Chit Chat Stocks - Meta Platforms (Ticker: META) Not So Deep Dive

Episode Date: January 24, 2023

Meta Platforms develops products that enable people to connect and share with friends and family. The company was formerly known as Facebook and changed its name to Meta Platforms in October of 2021. At the end of the month, we will publish an Arch Capital episode that will cover the company: Alphabet. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Meta. Enjoy the show! ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (3:10) Industry | (17:40) Management & Ownership | (20:00) Earnings | (30:07) Balance Sheet | (34:42) Valuation | (39:20 ) Our Analysis | (40:17) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Okay, welcome in. Welcome to Chit Chat Money. My name is Brett Schaefer, and I'm joined by my co-host, Ryan Henderson. As always, today is our Tuesday not-so-deep-dive episode where we analyze

one stock by covering its business model, ownership, financials, and future growth opportunities. We do one of these every week. So if you're new to the show, or you just found this on your podcast player or on YouTube, just follow the show and you get one of these analysis shows every week. We really try to turn them out with high consistency. After listening to one of these episodes, we hope you get a better perspective on the company. Today, we are covering Meta Platforms, the owner of Facebook, Instagram, WhatsApp, Oculus, and as we'll probably discuss, Mark Zuckerberg's Metaverse project. So this is the old Facebook company,

as I think most people are well aware of. But before we get to the episode, here are a few housekeeping items for everyone. We'll go through these quickly. If you're a regular listener to the Not So Deep Dive episodes and you enjoy these, you're going to want to subscribe

to our free newsletter that gets your show notes and the charts and all the analysis that is written or tables or whatever we talk about during each episode. The link for that will be in the show notes, or you can search Chit Chat Money on Substack. It'll pop up. You can subscribe for free.

If you like watching these episodes instead, where you can see us do screen sharing with the charts that we talk about with the analysis, you can do so on either YouTube or Spotify. And if you enjoy the show, give us a review on either Spotify or Apple Podcasts. Today's episode is presented by Stratosphere, the best web-based research terminal for your company-specific metrics like KPIs and segment revenues, which we're going to be using to analyze meta platforms. Today, Stratosphere has clean data for KPIs, segment data that is triple-checked for accuracy, and beautiful data visualizations helping save you time and frustration digging through all those SEC filings, which as we know, are not very

readable. Stratosphere makes those way more readable, way more, excuse me, accessible than looking on any investor relations page, which we all know are a pain. We use Stratosphere as our investing home screen and research terminal, and you can too for free by going to stratosphere.io. That is stratosphere.io. The link is in the show notes. Okay, Ryan, we're on big tech for our theme for january and it's always a mouthful to describe what they do so why don't you try to go and as we've talked about as succinct as possible what meta platforms does yeah this one's a little more obvious i would say i think um compared to like looking at amazon and microsoft there's probably some revenue drivers under that under those hoods that maybe you're unfamiliar with i think most

people understand what drives Facebook or Meta Platform's business. So I'm not going to go too long on this, but basically Meta now splits up its business into two segments, family of apps and reality labs. And this started, I want to say almost four quarters ago now. It started in Q1 of 2023 and they're about to report Q4. So we've now seen this for about four quarters. You would think since there's two segments that they both contribute meaningfully, but they do not, Family of Apps dominates the business in terms of revenue. So for reference, over the last 12 months, Family of Apps generated $115 billion in revenue out of $118 billion for the consolidated business. And they were doing that on a 42% operating margin. Just to provide some more

context here, Family of Apps consists of Facebook, Instagram, WhatsApp, and Messenger. Facebook Messenger got split out a couple of years ago, probably five years ago now from Facebook to its own app. It has its own monetization methods as well. As of the latest quarter, Meta estimates that 3.7 billion unique people use at least one of these four properties every month. So talk about scale, talk about reach. And then on the revenue generation side, I mean, everyone knows how these businesses make money, which is ads, but it's actually kind of when I was researching this, I wanted to get a better grasp on the actual advertising process.

If you're a business and you've ever run an ad on Facebook, you know how this works, but it's a really comprehensive platform and it's very customizable. You can run ad campaigns based on what you're trying to achieve. So whether that's brand marketing, reach, clicks, product redirects, that kind of thing, trying to move them to a certain site, trying to get them into a retail place. It has basically, I think it's 11 different strategies that you can run one under. It's got a whole bunch of different properties. So you could target certain aspects. You could say, I want a five-second ad in Instagram stories, or I want to display ad within Facebook's newsfeed, that kind of thing.

Or you can basically, there's another option which just says, Facebook, you do, here's what I want. Here's my budget. You go out and place them where you think they're best fit. And so this has, I mean, I think it's proven to be really valuable for a lot of small businesses. It's very effective. It's the second largest advertising business in the world behind Google. Is it number one over Google? oh no way it's not it's not are you talking about digital advertising no just pure on the advertising side uh no google's close google's about 200 billion so no i okay i thought there was a big chunk of that that didn't come from advertising it's not that far away um i can confirm i guess if anyone's interested but i i don't know if it's too relevant for the show i guess i maybe said it is not it's second it's second but it's not that far away google search does $40 billion in revenue each quarter on its own, and then they have more advertising as well. But as a teaser, we'll be covering Google two weeks from now. So we'll know for sure. We'll

have some numbers to back it up then. Yeah. And then WhatsApp is the other element here. This has been, I think, painfully difficult for Facebook to monetize. And there was even a point when they announced that they were rolling out ads on WhatsApp's platform a couple of years ago. And basically, there was a protest among WhatsApp users that they didn't want this. And so Facebook kind of clawed back that policy and said, we're not going to do that. And so they're trying to find a number, a couple of different ways to monetize now. And I think they have found some ways that are working pretty well. And Brett's going to talk about that later in future growth opportunities. But this includes click-to-message ads, which we can talk about in

a sec. It's basically when someone sends, it sends people that click on your ads, if you're a business directly into one of their messaging places. So click to WhatsApp would send anyone that clicks on your ad directly into your business WhatsApp account. So you could directly message them. There's payments as well. And there's even shopping, which they recently rolled out with GeoMart in India. But that's, I mean, the bulk of this is just advertisers coming to Facebook trying to advertise across its four or three big properties in Instagram, Messenger, and Facebook. The other element here, Reality Labs, this includes primarily the MetaQuest ecosystem, but it also has Facebook portal products. They don't break out how much is explicitly Facebook

portal, but you can guess the bulk is going to be MetaQuest. If you went to the MetaQuest store right now, you can buy one of three pieces of hardware. And I guess it's two pieces of hardware, but you can also buy accessories. You can either buy the MetaQuest 2 for $399. And that is meant to be sort of the all-encompassing VR headset. I would say it caters more towards kind of the gaming entertainment crowd. And then the MetaQuest Pro, which is $1,499. This is meant to be a more professional level VR headset where you are maybe using it in professional settings for VR meetings, which sound awful. But it's meant to have applications outside of gaming, essentially, meant to be sort of their higher end product. And then beyond hardware,

Meta also develops its own games and apps for its ecosystem. The most notable would be Horizon worlds i kind of think of this as like a poor man's roblox and horizon worlds has actually been around for a long time but this is um the reason i say it's more like a roblox is creators can create within the horizon world ecosystem so you can create experiences within horizon worlds if people transact in your horizon world experience um meta takes a percentage of that transaction and then the other part is once again if you go to that meta quest store you can buy different games. You can download different games. Some are free, some are paid, some are like workout things, some are Star Wars simulations. And Meta basically has a 30%

take rate in kind of looking through some online chat rooms among developers. I think they have a 30% take rate on any third-party transactions. I imagine there's probably some other monetization avenues within the MetaQuest ecosystem. So I would think promoted games on the MetaQuest site would be one, but they really haven't broken that out anywhere. But just in terms of size, in the last 12 months, Facebook Reality Labs generated $2.3 billion in revenue. So compare that to the $115 billion from Family of Apps. It's obviously much smaller, but they reported $13 billion in operating losses. So they're investing heavily into this. That's kind of no secret. I think anyone that's listening to this probably already came into that knowing, came into this episode knowing

the situation. But I do want to provide some history and I'm not going to, similar to last week where we talked about Amazon, I'm not going to tell the Facebook founding story if you want to. I guess you can go read social network or go watch social network if you want. I know that The Zuckerberg doesn't think that's a very accurate telling. But did I miss anything as far as business-wise? I don't think so. We'll hit the nitty-gritty in some of the analysis and all that stuff, but I think that covers it. Okay.

So let's talk about the last couple of years. Let's start with 2020. From what I could find, and there may have been some rumblings about it before, That was the year that Apple announced its new mobile OS would prohibit advertisers or apps from tracking users unless the user explicitly allowed it. And I think everyone kind of knew this. This was the IDFA changes. It's the changes in ATT, if you ever see that abbreviation in their conference calls. And it made it very difficult to kind of pair advertisers with users as effective as it had been in the past or as effectively as it had been in the past.

And shortly after that, in the fourth quarter of 2020, Facebook had this now kind of iconic conference call where you could almost timestamp right there the shift in focus from the company. Zuckerberg said, we increasingly see Apple as one of our biggest competitors. And then he kind of goes on, Apple has every incentive to use their dominant platform position to interfere with how our apps and other apps work, which they regularly do to preference their own. For reference, in Q1 of 2020, the term VR was only mentioned a single time and the word metaverse was never mentioned at all. So by the end of 2020, they had almost entirely... And by 2021, they had changed the entire company's name. So a year later, in February of 2022, the company announced that it would begin reporting its revenue in the two categories I mentioned, Facebook, Reality Labs, and then Family of Apps. And then three months after that, so this is actually 2022, I believe it was May 2022, the company formally changed its name from Facebook to Meta Platforms.

I think, and they were always kind of investing in the VR side, but because they had bought Oculus in 2014 for $2 billion, they were obviously still spending money in that segment and kind of ramping up spend. They talked about it just briefly on every conference call, but it was really throughout kind of Q2 and on from 2020, the spend started to ramp. And then after that kind of iconic conference call, it was clear this was Zuckerberg's focus. He no longer wanted to have to pivot his entire business model because the platform that he dominates decides to change its rules. And I mean, he's not alone in thinking that. There are a lot of businesses, any advertising-based businesses probably had similar thoughts to Zuckerberg. Any app-based business, really. Yeah. So this is where we are now. He is on a quest, no pun intended, to build his own computing platform, the next generation of computing platforms. And they're spending a lot of money there, but they still have that cash cow in the family of apps. And we'll talk a little bit more about that later on. You want to talk about the kind of industry and landscape? Yeah. So this one, it's fairly simple. It's not as complicated as a Microsoft or an Amazon, but Meta operates in two industries, like Ryan mentioned, digital advertising and virtual reality. And you might expand virtual reality out to what Zuckerberg and the Meta team might describe as the Metaverse, but I'm still unsure of what the Metaverse actually is. There are also some messaging features in WhatsApp and Messenger, the shopping stuff, the payment stuff, but those are really small parts of the company right now.

But looking at the digital advertising industry, it is large, but still growing steadily. Global spending is estimated to have hit $600 billion in 2022 and could get over $1 trillion by the end of this decade as budgets from linear TV and other places move online. The virtual reality market is a lot smaller at estimated. The third-party stuff I was looking at really varied, but I think about, I looked at something that said $21 billion last year, which makes sense to me. And third-party analysts predict it will keep growing in kind of the double digits range for the foreseeable future, which would make it, even by the end of this decade, still well under $100 billion opportunity. I think this is a good point to talk about this because it revolves

around the industry, is the virtual reality market too small for meta to go after? Or if they build it, will people eventually come? Because of the way I look at it, if there is $20 billion in total spending right now, and say they end up eventually selling stuff at cost, like a lot of these hardware providers do, say like an Xbox or PlayStation or other gaming stuff. And in the future what if there's 20 billion dollars or say in software revenue on that 30 percent you know stuff that that ryan mentioned earlier how it doesn't equate to in my mind to burning 10 billion dollars a year you're never going to make that up so i can what do you think is the industry too small or is there the potential well i think no one no one knows what the size will be in 2030

If Meta really succeeds, and this is the assumption that the demand is there, which is, I think, a bold assumption at this point. If Meta really succeeds building out the technology, I think they would obviously expand the TAM themselves. Yeah, it's got to be pretty damn big if you're going to burn $10 billion a year for 10 years. I'm going to reserve my opinion on whether or not I think the TAM will be there. We'll hit it at the end of the episode, yeah. But yeah, I think they can build it out themselves. All right. And if we look at competitors in advertising, these are the ones they mentioned on the annual

report, and these are definitely the ones that are the biggest competitors. You have Alphabet, number one, and you have someone like Amazon, who is definitely trying to encroach within the shopping advertising as well as video advertising, which is not a giant competitor to some of Facebook's, or excuse me, Meta's products, but I think the shopping stuff could be really... Amazon's shopping, advertising

stuff can be maybe encroaching on Instagram a lot, since that is a big where people get inspiration for shopping. You also have Apple with their app store advertising and really they talk about them being competitors just because of the stuff they... the

restrictions that Ryan talked about. There's also So ByteDance, I misspelled the company, but that is the parent company of TikTok. You have Microsoft, you have Snapchat, you have WeChat, and Twitter. I like how Twitter and Snap are competitors, but we saw a huge decline in revenue over at Twitter. And there were some theories floating around that that could flow to Alphabet and Meta, but they're just much smaller. So it's not going to be relevant either way. if we look at the competitors in virtual reality i think this one is more interesting you have sony and then you're going to have microsoft slash xbox eventually within gaming they're most likely

going to launch something sony already has a vr hardware that people can do uh or use there's also some smaller ones from upstarts like i think it's h what is it htc it's called voo it starts with a v i can't remember how to say it but the most important is apple who has apparently been working on something for many years within the augmented reality and virtual reality space and is rumored to launch this year although they continually push it back so we'll see they're not going to release it i guess until it's ready as apple does they wait a long time until something is fully fully ready for uh for the market and when that launches that'll be the big competitor for meta who is trying to bring their virtual reality and augmented reality hardware outside

of gaming, which is why I say that Apple is also the most important competitor within that market because the gaming market is going to be too small for how much Meta is spending on R&D. All right. Management and ownership. This is an important one. I think it's an important section because there can be a lot of positives and negatives you can find from companies that have the unique ownership structure like Meta. As we all know, the CEO is Zuckerberg. Zuckerberg owns almost all of the Class B shares, giving him greater than 50% voting power. Curiously though, Zuck has been a consistent seller of his shares with his voting power decreasing from 67% in 2013 to 56.9% today. I wrote a questionnaire.

It's kind of rhetorical to myself, but I think we could see that trend continue over the next decade because he's consistently selling for his charitable foundation. And then the other thing on ownership, the last thing that I thought was important was the alleged co-founder of Facebook, Eduardo Saverin. still owns 2% of the stock and some class B shares that give him 7.3% voting power. He could have some, this isn't that big, but say Zuckerberg's voting power dips significantly below 50%, that could be meaningful. But at this point, it doesn't matter because Zuckerberg has that majority voting power and it's still a dictatorship, which I think is the most important thing for people to track here going forward and really understand about this business. Zuckerberg can do whatever he wants with no repercussions. Moving on though, in 2022, Meta went through

multiple executive shakeups with longtime COO Sheryl Sandberg and CFO Dave Weiner leaving their positions. It looks like Zuckerberg decided to hire internal people to replace these roles with no outsiders, at least from what I could see on their new board of directors stuff, or excuse me, their governor's page. Now, if we look at the board of directors, it is made up of some other tech founders that I believe Zuckerberg is friends with. That would be the DoorDash founder, Tony Zhu, the Dropbox founder, Drew Houston, and then some other executives from some stuff that would make sense. You also have Mark and Sheryl Sandberg on the board of directors. So Sheryl Sandberg is also on the board. And then Mark Andreessen, who is the really famous venture capitalist who

invested early in Facebook. And as well, Peter Thiel and Reed Hastings used to be on the board. Reed Hastings left a while ago and Peter Thiel just left. Here's something that I was looking at with the proxy statement, the board of directors, the executive team. Are you worried that Zuckerberg has surrounded himself with too many yes men recently? And that's a worrying trend for this company. Yeah. I mean, one of my lowlights here is the CFO departure at this time. I also think we own Dropbox. We know who Drew Houston kind of is, and I don't think he'd challenge Zuckerberg on anything

if push came to shove. I don't think Tony Zhu would either. And then I think it's telling that Reed Hastings left the board. Yeah. Yeah. Rumors were, I remember it wasn't good. He left because he was upset about that they weren't being... All the stuff that Facebook has gotten in trouble with over the last five years. Now, let's look at executive compensation though. They follow the standard three-tiered approach. They got base pay, annual cash bonuses, and equity awards that vest over four years.

The base salaries are pretty light for all the executives that are under $1 million a year, which is very, very reasonable for a company of this size. The cash bonuses are all based on unquantifiable metrics. Let me just share the screen here, Ryan, so you can see these. Because when I say unquantifiable, they are unquantifiable. And I'm going to zoom in. I know the zoom takes a while to zoom in here. Okay. For the podcast listeners, here's what their metrics are for cash bonuses. One, continue making progress on the major social issues facing the internet. Two, build new experiences that meaningfully improve people's lives. Three, keep building our business by supporting the millions of businesses that rely

on our services. And four, communicate more transparently about what we're doing and the role our services play in the world. So really, they're going to get the bonuses because that's just made up nonsense. But either way, the bonuses aren't that they're not the largest percentage of the compensation. And I think they just did that because a compensation consultant told them to and here is what i think the odds are they look at this thing and they go yeah you know what we deserve nothing for this yeah i'm pretty sure they got him this year um but i don't remember exactly and if we look and again so the big thing they talk about is the equity pay it's all in rsu's they've asked over four years um there are no performance metrics

attached but remember i talked about the executive turnover and here's a quote that concerns me from the proxy statement that relates to this executive turnover. Quote, we use executive compensation to align our executive officers' financial interests with those of shareholders to attract industry leaders of the highest caliber and to retain them for the long term. Well, I would hope, look, in the past, they've had long tenured executives. Sandberg has been there for a long time. Their CTO has been there for a long time. I forget who else has been there for a long time, but they did have that. But recently, we've seen the executive turnover, and I wonder if this is changing. Also, as a side note, it just shows that no matter how much equity compensation you

give to executives, it doesn't matter. It's whether they want to stay there or not and work on the products. Lastly, Zuckerberg famously has a $1 a year salary that they market to, I don't know, they talk about that a lot. However, he does get paid a whopping $26 million worth of security measures and private aviation paid for by the company each year so I kind of said this is a little bit of a gaslighting because that's it's 26 million dollars in compensation

and really it's a salary I mean I assume the security spending will go down as he continues to work on his taekwondo well that's a fair point also a joke also will the security be needed

if we're in the metaverse so it's a bit of a um okay i mean this either way it's a lot it's a lot of money i mean we looked at bezos who is probably more hated by people and would need security measures it was maybe equally no i would say zuckerberg now is probably more i think after politically i think there's really a lot of people that just think he like you know got rid of trump and that probably calls for a lot of people don't and not like them yeah and plus yeah either way both both have both have uh security concerns that are warranted and when we saw bezos it was significantly less so i just i

was just a little concerned about that like you're paying 26 million dollars a year for security i mean come on uh but either way let's move on no giant red flags outside of that dictatorial ownership structure but really i it's always a feel with the proxy statement but i didn't like the Metaproxy versus the other big tech companies that we've covered? It feels like he has surrounded himself with people

where or maybe at least in the past he's like, you know, I really want everyone's thought. I really want everyone's input until he's challenged and then he gets rid of them. I imagine that's what happened with Reed. I imagine Reed didn't want to be on the board anymore and

there's probably some conflict where Zuckerberg they didn't see eye to eye Reed Hastings, Netflix CEO I like that they got rid of Teal though he's kind of gone off the rails if we're being honest I'm fine with that too

but the CFO departing I have to imagine my thought is that he had some concerns about the spending and Zuckerberg and him probably didn't see eye to eye on it and so i just don't well here's something that it does concern me that he can you know

yeah it is a dictatorship so here's just something that um okay you know how people talk about their repurchase program and how they peaked it in 2021 i wonder if there was a conflict between the finance department and zuckerberg where they were miscommunicating on how much they were going to spend in 2022. Because let me just share this, and we'll talk about this as a low light. But if we look at the Stratosphere chart here, and I'll describe it for anyone that's listening,

their buybacks on a quarterly basis started peaking in mid to late 2021. Overload the stock price. Okay, either way, just scroll up here. That's where the stock price peaked. So while they were buying back stock, as the share price peaked during the COVID bubble. and now they're not buying back stock at all. And they depleted probably, I haven't added up here,

basically the peak was $20 billion in one quarter, and then they did $10 billion, and then $13 billion, and then like $7 billion. It was 66. I think since the start of 2021, they bought back 66 billion in shares. Okay. So during the bubble period, so we'll discard this year, maybe let's just say 50 billion. That is a meaningful amount of money. And I wonder if there's a miscommunication between the two people because you'd have to be, if you're the CFO, you'd have to be very, very incompetent if you knew about all the spending in 2022 and what the numbers were going to look like to have bought back the stock. So I just worry that there's no focus from Zuckerberg on the finance department. And then that's why they may have butted heads or the CFO wasn't good at his job and that's why he's gone now. But either way, let's move on.

what do we got next, Ryan? Earnings? Yeah, earnings. I had a difficult time kind of trying to figure out what's important here because I guess my hiccup is I have a hard time predicting what they're going to earn any of the years out. Next year, year after, it's just difficult to tell. But just in terms of the last 12 months, $118 billion in revenue, That was up 5% from the 12 months prior. All of that pretty much is family of apps. $35 billion in operating income. That was down 25% versus the 12 months prior. And then $54 billion in operating cash flow, but just $26 billion in free cash flow. They spent $28 billion on CapEx in the last 12 months. It's worth noting, we haven't really talked about this, they're investing a lot in AI, which I know every company is, but basically the server requirements are much more expensive. They need more compute room, compute power. As you can tell, Ryan is an IT expert here.

Yeah. And so basically, they're spending a lot on data centers. And that's driving a lot of the CapEx increases. And the AI investments are meant to power the discovery engine in reels and newsfeed and basically just helping people find new content. Yeah. And for anyone that doesn't know, Face or Meta has their own internal data centers and really at their scale, they have their own internal cloud that they use for all their different assets. And theoretically, if this AI is good enough, it potentially replaces some – well, first of all, it would have benefits in terms of ROI and basically more time spent from users, but also potentially replaces some roles and save some money in the long run, despite having some expensive CapEx requirements in the near term. So anyway, the number to take away, I guess, $26 billion in free cash flow over the last 12 months. Most recent quarter, though, revenue actually declined by 4%. It would have been up slightly on a constant currency basis, but with all the FX headwinds they saw, revenue was actually down. Active users are still growing gradually. They have continued to grow despite just an unbelievable scale.

But the average price per ad is coming down. And that's due to both the macro difficulty. A lot of companies are pulling back on their marketing budgets. I don't think that's a surprise, but also the shift towards reels. So reels right now is a headwind to monetization because it doesn't monetize at the same level as other ad placements, but they're seeing the demand for it. So they've had to go through this cycle before with stories where it's a headwind to monetization, but it helps them stay alive, essentially. And it helps them compete against new platforms.

They also had the same thing on mobile when they moved from desktop to mobile. So they've gone through that cycle before. I think it's ultimately, if I had to guess, five years out, I think there's going to be more money spent advertising across Facebook's properties. Operating margin was 20% this quarter versus 36% a year ago. And then just in terms of guidance, and I think this is what's probably scaring a lot of investors, management expects total costs and expenses to be $94 billion to $100 billion next year. That's up 13% year-over-year. They expect CapEx to be $34 to $37 billion. That's up 14% year-over-year. And then the only real sort of earnings guidance they've given is they want to grow operating income in the long

run. So it's difficult if you have, especially like we don't know what revenue is going to look like. They probably don't know what revenue is going to look like entirely, just given some of the advertising pullback. So that's why I say, if they're really committed to spending this much money, I have no idea how much they're going to earn next year or the year after. People might have their own projections, but it's hard to tell. That's why when we do the valuation, we will talk about why the stock looks so cheap. I think that is exactly why. Forward earnings are very unpredictable right now. Yeah. All right. Balance sheet and liquidity, this is a pretty straightforward balance sheet, especially compared to the other tech companies we've looked at. Cash, they got $42 billion in cash and short-term marketable securities. It's all pretty much just US and corporate debt securities. Most of the debt matures in the next 12 months, so pretty standard in that front.

They do, however, have $6.5 billion in long-term equity investments. I have really no idea what's in this. I assume it's probably a lot of private investments. They have a $250 million investment in Giphy, which I don't think they can get rid of. And they tried to acquire them, if I'm not mistaken, and it was blocked by UK regulators. So that should probably tell you how they're viewed in the eyes of regulatory uh they're hated by everyone they're hated by the government they're hated by people that hate the government they're hated by the people that want to overthrow the government no one likes not no one no one likes them yeah i mean if they can't close on a acquisition of gifts i'm not sure they can close on anything they actually even try to close on

like a workout um a workout app for their uh for meta quest and it was i believe like blocked so that could have been the next instagram run who knows yeah apparently um anyway debt they've got 10 billion dollars in long-term debt so they actually raised this in august um last august of 2022 it's the first time they've ever raised debt as far as i can tell i love when they talk it's our inaugural debt offering like yeah it makes it sound like there's more coming but we'll see um it looks pretty cheap i guess it consists of a mix of 2027 2032 2052 and 2062 notes and has an effective interest rate just under four percent look at i mean this is another example of mismanagement at the finance department look it's hard to be a hater why did they raise this in 2021

Exactly. 2019, 2020, 2021. Look at the giant companies out there. Look at the best run finance department out there. Apple raising $100 billion of debt. Meta could have raised $100 billion at really, really cheap multiples. It would have been before all this metaverse stuff too, which means they would have gotten probably not only lower debt from just a lower interest rate regime, but also if they were earning $55 billion in free cash flow versus $25 billion today, I think. right they would have room to do it even a lot more and just for reference for people that maybe i just as an example here to to show how much because they would have been able to get probably even cheaper debt than this company electronic arts got i believe it was 2032 notes at sub three percent no and that is basic standard bond i think uh so think about how cheap they would have got that they would be able to offset all the interest expenses now through um interest income so again i just think the finance department big low light we'll talk

about it later we'll probably harp on it again but anything else ryan i mean it's not them isolated either i think obviously there was poor communication to the finance department of what they expected to do um because there's no way if if it was articulated to them that they're going to spend however much they have on the metaverse or on CapEx for AI investments, that they would have done what they did. So yeah, I think obviously a lot just mismanagement all around. Lastly, I'll say basically $30 to $35 billion in net cash. It depends whether or not you include the long-term investments. I probably wouldn't. Maybe you include half of it. I don't really know. And then it also matters whether or not you include the operating leases. A lot of the

platforms, a lot of the data aggregators include the operating leases, which would basically make the enterprise value closer to the market cap. Ultimately, I would just think about it as the enterprise value is about $15 billion to $30 billion lower than the market cap. Yep. And that leads right into valuation. I'll keep this one short. Pretty easy. $370 billion market cap. Enterprise value I have at about $331 billion. And I'm looking at three metrics for this one. EBITDA gross profit, EBITDA operating income, and EBITDA free cash flow. I think that kind of shows three different things. EVD gross profit looks at maybe closer to that core earnings potential from the advertising business than what the operating income would look like for when you combine all the crazy investments they're doing right now. And then free cash flow looks at stuff after their huge capital intensity recently. So EVD gross profit is 3.5. EVD operating income is 9.4. And EVD

free cashflow is 12.6. All three are well below the market average. So there's not going to be any... The gripe here or the analysis here is not whether the stock is cheap based on their training multiple. But let's move on then. Anecdotal evidence, Ryan, what do you got for us? Yeah, actually, I no longer... I mean, I think I have a Facebook account. I think I probably logged into it maybe a couple of times in the last year just to make sure I'm not missing anything super important. You're an MAU three times a year. There we go. I'm not on Instagram anymore. I don't really use WhatsApp. Maybe if I'm traveling internationally and the person that I have to talk to someone who doesn't have iMessage, then I would maybe

use it. But really, I don't think I've used it in like two years. My friends still use Instagram a though. Not so much Facebook. From what I've seen, because I think this is boring anecdotal evidence if I don't say anything relevant, Reels really has taken off in adoption. We've also seen the contraction in TikTok consumption in the US. I think a lot of that has to do with competitive threats from Reels, from YouTube Shorts. I think they've done a really good job garnering demand and and kind of um integrating short form video into their user experience on both facebook and instagram yeah they mentioned that 20 of time spent on instagram is now reels which is nice i guess for anyone that's worried about the tiktok threat i gotta

say though i tried we're gonna cover google you know recently i did try youtube shorts and i say That stuff is insane. I mentioned that on another episode we did. It really scared me. But either way, I'm going to humble brag again, like Ryan, and say that I do not use Facebook or Instagram, but I do have experience with WhatsApp when living in Mexico for a while. The app is very prevalent in Latin America and Asia, just like the numbers say. And the usage is very ingrained within messaging, almost like a combo of email and messaging of how we may look at it in North America and Europe. and it has a more social feel to it it's almost social media like it's maybe more like a snapchat

for younger people uh not exactly the same but it's a bit of hybrid you know it's kind of its own thing uh yeah they actually had stories on it in mexico that are fairly popular with the locals to use that i saw and the two things i wanted to talk about or the question i had is i wonder whether they're having the same success in africa as they're having with whatsapp in latin america which would just be Mexico South and Southeast Asia and India. I have no idea. Ryan, you probably don't know. You know as well as I do,

but there will be 2 billion people in Africa soon. They're all going to be coming on the internet. And I just wonder whether they're gaining the traction or if there's another upstart there. But let's move on to future growth opportunities, Ryan. We got two here and it's kind of the key ones outside of the reality labs debacle and that is Reels and WhatsApp.

So you got Reels. What do you think? Yeah. For people that don't know, this is their short-form video competitor to TikTok. I think it was launched at some point last year. And it exists on both Facebook and Instagram. So it's not just Instagram Reels. And then I guess in the second quarter, management mentioned that Instagram Reels was on a billion-dollar revenue run rate. And then a quarter later, so the most recent quarter that we've seen, they said Facebook and Instagram Reels together combined were at a $3 billion revenue run rate. Ultimately, unless Facebook Reels is twice as big as Instagram, that means it's growing pretty quickly. In terms of demand, here's what management had to say. They said, there are now more than 140 billion Reels played across Facebook and Instagram each

day. That's a 50% increase from six months ago. Reels is incremental to time spent on our apps. The trends look good here. And we believe that we're gaining time spent share on competitors like TikTok. I think we're starting to see that in the numbers now. This is going to be a lag to revenue as advertising on Reels grows because they're not able to target it quite as effectively as they do in other parts of their digital properties. But I think this is important to keeping engagement high. And I wouldn't be surprised if over time, they were really able to increase that monetization

like they did with stories. Yeah. If you're a shorter term trader or a shorter term investor, which we're not, that's not how we look at it generally, but you could add up things like the advertising slowdown that happened in 2022 is only a shallow slowdown that's going to recover in 2023. They have foreign exchange

recovering. And then you have Reels that, along with WhatsApp, which I'm about to talk about, it's a pretty compelling case for revenue to really accelerate. So my future growth opportunity is going to be WhatsApp monetization. There are multiple products that seem to be working together to drive strong revenue growth on top of the core messaging and social platform. They have click-to-message ads, they have payments, and they have shopping. I have a link for the newsletter subscribers, which again, it's free. It's just a part of every episode for the Not So Deep Dives that goes through a lot of the stuff they're adding on for WhatsApp. And these are not really in North America.

These features have launched in markets like Brazil and India. My only gripe is that they're not really investing faster to launch these products around the world. With 2 billion DAUs, which are daily active users, and North America now as its fastest growing market, according to management, there could be tens of billions of revenue potential for what's to go after this second. I wonder, that's really, really meaningful for them. And I just wonder how fast that's going to grow. But either way, I think it's a fantastic growth opportunity, especially with some of the emerging markets as they become more online, more spending on e-commerce, stuff like that. All right. Highlights and lowlights. Ryan,

would you like, dislike about this business? Highlights for me, I mean, I think there's been a lot of questions over time about the durability of individual social media apps. But I think Facebook's core family of apps has really done a good job proving that they're durable. They've been able to integrate all the popular new trends into their apps and basically steal that engagement back anytime there's a competitor that's popped up. um they've adapted really well over the years stories reels shift to mobile i know uh zuckerberg's love loves to highlight those i just think those are going to be around for a long time and be big cash cows um also obviously one of the best places uh on the internet to advertise if you're

trying to get effective ad dollars um business wise from the advertiser's perspective yeah and then just as a note here i'm sharing the screen for the video watchers but it's in a chart of arpu uh that is on stratosphere.io and it's just a nice kpi that highlights when you think about meta you get concerned and we've talked about this before and our in reality we were bearish on meta like two three three four two three years ago and we were right for the wrong reasons because we thought that there was a total stagnation within usage among facebook and Instagram. And this chart here is ARPU, which is average revenue per user on an annual basis from 2013 to 2021. Average revenue per user has compounded at 25% per year. That is not possible

unless people are spending more time on these things. So clearly, the family of apps are still relevant. Even if Facebook is dead, quote unquote, that's the narrative. It's apparently not because there's no way they'd be able to get this advertising with a declining user base. They can't be that effective with the advertising. They just need more people to spend time on these products. Yeah. Second highlight for me, you already alluded to it. It's just the potential of WhatsApp. The click to WhatsApp is one of those messaging services that I mentioned where a consumer clicks on your ad, it leads them right into messaging with you as the business. That's on a $1.5 billion revenue run rate growing 80% last quarter.

So they are starting to finally see, I think, some success in monetizing that platform. Low lights. The first one is the biggest, Reality Labs, plain and simple. And I know there's the occasional investor that thinks there's a lot of promise here and that tech is really promising. I watched that three-hour MetaConnect presentation. I can now say with confidence, that's three hours of my life. I'm never going to get back. It was a waste. Well, Ryan, Ryan, I'm stealing this from a comedian. Every hour of your life, I got to spoil. You're not getting back. But I get your point.

It feels like they're exerting so much effort around the technology and the possibilities of the metaverse and the virtual reality space that they're creating, the ecosystem, and not really considering whether or not people want it. and it just, to me, feels like Zuckerberg wants his Steve Jobs moment so bad. And I know some people are probably going to say it, because anecdotally, I have not seen anyone use this on a regular basis. I haven't heard anyone. It does not feel similar to the early days of the iPhone. Oh, no, no, no way. Not even close.

No one is talking. I haven't even... Outside of online financial world or just investors I talk to, there's not a single person that even knows that the MetaQuest Pro exists. I'm saying in my circle. And I'm not a tech-heavy, maybe hobbyist, hardware hobbyist circle. But again, it's got to be mainstream when you're spending $10 billion a year. Yeah, absolutely. And some people might say that it's early days, but I would be even more concerned if that's the rebuttal.

Yeah, that's old. Because that means they could be losing more money later on. Yeah. And they are probably in 2023. I think they've said they expect operating losses to widen. At Reality Labs or in general?

At Reality Labs. I don't know. It just, it worries me. And then that kind of leads into my second low light. I find myself constantly questioning what Zuckerberg's motivation really is here. Does he want to drive value for shareholders still? And people are like, well, he owns 56%. Okay, well, he's also-

He doesn't care. Yeah. He's worth so much money. It probably isn't that valuable to his personal life to have another 50 billion. Yeah, he could go down 95%. It doesn't matter. He's going to have enough for life. And you have a quote you're going to talk about, which scares me.

Yeah, here's from a conference call. Yeah, because this is my low light as well. I'll just skip it when I go through my low lights. Here's a quote from a recent conference call. But I think our work here is going to be of historic importance. I read that and immediately just thought, yikes. He is in this mindset that when you say you're doing something that's of historic importance, you're attaching this narrative, you're attaching this emotion to it.

that's going to be really hard to quit. Yeah. And if he doesn't start to see the ROI, now he's dug himself in such a hole. And I, I'm not like the biggest Zuckerberg hater. They're definitely like, I think,

I think he's a pretty, these last years make it tough, but I think he's a pretty good operator, but good track record. Look at that. Yeah. Good track record. It's going to be just like,

so painful to his pride to shut this thing down after two years. And especially after he puts a quote out there that this is of historic importance. Well, there's an, I mean, what would you say? There's an 80% chance they get crushed by Apple because Apple is the best hardware company ever. If it's worth going after this in 10 years, do you think, do you think this is the main computing platform?

Do you think this is even a relevant computing platform? I think 10 years, it's going to look a lot like today. Yeah, because people in 2015 would have said, oh, well, I mean, they're investing in VR now, but think about it. What is it going to look like in 2023? This VR was like the thing 20 years ago. I mean, it's one of the things that people would say, like, I'm in the future. Like, think about the gaming opportunities. Think about that.

That's why Apple's strategy is great because they're producing it in-house. They have the capital flexibility to produce it in-house. And they know because of how public Meta is with their products, they're definitely looking at their stuff and saying, oh yeah, ours is better. But they understand the consumer, probably the best of any company in history, maybe outside of Nike. And they understand, okay, we cannot launch this and ruin our brand until we know there's going to be consumer adoption, just like they probably had with the watch, just like they had

with the AirPods. Meta's brand with all this stuff is going to get blown. Let's say that this VR stuff is all a bust and no one actually likes it and Apple has to shut it down. Fine. But if it is the next big thing, they're still

going to win because they already have the platform advantage. So either way, I say I see Apple winning. I mean, the The ecosystem might be tougher to gain adoption from developers after the stain Apple's left in developers' mouths. Fair. That's a fair point, yeah. But if you're betting on whether or not this is the computing platform of the future, first of all, my gut says no. But also, that's not an investment I want to make.

and i know that kind of leads into my more or less interested but uh it's just like a bet i'm really uncomfortable making yeah yeah that's that's those are my main lowlights anyway okay my highlights to be honest i struggle to find highlights but it's strange to find highlights like to not have highlights when the business is so profitable but my biggest highlight has to be the current durability of instagram which i know knock on wood um even with all the onslaught of apps trying to steal attention over the years like snap tiktok discord we were doing in the camp like yeah instagram seems stagnating but it's really you know it's been durable it's it's really really sticking around yes you know tiktok has grown rapidly but usage on instagram is still

at record highs according to management um and with its users skewing to the demographic the absolute demographic sweet spot, which is wealthy 20 to 60-year-old females. And that's 20 years old to 60 years old, not 26 years old. Instagram real estate is some of the most valuable on the planet. And then the second one, my highlights would be WhatsApp. We already discussed that. Lowlights, we talked about the Zuckerberg dictatorship. We talked about the reality lab losses. We talked about poor balance sheet management. Those three are all my lowlights. Fourth one, there's been little to no growth from the non-advertising part of the business for the last decade with tons of failed initiatives like crypto, payments, shops,

maybe TBD on shops, but a lot of other stuff has failed. They really haven't shown they can do much outside of advertising, which is fine, but that makes you... All the other big tech companies have shown an ability to have some form of diversification. than the last one um this was a bit strange i think this is kind of not a black swan but that'd be the wrong definition here but something that is hard to quantify but deep down we and we all know this a lot of the content they are monetizing off of have either potential political cultural ethical red flags for a lot of people i'm not just talking about the political whatever stuff that is in the news i'm talking about um

how is it uh people know if you know you know why don't we don't describe it on an investing podcast i don't want to say the word it's like you know the the judge that said when you know it when you see it it's the thing he's describing there you mean like it's probably like a net negative to society just in general yeah and that's what i'm getting to but i mean some of the stuff Again, the political stuff can be dynamic if we've all seen that, but also maybe the best word would be promiscuous stuff, which is really popular. I think the potential downside from all this stuff is not quantitative, but shows that they are not playing a non-zero-sum game with all their stakeholders because it's not healthy for the women on the platform. It makes the business a bit more fragile, I think, compared to some of the other technology giants. Ryan, what do you think about that?

Yeah, I would probably agree. But we've gone long. So let's do our bull case and bear case because at the end of the day, this is still a potential investment and it is one of the biggest businesses in the world. Do you want to kick things off with the bull case? I mean, I feel like we have very similar ones.

Yeah, I mean, look, at an EV to operating income under 10, all you need to do to get adequate returns here going forward is ask, are earnings durable? and will the executive team not mishandle the earnings that they get? If you answer positively for both of those questions, I think the stock is an easy buy at today's prices, really easy.

And that's really it. Ryan, do you agree or disagree with that? Yeah, I mean, I guess the fun thing about this one is it feels like there's a very wide range of outcomes for the bull case and bear case here. um in an ultra bowl case uh reality labs is a success uh next platform 10 bagger yeah um i don't see or maybe it has enough staying power that they can really rein in costs and um maybe generate some profits at some point down the road i don't it's obviously

hard to kind of see that right now. So if that works out, that's great. The other part is, I mean, if they just continue to generate more cash, if ad budgets on their platform or across their properties are larger in three, five years, or they're just... Honestly, if they're just generating more than $30 billion in annual cash flow in three or five years, this was going to be an adequate investment. Well, Ryan, I think you got to ask about the executive team. They're going to get all this money, right? And they've shown time and time again that they're going to burn it.

Buybacks, taking out debt at the wrong time, and this Reality Lab stuff. I think any investor should really think about the finance department at Meta. Yeah, actually, let me redact my statement. It's going to have to be more than $30 billion because I think now, and it depends what Zuckerberg says, but I think it's going to have a discount for a long time. I think it's just going to have a discount in multiple. That'd be great if they bought back shares, but alas, they cannot seem to reduce share count. They can't get that engine going. My bearish case is going to be so easy.

It's just the anger-inducing level of poor Apple capital allocation continues. That's plain and simple. I really don't see a bear case with the family of apps, but the capital allocation is just such a red flag. I can't. Unless there's material changes over multiple years, it's, again, this will come to more or less interest. It's just not something I want to touch.

But Ryan, what's your bear case? Well, I'm tempted to just not even say anything because everyone I think knows what it is, but it's like entirely dependent on the operating losses within Reality Labs. And if they refuse to rein in spend, despite lack of demand, this is going to be an underperforming investment. The good thing is, for me, I think the lower the stock goes, the more pressures on Zuckerberg to rationalize cost. Maybe. It'll be interesting to see for sure.

But I think the bear case, summed up into one word, is uncertainty. yeah i mean that's i guess more or less interested for me i'm less interested and especially of all the big tech companies we've looked at i mean this does not excite me it feels i mean the the big thing is it just feels completely unpredictable i agree less interested we're in the same camp here which for anyone listening we agreed pretty closely in the last couple. We do disagree on some of the episodes and I'm sure we will in the future as well.

So this is not just us agreeing. When we get to more or less interested, we do disagree a lot. But I am less interested. And again, personal preference. I know a lot of smart people that own Meta. I hope it is a great investment for them. But I cannot see why

you would own this over any of the other big tech companies. Maybe. extreme valuation concerns, but still, given the capital allocation track record, it's just not something I want to look at. All right. That's going to do it for this episode. The stock for next week is going to be, I guess, another large cap, maybe mega cap, big tech company that used to be a mega cap, and that is Salesforce. Go look at them for the first time. It'll be really fun as one of the biggest software

companies in the world. That's going to do it for this episode, though. Remember to check out stratosphere.io for free, the best web-based research terminal out there. Thank you all for listening. We are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you all for listening again and supporting the show. We'll see y'all next time. Thank you.