Meta Downgraded to Beta

The finger-pointing has started and so too have the post-earnings exoduses. It has been a big week for Big Tech, many of whose stocks are set to slip as their earnings have left investors screaming for financial discipline. Executives from Microsoft, Google, Meta and more are blaming the impact of inflation and rising interest rates. Let's deep dive into companies' key detractors this quarter, and one of the biggest stock-level detractors: Meta. 

Bottom Line Up Front

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• Twitter shares will be suspended from trading on Friday, the New York Stock Exchange's website showed, as billionaire Elon Musk faces a court-ordered Oct. 28 deadline to close his $44 billion deal to buy the social media company.

• The U.S. economy grew at a 2.6% annual rate in the third quarter but showed signs of a broad slowdown as consumer and business spending faltered under the weight of high inflation and rising interest rates.

• Credit Suisse plans to raise $4 billion from investors, cut thousands of jobs and shift its focus from investment banking towards its rich clients, as the bank attempts to put years of scandals behind it.

But first, a quick note from The BAD Investment Company.

Tired of ESG Bullsh*t? Fortunately, there's a money manager that decided that B-A-D might be the better acronym for investors.The BAD ETF (NYSE: BAD) launched last December and is taking a different stance in this green washed world focusing on 3 industries for which the ticker represents – B-A-D. 

The U.S. economy grew at a 2.6% annual rate in the third quarter but showed signs of a broad slowdown as consumer and business spending faltered under the weight of high inflation and rising interest rates.

• Betting – Casinos, gaming, and online gaming operations – 33%

• Alcohol – Alcoholic beverage manufacturing and distribution – 23%

• Drugs – Pharmaceutical and biotechnology product development and manufacturing – 33%; Cannabis cultivators & distributors - 10% 

The case for these BAD industries remains strong for a simple yet important reason – they have historically offered attractive risk-adjusted returns. In addition to these industries overcoming government scrutiny, these industries have shown resilience during economic downturns because people tend to indulge in their vices, or what some call hobbies.  

As a result, we believe these asset classes are typically underappreciated and therefore under-valued but the reality is that people will continue to consume alcohol, gamble, and need medicine in good times, and in BAD.  

In regards to the betting and cannabis aspects, as these industries become more widely accepted socially and legally, they may offer investors additional growth as more states look to legalize those industries for additional tax revenues.

Learn more about the BAD ETF fund details and sign up for our mailing list to get the latest fund insights and information.

Deep Dive: Meta Downgraded to Beta 

Technology stocks tumbled yesterday, dragging the entire market down with them. A series of disappointing earnings reports from industry heavyweights, including Microsoft and Alphabet, rattled investors. But the Big Tech company who got battered the most was Meta. 

Meta's net income has fallen over the course of three consecutive quarters. That’s down from $10.28 billion in Q4 2021 to $4.4 billion in Q3 2022. For reference, that’s actual money, not whatever coin Zuck is using in his metaverse. 

A track record of turbulence 

Yesterday, Meta shares were initially up 8%. They then tanked with Zuckerberg commentary that they are increasing investments in the metaverse. In short, Zuck is telling investors to get onboard with the metaverse or go away. They chose the latter, and Meta shares then dropped ~21% in after hours trading. 

Zuckerberg’s strategy, or at the very least, goal, has been to continuously reinvest in a product-led future. Zuck’s previous track record, paired with the more important factor that he simply has voting power, has worked well for him for the past half-decade.

The bear market has not been as friendly to Zuckerberg’s metaverse bet. In 2021, Facebook was valued at $1.1 trillion. In 2022, Facebook is valued at $350 billion.That’s $750 billion of value destruction. 

Now, investors are calling for Meta to streamline and focus its path forward. Like many other companies in a zero-rate world, there are too many people, too many ideas and too little urgency. Meta’s lack of focus and fitness was more obscured when growth was easy, but it’s now deadly as growth slows and technology changes.

So when Meta ramped up its spend, it lost the confidence of investors. The conventional wisdom — press and investor — is that the core business hit a wall last fall. As a result, the team hastily pivoted the company toward the metaverse — including a surprise re-naming of the company to Meta. Worse, this skepticism seemed to be affirmed with a nearly-immediate and sizable miss in financial results and continued under-performance throughout 2022.

The facts are startling. In the last 18 months, Meta stock is down 55% (compared to an average of 19% for its big-tech peers). Its P/E ratio has fallen from 23x to 12x and now trades at less than half the average P/E of its peers. And notably, this decline in share price mirrors the lost confidence in the company, not just the bad mood of the market.

Burn the rebrand 

The silver lining is that unlike many companies, Meta’s multiples as of recent may obscure the truth. Meta’s core business is one of the largest and most profitable in the world with over $45B in operating profits last year alone. Whether you’re a bear or bull on the future of technology, Meta has industry-leading capabilities in key future technologies like artificial intelligence and immersive 3D that could help drive new products and future growth. Not to mention, Meta never fails to leverage its abundant financial resources to invest and return to its shareholders.

It’s Wall Street’s worst-kept secret that Meta needs to get its mojo back. It needs to re-build confidence with investors, employees and the tech community in order to attract, inspire, and retain the best people in the world. Meta needs to get fit and focused.

Let’s look at one recommendation from Altimeter Capital’s Gerstner that could double Meta’s FCF back to $40B per year and focus the company’s teams and investments:

• Reduce headcount expense

• Reduce annual CapEx (by at least $5 B from $30B to $25B); and

• Limit investment in metaverse / Reality Labs to no more than $5B per year.

Headcount reduction and expense control

Rapid mobile adoption helped market leaders blaze through the s-curve with astounding growth rates and a historically low cost of capital made investments in people and things the rational economic decision. At Meta, the number of employees is up over 3x from 25k to 85k employees in just the last four years. 

Today, the cost of capital has radically changed, and so has Meta’s growth rate. It is a poorly kept secret in Silicon Valley that companies ranging from Google to Meta to Twitter to Uber could achieve similar levels of revenue with far fewer people. 

Investing aggressively in the future of AI

Over the last three years, Meta has dramatically increased its capital expenses. Even excluding its metaverse investment, Meta has gone from $15B in annual CapEx in 2018, 2019, and 2020 to $30B in annual CapEx in 2022. To put that in perspective, excluding its large metaverse investment, Meta is investing more in CapEx than Apple, Tesla, Twitter, Snap, and Uber combined.

Thus, Meta can responsibly and reasonably reign in CapEx while continuing to invest aggressively in AI and other critical areas. As such, it may be optimal, or at least better, during this period of growth transition and economic uncertainty to decrease CapEx by ~$5B. This would allow Meta to maintain more fiscal discipline until revenues re-accelerate. It would also bring Meta’s CapEx as a percentage of revenue more in line with its large cap peers. At $20-$25B of annual CapEx, Meta can still invest market-leading amounts to help invent the future of AI.

Genuinely what is the metaverse 

Meta’s investment in the metaverse, while smaller than its AI investment, has led to much confusion across the industry. Perhaps it was Zuckerberg’s re-naming of a company to an activity that’s barely adjacent to its core business.

Plus, people are confused by what the metaverse even means. If Zuck was investing $1–2B per year into this project, the confusion might not be a problem. Instead, Meta announced investments of $10–15B per year into a metaverse project that largely includes AR / VR / immersive 3D / Horizon World. It may take 10 years to yield results. 

An estimated $100B+ investment in an unknown future is super-sized and potentially radioactive to even some of Silicon Valley’s bigger bulls. 

Do less, make more 

Reigning in Zuck’s fever dreams could reign in spending enough to focus on core revenue generators. The evolution could increase FCF by ~$20B in 2023. This enhancement would come from approximately $10B from people-related expense reduction, $5B from CapEx reduction, and $5B from reduced metaverse spend. This would double annual FCF and put FCF as a percentage of revenue more in line with Google, Microsoft, and Apple.

If doubling annual FCF will improve share price, then Mea may have finally created something more radioactive than the design of Zuckerberg’s metaverse character.

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