Q3 2021
By Manuel Maurício
October 26, 2021
A fellow investor recently said that Facebook is the most painful stock to own.
The company is constantly being bombarded with accusations by the media, with hearings in the Congress, with software updates from its competitors, with leaked documents by whistleblowers…
There’s always so much to worry about.
The other day I was having dinner with a couple of friends when one of them- who just started working for a tech company – said “all these kids in my company, they’re all using Google products. It’s impossible to kill Google“.
That got me thinking.
Although Facebook and Google are often compared to each other, Google is a much more consensual company than Facebook.
And I could even go as far as saying that it enjoys a much stronger competitive position compared to Facebook. At least, I don’t believe that there are as many threats to Google as there are to Facebook.
Let’s take a look at the recent results.
The revenue went up by 35% compared to the same quarter last year. As much as I like this, the fact that the revenue was flat on a quarter-over-quarter basis left me wanting.
The flat revenue was mostly due to the Apple iOS14 update that created serious obstacles to the way Facebook gathers information about its users across apps.
And with higher costs, the company had a lower Operating Income.
And consequentially, a lower margin.
A portion of this higher spend was related to the Facebook Reality Labs, the division that is taking up all the efforts on Augmented/Virtual Reality and the Metaverse. This division is becoming so important that the management has decided to post its financials as a separate segment going forward.
For the full year, the management is guiding for a total spend of $10 billion in this division. That’s massive. It’s roughly 20% of the Operating Income for 2021.
Now, it’s easy to rush into adding back those $10 billion to the operating income to get a more “pure” figure of how much cash the core business is generating. I get that. I did it myself. But should we do it?
It’s true that those $10 billion are being spent on a “new business” and that the core business is what matters, but unlike Google’s automotive division Waymo that is completely unrelated to the rest of Google’s business, the AR/VR and Metaverse may actually be necessary to keep Facebook relevant.
Recently it has been shown – quite dramatically – that in order to thrive, Facebook can’t rely on other companies’ platforms (like the iPhone). So, I guess the $10 billion (a figure which will only be growing in future years) are needed to keep the company relevant in the future.
Turning now to the Capital Expenditures (those expenditures on long term assets such as data centers and transatlantic fiber optic cables), I’ve briefly mentioned in prior write-ups that they’re not spending billions and billions of dollars in data centers just to store our photos and videos.
They’re building the infrastructure to house all the features that are coming (e-commerce, music, video, games, augmented and virtual reality, the metaverse, the Artificial Intelligence, etc etc), but I don’t really know what they’re building. Feel free to chime in on this if you have further insights.
And if you look at the chart below, these guys never stopped spending.
By the way, the next Facebook Connect will be on Thursday. Connect is the conference where Facebook presents all of its new technological advances.
As an interesting data point, Facebook is considered to be a capital light business, but that’s not quite accurate.
Although the Capital Expenditures have been going down as a percentage of revenue, they still amount to 16% of revenue, and that’s before factoring in expenses such as R&D.
Still on the capital allocation, the management also announced a share buyback program for $50 Billion (!), a massive number that got everyone talking about it.
It’s not as if the company hasn’t been buying back shares. In fact, Facebook has been dramatically increasing the amount spent on repurchasing shares…
…but that’s mostly to offset the dilution created by the Share Based Compensation. The total amount of shares outstanding has remained mostly flat for the past 5 years despite the buybacks.
But as much as looking at the financials is important, the cool part of owning Facebook aren’t the numbers. It’s the vision for the future (I know, I know).
Books will be written about Facebook and Mark Zuckerberg. He’s definitely up there with the Steve Jobs, the Jeff Bezos, or the Elon Musks of the world.
Yesterday, he started the Conference Call by addressing the current barrage of criticism by the media. The Wall Street Journal has a whole section on its mobile app called “The Facebook Files” dedicated to scrutinizing the leaked documents that show how Facebook allegedly mishandled sensitive subjects like teen addiction to Instagram.
Mark isn’t happy about this. He repeats it over and over again: Facebook (and the other tech companies) shouldn’t be the ones deciding if a piece of content is offensive. Even so, he states loud and clear that Facebook has done way more than anyone else in trying to filter and control misinformation on its apps.
Once he got that out of his chest, he and the other managers proceeded to talk about all the great stuff that’s coming.
This is the first time that I hear Mark say that their focus going forward will be the younger adults, aged 18-29. The company is “retooling” its teams to optimize for younger adults. Mark understands that this shift will carry some costs, namely, a lower focus on older users.
This redirecting of the strategy was obviously created by Tik Tok. Who says that Facebook has no competition?
So much so that Facebook is betting heavily on Reels, the short video format copied from Tik Tok.
Another interesting thing that caught my attention was learning that Facebook is introducing Daily Live Shopping in partnership with big retailers like Macy’s, Walmart and others starting next week.
I’ve been learning about the Livestreaming e-commerce industry (mostly in China) and I believe that it will be huge in the West.
Mark mentioned that they’ll be bringing exclusive gifts to Shops such as 20% off the first purchase and free shipping. Something tells me that they’ll be betting heavily on this.
But there are also a few things that I didn’t like as much.
I didn’t like it that no one talked about the recent outage that made headlines around the world, I didn’t like it that no one talked about the company changing name as reported by The Verge, nor did I like that Mark talked so little about the new AR Ray Ban glasses.
Conclusion
Circling back to the beginning of this write-up, owning Facebook is never dull. There’s always a lot of noise, always something to worry about. But investors should block all the noise and assess if the long term prospects of the business are still valid.
I believe so.
Although the competition has never posed such a high risk as today – Mark admitted it by saying that Tik Tok is one of the most effective competitors that he has ever faced – and although the ghost of regulation breaking up the company is always lurking, I couldn’t be more enthusiastic about Facebook’s future.
Some say that to own Facebook right now is to believe in Zuck’s vision of the Metaverse and Virtual and Augmented reality. And that’s somewhat of a shot in the dark. I have two things to say about that.
The first is that I’m not even counting on the Metaverse or on AR/VR to bring material profits in the next 10 years. That will all be achieved by the advertising and e-commerce businesses.
Second, if I’ve learned anything by spending the last few years studying businesses is that an extraordinary leader is much more important than the products that the company is developing. Mark Zuckerberg has shown time and time again that he is brilliant and that he follows through with everything he sets his mind into.
I couldn’t be more excited by owning a piece of this amazing business and by being partners with Mark Zuckerberg.
Facebook will be kept in the Portfolio as a core long term position.
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