Meta Platforms (FB)

Jon Baker, CFA

Equity Research Analyst

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Jon Baker, CFA

Equity Research Analyst

Investment industry experience since 1997

Jon joined Weitz Investment Management in 1997. Prior to joining the firm, he audited equity funds (including the Weitz Funds) as a certified public accountant at McGladrey & Pullen. Jon has a bachelor's in accounting and computer applications from the University of Notre Dame.

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A social media giant with a long glide path of global growth

We've been publishing investment theses at Weitz for over a decade. Having penned several over the years — even ahead of its recent earnings report — it was apparent that writing about Meta Platforms (formerly known as Facebook) was going to be a unique proposition. Alternatively hated and loved, we began with an already fraught topic. Throw in an earnings report that resulted in the largest one-day market value decline (over $235 billion) of any stock in history, and we are left with an amount of theater to which even this slightly grizzled writer is unaccustomed.

We don't need to devote much time to Meta's history. The story of Facebook founder Mark Zuckerberg coding away in his Harvard dorm room is, by now, the stuff of legend. Meta is the owner of some of the best-known brands on Earth, but the scale of its services can be difficult to grasp. We are approaching eight billion souls on this planet, and nearly half of them use at least one of Meta's services monthly. Over a third of the globe uses at least one of Meta's services daily. And despite lapping a 2020 that benefitted from strong, COVID-driven user engagement, that number of daily users still grew at a double-digit pace in 2021.

Over the years, Meta has acquired dozens of companies, most of which wouldn't be considered household names. There are five businesses that will likely matter to Meta owners over the next many years. They include Facebook — the social media colossus; WhatsApp — the global text and voice messaging service; Messenger — Facebook's homegrown instant messaging application; and Instagram — the photo and video sharing platform. The fifth business, Reality Labs, houses Meta's augmented reality (AR) and virtual reality (VR) efforts, including Oculus, the largest seller of VR headsets. Per App Annie's State of Mobile 2022 report, Facebook, WhatsApp, Messenger and Instagram — in that order - occupy the first four spots on the list of largest global mobile apps by number of active monthly users.

Meta does not disclose user statistics for most of its messaging and media businesses, nor do they break out revenues amongst them. Meta's total 2021 revenues came in at $118 billion, up 37% from 2020. Reality Labs, for now at least, contributes an ignorable portion of that, and we have seen estimates that put WhatsApp and Messenger in the $5-10 billion revenue range. All those businesses are growing quickly, though they are unlikely to be meaningfully positive contributors to earnings in the near term. This leaves perhaps 90% of Meta's revenues contributed by Facebook and Instagram, and virtually all of that revenue is from advertising. Market research firm eMarketer estimates that Instagram's U.S.-sourced revenues finally surpassed those of Facebook as of late 2021. Instagram has doubled its global user base to two billion over the past 3+ years.

Meta does not disclose operating income by service either, but Facebook's earnings have clearly subsidized the growth of Meta's acquired businesses over the years. The company bought Instagram in 2012, but it was not until 2015 that its audience was made widely available to advertisers. WhatsApp and Oculus were both acquired in 2014 and little, if any, financial contribution has yet been asked of either. In fact, Meta recently disclosed a $10 billion operating loss for Reality Labs in 2021. Our simple takeaway from this investment behavior is that the founder-led Meta is willing to invest substantial sums, for extended periods, to nurture the seeds it sows. In total, that approach has created great financial value, and we believe it will continue.

Prior to its recent earnings release, Meta's stock had already weakened, having underperformed the Russell 1000 by around 15% since mid-September 2021. The impetus for that initial decline was the release of thousands of internal Meta documents by a former employee whistleblower. While connecting billions of people around the world has surfaced staggering examples of beauty, kindness, creativity, and humor, parts of Meta's social networks have also become beds of vitriol and misinformation. Every aggregation of humans at this scale will, without exception, produce both good and bad. What — if anything — to do about that is the question for our times. The fact that answers to that question would vary so widely is a testament to both our collective diversity and the intractability of the problems we create for ourselves. The issues highlighted by the release of those documents are — and had already been — important and deserve a deeper discussion than these few pages permit. In the interest of brevity, we will say this: the services Meta provides to half the globe will — one way or the other — be made to better align with the mores of the societies they serve.

We believe Meta is trying. If Mark Zuckerberg could snap his fingers and create perfect filters for hate and depravity, we believe he would do so in an instant — whether financially or morally motivated. This does not mean that Meta has tuned its content algorithms ideally (though, to whose ideal?) or has sufficiently invested in safety measures (though, to whose standards?). So, we are thankful for the whistleblowers, journalists and elected officials who work to shine a light on the deficiencies of powerful companies. One may even choose to own this business both despite and because of the course corrections it will be required to make in the future. We believe that over the past several years the direction of travel of Meta's alignment with societal aims has been positive, and it will likely continue that trajectory.

From November of 2021, Meta's stock loosely tracked with the broader market until opening a -30% gap since reporting earnings in early February of 2022. While the large operating losses at Reality Labs are controversial, Meta's weak first quarter 2022 revenue guidance was likely the dominant driver of that decline and can be attributed to several causes. The least compelling of these are either cyclical or expected. Management noted potential advertising weakness in response to economic headwinds, such as supply chain disruptions, labor and inflationary pressures. Such wobbles come and go and seem unlikely to have much bearing on where the business — and the value the business commands — lands in several years.

From the third to the fourth quarter of 2021, global daily Facebook users marginally declined, the first decrease in the company's history. Given the maturity, scale, and penetration of the network — and the fact that we are lapping a period of heightened, COVID-driven global engagement with all things digital — it neither surprises nor disturbs us that users finally ticked lower. In all but the most improbable scenarios, whether or not Meta works as an investment will depend very little upon quarter-to-quarter changes in the number of daily Facebook app users.

Deserving of more of our attention are Apple's privacy changes, the rise of short-form video app TikTok, and Meta's responses to each. In 2021, Apple unveiled new privacy features for the iPhone that have taken a bite out of Meta's revenue. Meta has long ingested an immense amount of data from third-party sources. Combined with the extensive browsing and shopping behavior on its owned properties, Meta had been left with the ability to not only serve very productive ads to its users, but also demonstrate the productivity of those ads to advertisers. Apple's privacy changes required iPhone users to “opt in” to the sharing of their data between apps, and relatively few have done so.

These changes, feathered into Apple's user base over the past year, have increasingly garbled Meta's “signal,” impeding its ability to attribute consumer transactions to the advertising that drove them. The impact of the changes likely approached full strength in the back half of 2021, and the efficacy of Meta's efforts to reclaim some of that lost ground should continue to improve with time. It seems likely, then, that we are past the worst of the Apple headwind, and Meta's unimpacted growth rate can begin to shine through in the back half of 2022.  

Finally, and likely most importantly, there is the meteoric rise of TikTok, App Annie's most downloaded app in the world for 2021. Per social media management platform HootSuite, over the past few years, TikTok has risen from relative obscurity to the fifth-largest social media app in the world, ranked in order of total time spent by users. While TikTok, Facebook and Instagram users wouldn't say the apps serve the same purpose, they all do compete for a finite amount of user attention, especially attention devoted to users' mobile phones.

While both Instagram and Facebook still rank ahead of TikTok based on total time spent, TikTok is on a trajectory to close the gap, and it is large enough to demand a defensive response from Meta. That response came in the form of Meta's copycat short-form video service, Reels. Instagram began piloting the service in Brazil in late 2019 and rolled it out more broadly in mid-2020. Instagram launched Reels in India shortly after the China-based TikTok was banned, and a month later in 50 other countries. Reels wasn't launched on Facebook in the U.S. until September of 2021. On the February 2022 earnings call, Zuckerberg called Reels “our fastest-growing content format by far” and “already the biggest contributor to engagement growth on Instagram.”

To attract users to the Reels format and keep them coming back, Meta has, for the time being, kept the volume of ads one sees while consuming video to a minimum. Any mix shift of user activity from higher revenue generating — such as Feed and Stories — to low will dent revenue growth until Reels can manage to offset the revenues it has displaced elsewhere in Meta's apps.

Longer term, this transition to video feels to us like an opportunity. Yes, it has and will continue to result in some amount of short-term pain as Meta invests to grow video consumption. And we agree that the shift is, at its core, defensive in nature. But Meta brings some advantages to the table, notably its already massive user base. Although marginally diminished by Apple's changes, Meta is still one of the most adept in the world at matching consumers with advertising they actually want to see and with merchants with whom they actually want to transact. That is powerful, it earns them staggering amounts of revenue and that revenue results in a potent means of rewarding and motivating content creators. We are excited to see all these capabilities brought to bear in short-form video over the coming years.

The future is certainly not without risk for Meta, and that's how one gets a stock down over 40% from its highs. Longer term, Meta needs to adapt, continue to engage users, and again improve its performance for small and large advertisers. If Apple's changes create headwinds that only increase in the future, the capital we have devoted to Meta will have been better aimed elsewhere. If TikTok — or other competing uses of mobile time spent — continue to grow in appeal relative to Meta's apps, the same will be true.

In the nearer term, the path of Meta's earnings will most likely be determined by the level of Meta's own aggression; the more they hasten the growth of video consumption, the more earnings will be negatively impacted. We can imagine an unusually wide range of earnings for 2022, and that is off-putting for many investors. In retrospect, our position sizes may ultimately prove to have been too large heading into the quarterly update and we could have been more respectful of the likelihood of an earnings reset. But Meta's willingness to invest at scale — to endure some lean years in support of a better, higher future — is a large measure of its appeal to us. From today's price levels, we think the stock has ample potential for excess returns over our investment horizon.