Portfolio holding Meta (FB) reported Q4 2021 earnings results. The stock tanked more than 20% in after-hours trading. Let's take a look into the results, try to make sense why the stock tanked so much, and decide whether we want to buy on this giant dip. 

Company-wide results

On the top line, revenue of $33.671 billion (+20% YoY) came in higher than the $33.191 billion expected. However, on the bottom line, diluted earnings of $3.67 per share (-5.4% YoY) missed the $3.81 the Street was expecting.

As a reminder, beginning this quarter, Meta introduced a new earnings format, now reporting results in two segments: Family of Apps (which includes Facebook, Instagram, Messenger, WhatsApp and other services) and Reality Labs (which includes augmented and virtual reality related consumer hardware, software and content). Due to the change, we do not have apple-to-apples comparisons for the results versus expectations for every single item. 

Within Family of Apps, advertising revenue of $32.64 billion outpaced expectations of $32.5 billion. Reality Labs revenue came in at $877 million, slightly higher than estimates of $829 million.

As for profitability, Family of Apps operating income came in at $15.889 billion (+6.8% YoY) while Reality Labs reported an operating loss of $3.304 billion. Combined, Meta reported total operating income of $12.585 billion, a miss versus expectations of $13.042 billion.

Finally, Meta repurchased $19.18 billion worth of shares in the quarter, bringing the FY2021 total to $44.81 billion, and ended the quarter with $48 billion in cash, cash equivalents and marketable securities.

Engagement

Taking a look at Facebook specific engagement metrics:

• Facebook Daily Active Users (DAUs): 1.929 billion (+4.6% YoY) vs. 1.949 billion expected

• Facebook Monthly Active Users (MAUs): 2.912 billion (+4.1% YoY) vs. 2.911 billion expected

• Facebook DAUs/MAUs: 66%, consistent with the level seen since 2Q 2020

• Facebook Global Average Revenue per User (ARPU): $11.57 (+14.1% YoY) vs. expectations of $11.41 per user

Guidance

Moving on to guidance, the company expects total revenue in the first quarter of 2022 to be in the range of $27 billion to $29 billion (+3% YoY to +11% YoY). This is a big ~10% miss compared to the Street estimates of about $30.18 billion. Management cited a few headwinds impacting impression and price growth.

On impressions, they expect continued headwinds from both increased competition of people’s time and a shift of engagement within their apps towards video like Reels, which have lower monetization rates compared to Feed and Stories.

On pricing, growth is being negatively impacted by three factors.

• First, the company is lapping a period in which Apple’s iOS changes were not in effect, and they are anticipating “modestly” increasing ad targeting and measurement headwinds from platform and regulatory changes.

• Second, they are lapping a period of strong demand in the prior year, and management said they are hearing from advertisers (which are mostly small business owners) that higher costs and supply chain disruptions are impacting their budgets.

• Lastly, foreign currency is expected to be a headwind to year-over-year growth.

Particularly on the first point, management commented that headwinds related to Apple's iOS changes will amount to approximately $10 billion revenue hit for 2022. 

On the expense side, management lowered its full-year 2022 expense outlook to the range of $90 billion to $95 billion from the range of $91 billion to $97 billion. Management’s capital expenditure outlook was unchanged at $29 billion to $34 billion. On the call, the team highlighted several key investment including Reels, community, messaging, commerce, ads, privacy, AI, and of course the metaverse.

Bottom Line

While we like to see companies investing in future growth, especially the Metaverse, the results were disappointing as the aggressive investments resulted in lower-than-expected earnings. Let us remind you, in a free-money environment it could be easily forgiven, but we are facing the backdrop of multiple Federal Reserve interest rate hikes which does not allow any imperfection.

We've identified that factors that are affecting company's earnings include i) intensifying competitions for user's attention (such as TikTok or Youtube), ii) changes that Apple made to allow iOS users to opt out of tracking, and the iii) transition to Reels from Feed and Stories. These challenges have clearly taken their toll in this earnings report, and will likely materialize this quarter (to be reported ~3 months from now) as management issued disappointing revenue guide.

Our Thoughts

On the problem of i) competition for users' attention, the solution would be for Meta to come up with new and attractive platforms. We believe that management have forecasted this time would come, that's why they have been investing so aggressively in seeking  growth, to the extent that these investments affect their earnings results. We're willing to give management the benefit of the doubt, that with the investments they're making, they'll be able to come out fine on the other side. 

On ii) regarding Apple's privacy changes, we acknowledge that this is something Meta cannot change. Yes it will hamper their growth, but market has known about this since September of last year when the news was announced, and the stock had been punished going into the print, and punished sharply afterwards. There's a reason Meta (FB) has been the lowest valuation-multiple stock in the mega-cap technology stocks (prior to the print, FB's forward P/E was in the low twenties).  

On iii), we are on the side that management will be able to pull off the transition again. They successfully navigated the changes from desktop Feed to mobile Feed, and Feed to Stories to Reels. These are near-term headwinds that we just need to be patient about.

Again, these are real challenges that have been and will affect Meta's earnings power for months if not years to come. However, these challenges are not particularly surprises to the market. As mentioned, there's a reason why FB have been trading at a low multiple relative to its mega-cap tech peers. With the price of $323/share going into Wednesday's close, and estimated 2022 EPS of $14.18 share, FB was trading at 22.78x 2022 numbers, and 18.97x 2023 estimated EPS of $17.03/share. Comparing to a similar social media platform Snapchat (SNAP) which trades at 59.4x 2022 numbers, FB represented a great value play in this digital advertising sector. We will have to see how 2022 estimates for FB will change, but keeping the $14.18 EPS for 2022 and the after-sell-off stock price of $249/share, FB would be trading at 17.6x 2022 earnings. FB generated $ 39 billion in Free Cash Flow during 2021, so with the stock price of $249/share, it's trading at 18x 2021 FCF.

Here's the key question: do you buy or sell the stock here? Well, it's up to you. Here's what we think. It'll take months for the stock to climb back to where it was, predicated on how management will execute. If you made a big bet on this name before the print, and cannot handle the pain, you should get out. But if you were nimble going into the print (like us with a 3%), we think this is the perfect moment to pick up some shares at this level and be ready to buy some more. That's exactly what we will be doing, as we will increase our portfolio allocation for this name from 3% to 5%. To us, Meta (FB) at this price level represents great value for an enterprise that's generating so much free cash flow and is the dominant player in digital advertising.