Moving fast and breaking things…
We thought Zuck was busy renovating his company to be a Metaverse Meta Giant. After renaming the company there was no going back! This is a rough outline of what’s been happening in the real world:
- Tiktok became a threat during the pandemic.
- In response, Meta launched Reels.
- Advertising revenue growth slowed down.
- Reels needed a CPR.
- The stock tanked.
- Meanwhile, Elon took over Twitter. WTF.
- Reels CPR started working. Kinda.
- Advertising revenue growth improved.
- Side note: WTF is happening with Whatsapp?
- Stock recovered.
- Elon challenged Zuck to a cage fight. WTF.
- Zuck unveils Threads. WTF.
- Your move, Elon. Buy Snapchat?
We might have missed a couple of events. But that’s the broad outline of how things unfolded in this bizzarro turf war. Now, Elon may not be nervous about the cage fight, but he is probably hyperventilating because of Threads. The market seems to like Zuck’s pre-game mind(z)uck, also known as Threads. It caught our attention for sure, and probably yours too.
So, we pulled up The Buycaster to do a quick analysis on META. Oh yes, we want to be clear – this is not a deep dive on Meta. It’s a quick(ish) take – kind of like the Threads version of a full Facebook post.
So, is Meta investable?
What do we need to believe?
The Buycaster doesn’t like Meta. Yes, we were disappointed too. It’s so tempting to buy into the latest chatter about the next winner that’s bound to “take it all”. But that’s just a weak, emotional “thesis”, which usually starts with “everyone uses it bro…”. Thankfully, we have The Buycaster to keep us rational. Here’s a screenshot of the overall Buycaster Rating – right at the top of the Buycaster page.
That’s not encouraging at all. Normally, we like to dig into stocks that have a rating of at least 9 – that’s what we consider “investable”. Even 8 is OK sometimes. 2.9 is not even close. What’s going on?
We’ll skip a few steps and go straight to THE BUYCAST – revenue growth that we need to believe to consider buying the stock. It turns out that Meta’s Buycast is hard to believe.
Here’s how we explain this chart in The Buycaster:
META has a LOW SANITY Rating because it is DIFFICULT to believe THE BUYCAST of 25.7% – our measure of ‘what we need to believe about the business to consider buying META today’. The BUYCAST is measured in terms of future Annualized Revenue Growth (ARG). So, to consider buying META, we need to believe that Meta Platforms Inc.'s revenue will grow at an average of about 25.7% per year for the next 5 years. This looks like an irrationally exuberant scenario.
To be specific, The Buycast is our estimate of “revenue growth in the underlying business that we need to believe to RATIONALLY expect a stock to deliver 80% cumulative return in 5 years (12.5% CAGR)”. The Buycast is the crux of, well, The Buycaster. This is a back-solving process – we back-solve from the “desired stock price” (what we want) to the “revenue growth that needs to happen” while make some reasonable assumptions along the way as we move the cash flow waterfall (details and mechanics in the Appendix). We call this process “Buycasting” – we’re not forecasting, we’re Buycasting. The key question, however, is “is The Buycast believable?” So, we compare The Buycast to not just to the past historical revenue growth numbers but also Wall Street expectations of future revenue growth (which we consider with a grain of salt), and some industry-specific adjustments on our part. Once we take all that into account, we apply a 20% margin of safety discount (in most cases) to be more conservative. And so, we get to the second-most important variable in this dashboard: THE DOWNCAST – this is our estimate of a realistic low-growth scenario. The difference between The Buycast and The Downcast is the basis of the SANITY Rating The bigger the difference, the less believable our Buycast is, and so, lower the SANITY Rating; and vice versa...
OK. Enough. Let’s stop right there. We should move on to another potential investment that has a HIGH Buycaster Rating of >9. But something tells us that you want to know why The Buycaster is not nice to Meta. Secretly, so do we.
Moving fast and spending billions…
It turns out that Meta has been spending billions annually to compete with Tiktok and to, well, pivot to a Metaverse. These investments – both in Fixed Operating Costs and Capital Expenditure – generally have long-term payoffs, if any. We’re talking around 3 to 5 years. Reels seems to be holding up already. But we don’t know what’s happening with the Metaverse. Or the Oculus. Or Whatsapp. How much will it cost to make them monetizable? There are lots of black holes in this Meta-verse. But that’s a discussion for another day. The point is that Meta’s Fixed Operating Cost and Capital Expenditure bills have been gargantuan for various reasons. Take a look at this:
This is the culprit – this is what’s ruining The Buycast. Remember that arriving at a Buycast is a back-solving process – from Desired Return to The Buycast. To do this back-casting, we need to go through capital costs and operating costs. Here’s a rough “reverse waterfall” that we follow to get to The Buycast:
- Start with Desired Return.
- Back into Desired Stock Price (DSP).
- Assume an Exit Free Cash Flow Multiple.
- Back into Desired Free Cash Flow.
- Make reasonable CAGR assumptions for Capital Costs like Capex, Cash Interest, Taxes, and Working Capital swings.
- Assume reasonable CAGR assumptions for Fixed Operating Costs like R&D and Cost of Labor.
- Assume that the current gross margin is a reasonable estimate of future gross margin.
- Back into Desired Revenue.
- Back into BUYCAST – revenue growth we need to believe.
Let’s put some numbers around this back-cast. Here’s a screenshot from The Buycaster Appendix of Key Assumptions we needed to make in the steps above:
Notice how high The Buycaster’s assumptions are for Fixed Operating Cost (FC) Growth and Capital Expenditure (Capex) Growth. Now, compared to how things have been over the last 3 years, those assumptions look quite rational. In fact, we’ve even baked in some Economies of Scale in those assumptions (the idea that growth in costs will decrease as revenue increases). But we asked ourselves, will Zuck and Team continue down this very expensive path?
Let’s play around with the costs a bit. Let’s superimpose an optimistic scenario by assuming low growth in both FC and Capex. What happens to the Buycast? The chart below shows the corresponding Buycast (revenue growth we need to believe) and the Final Buycaster Rating for each optimistic cost-growth scenario:
Wow. That is indeed a meta improvement! We’d just like to reiterate this point: A lower Buycast is better – it means we don’t need to believe in fairies and goblins to consider buying the stock. So, as you see in the charts above, a lower Buycast corresponds to a higher Buycaster Rating.
Well, now we know what to ask Zuck if we bump into him in the dojo: “How much you gonna keep spending Zucker?”
Since this is not a full-fledged, long-form, deep-dive investment thesis, we’re not going to wax eloquent about Meta’s competitive advantage or how durable it is, we just have 2 specific questions:
- How much do Zuck & Team need to reinvest in the business just to maintain their competitive advantage?
- Does maintaining their competitive advantage mean investing in moonshot projects? If so, how much are Zuck & Team willing to spend on them?
Some Wall Street analysts have pressed Meta on these in recent earnings calls. Meta’s management has been hinting towards some cost rationalization. But they (understandably) won’t commit to a number. So, if (when?) we dig deep into Meta, what cost growth assumptions should we believe? More pressingly, if you’re a holder of Meta, let us leave you with 2 insights:
- The market has priced in a low cost-growth scenario.
- Therefore, the market believes that Zuck & Team don’t need to spend as much as they have been - to maintain their competitive advantage.
Take a look at these 2 charts from The Buycaster. The first one here is the Buycast chart you’ve already seen – but notice the average revenue growth expectation of Wall Street Analysts. It’s pretty low compared to Meta’s actual historical numbers.
Now, at The Buylyst, we don’t take Wall Street Analyst Ratings too seriously when making investment decisions. But we do like to keep track of them – as a sort of proxy for “what the market thinks”. In fact, in The Buycaster we show a Wall Street Analysts’ Rating as well, scaled up to 10 to make it comparable to The Buycaster Rating.
Now, if we put these two charts side by side, we can easily argue that Wall Street, on average, expects Meta’s revenue growth to slow down significantly over the next few years…BUT they’re reasonably bullish on the stock. How do we square that circle? They must believe that cost growth will slow down significantly as well. We’re secretly hoping that Wall Street is right about costs.
You may have also noticed that Mr. Buffett and Mr. Munger would have a high opinion of Meta if they were asked about it, at least according to this Buffett-Munger Rating system that we’ve created based on their (well-published) methodology. While their methodology has inspired ours, The Buycaster Rating is also a complex concoction of other ideas (especially those from Howard Marks, Phil Fisher, and Michael Mauboussin).
Well, maybe our Buycaster Rating for Meta is too draconian after all. However, we wouldn’t buy Meta unless we were very confident that both operating costs and capital expenditure will decrease significantly. Regardless of how many fancy models we build, that will be an educated guess at best. Heck, maybe even Zuck doesn’t know for sure how this will pan out in 5 years!
If you hold Meta, we hope you buy into this cost-rationalization scenario. Otherwise, it’s a risky gamble.