating income fell modestly on a year-over-year basis in the period, as its operating margin shrunk a full 9 percentage points. Diluted earnings per share dropped 5% in the final quarter of the year.
There’s still plenty of good news, however.
With its newly released guidance, Meta Platforms may have set the bar low for a big upside surprise this year (we still believe in the leverage in its business model). Total cash and cash equivalents stood at $48 billion at the end of the year against a debt-free balance sheet, revealing substantial financial flexibility. Traditional free cash flow generation continues to be fantastic, coming in at $39.1 billion in 2021, up from $23.6 billion in 2020. We note, however, that capital spending during 2021 was $18.5 billion, and the step change to $29-$34 billion in 2022 will not be insignificant to potential free cash flow growth.
Concluding Thoughts
The company formerly known as Facebook, Meta Platforms is facing a long list of headwinds from moderating revenue growth, tightening margins, slowing free cash flow expansion due to rising capital spending, and tail risks of the regulatory and antitrust variety. We expect a downward revision to our fair value estimate of Meta upon the next update to factor in these dynamics, but we still believe shares are undervalued.
We’re very surprised by the aggressiveness of the market sell-off after the release of fourth-quarter 2021 results on a company that we thought had already priced in an adequate margin of safety for consideration. We’re not making any changes to its position in the simulated Best Ideas Newsletter portfolio, but we’d like to see some bottoming before considering allocating a higher “weighting” to the name. What was once a simple story has become one of the most complicated on the Street.
Though we would have liked to see things go a different way the past few years with Facebook, we’re not panicking. We’re sticking with Meta Platforms. Please expect our updated fair value estimate and report in the coming days.
Tickerized for FB, SNAP, PINS, TWTR, SOCL, MTCH, BMBL, MVRS
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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.