Meta: A Free Cash Flow Machine

There are many opinions about Meta as a company, and I understand that it may not be a suitable investment for everyone. However, Meta is generating a significant amount of cash, and they are planning to share some of that cash with shareholders through buybacks and dividends. The question is, is it time to buy Meta? I will try to provide you with the answer in this analysis.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Meta. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I do not own any stocks in any of Meta's direct competitors either. Thus, I have no personal stake in Meta. If you want to purchase shares or fractional shares of Meta, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.

I believe that most people are aware that Meta is a social media and social networking service. Apart from their flagship Facebook, they also own several other businesses, including Instagram (a photo and video-sharing app), WhatsApp (a mobile messenger service), Oculus VR (a virtual reality technology company), Onavo (a mobile web analytics company), and Beluga (a messaging service), among others. Meta has two business segments. Their highly profitable "Family of Apps" includes Facebook, Instagram, and other apps, along with "Reality Labs" comprising Oculus and all Metaverse-related businesses. Meta generates substantially all of its revenue from selling advertising placements on its Family of Apps to marketers. Marketers purchase ads that can appear in multiple places, including on Facebook, Instagram, Messenger, and third-party applications and websites. While Meta has a global sales force with offices in approximately 90 countries around the world, the majority of marketers use Meta's self-service ad platform to launch and manage their advertising campaigns. This is why the Family of Apps segment managed to deliver an operating margin of 47% in 2023. Meta is one of the largest advertising companies in the world. The Reality Labs segment generates revenue from sales of consumer hardware products, software, and content. These sales are made through third-party sales channels such as retailers, resellers, and Meta's direct-to-consumer channel. The Family of Apps contributed approximately 98,5% of the revenue in 2023, while Reality Labs contributed 1,5% of the revenue. Investigating moats, I believe that Meta has two moats. The first is a brand moat, as consumers tend to place greater trust in the brand, especially Facebook, Instagram, and WhatsApp, which are widely used globally, with 3,1 billion people using one of Meta's apps every day. This directly leads us to the second moat, which is the switching moat. The apps are such a significant part of people's lives that it is hardly worth switching if there were to be competitors at the same scale

The CEO of Meta is Mark Zuckerberg, who is also the founder. Besides being the CEO, Chairman, and Founder of Meta, he is also the largest shareholder. Mark Zuckerberg is, in many ways, a controversial figure, and there are numerous opinions about him. However, one thing that cannot be disputed is that he possesses a brilliant mind. He founded Facebook when he was just 19 years old, and now, 20 years later, it is a multibillion-dollar business. I do not want to delve into his entire tenure as a CEO, but some of the highlights include being named Person of the Year by Time Magazine, overseeing the biggest tech IPO in history at the time (2012), demonstrating commitment to philanthropic causes, and displaying a willingness to invest in acquisitions (Instagram $1 billion, Oculus $2 billion, and WhatsApp $19 billion). He has a high approval rating as a CEO, and I always appreciate it when a founder serves as the CEO because they are usually more dedicated to growing their business than to filling their wallet (not that Mark Zuckerberg needs to worry about that). If you examine the results of Meta, I am confident that you can conclude that Mark Zuckerberg is an excellent CEO for Meta.

I believe that Meta has not only one but two moats. I really like the management as well. Now, let us investigate the numbers to see if Meta lives up to our requirements for a strong moat. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.

The first number we will look into is the return on invested capital, also known as ROIC. We would like to see the Return on Invested Capital (ROIC) exceed 10% each year and show an upward trend. Meta made its IPO in 2012, and although they achieved an acceptable Return on Invested Capital (ROIC) in the first couple of years, it really took off since 2017. Meta has achieved a return on invested capital (ROIC) of over 20% in 5 out of the last 7 years, which is encouraging. 2022 was a very challenging year for Meta in many ways, but the company still managed to deliver a high Return on Invested Capital (ROIC) above the 10% threshold that I would like to see. It is also encouraging to see that Meta managed to deliver a ROIC above 20% again in 2023, indicating that the lower ROIC in 2022 was an outlier.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Meta managed to grow its equity every year until 2021, despite being significantly impacted by the pandemic and reduced advertising spending. Thus, the slight decline in equity from 2020 to 2021 is not something I worry about. Equity grew slightly in 2022, which is encouraging, despite still being below the 2020 level. However, Meta managed to significantly increase its equity in 2023, reaching a new all-time high. This is encouraging to see, and hopefully, the trend continues.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Up until 2022, Meta was essentially a textbook example of desirable growth in free cash flow, with year-over-year increases. 2022 was a very challenging year for Meta, as evidenced by its significant decrease in free cash flow. Fortunately, it appears that 2022 was an anomaly, as Meta managed to achieve its highest free cash flow ever in 2023. Levered free cash flow margin isn't as high as in the first four years, but it is encouraging to see that the levered free cash flow margin reached its second-highest level in the past six years in 2023. A company with a levered free cash flow margin above 30% will always be an intriguing investment opportunity. Free cash flow yield reached its highest point in 2022. If you had bought shares back then, it would have been a good investment. The free cash flow yield in 2023 is slightly below the ten-year average, indicating that the shares are not cheap. However, we will revisit this point later in the analysis.

Another important factor to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We do this by dividing the total long-term debt by earnings. Looking at Meta's debt, we can see that Meta has 0,47 years of earnings in debt. It is, of course, a very good thing and yet another reason to be positive about investing in Meta.

As with all other investments, there are risks associated with investing in Meta. One risk is regulations. There can be regulations regarding data collection, as well as antitrust and anti-monopoly regulations. Previously, when asked about data collection management, the company mentioned that "the regulatory environment is a real challenge for our industry." They also stated that they are actively working on technologies that require less data but acknowledged that this is a significantly challenging time for the industry. Management has also mentioned that they continue to monitor the active regulatory landscape, including the increasing legal and regulatory challenges in the EU and the U.S. that could significantly impact Meta's business and financial results. They also mentioned that the Federal Trade Commission is seeking to substantially modify Meta's existing consent order and impose additional restrictions on Meta's ability to operate. Meta is contesting this matter, but if they are unsuccessful, it would have an adverse impact on its business. Competition. In its annual report, Meta mentions that they face significant competition in every aspect of their business, including, but not limited to, companies that facilitate the ability of users to create, share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences. TikTok is still growing and is the fastest-growing social media application of all time. TikTok was released in 2016 and reached 1 billion active users in 2021, whereas it took Facebook and Instagram nearly a decade to achieve a user base of that magnitude. Hence, TikTok may be the strongest competitor that Meta has ever encountered, despite TikTok being restricted in the United States. Developments in advertising. Meta makes almost all of its revenue from advertising on Facebook and Instagram. They rely on targeting and measurement tools that incorporate data signals from user activity on websites and services that they do not control to deliver relevant and effective ads to their users. These factors can be influenced by regulations, as mentioned earlier, as well as by mobile operating system and browser providers like Apple and Google. These companies have made product changes and/or announced future plans to restrict websites and application developers' ability to gather and utilize these signals for targeted advertising and measurement purposes. For instance, Apple has introduced its App Tracking Transparency changes, which is a modification in iOS. This change mandates that developers must now seek permission from users before tracking their data. If we see more of these developments in advertising, it could impact Meta's future.

There are also numerous reasons to invest in Meta. One is monetizing messaging. Management has mentioned that they have two ways to monetize messaging on Messenger and WhatsApp: click-to-messaging ads and paid messaging. Click-to-Messaging allows people who click on a company's ads to be directed straight into conversations with its business on Messenger, Instagram, or WhatsApp. Paid messaging allows companies to send offers, promotions, and updates directly to the individuals with whom the business communicates on Messenger. Meta has experienced significant growth in revenue from purchase optimization on click-to-Messenger ads since its introduction. They have expressed enthusiasm about the long-term prospects for click-to-messaging. Paid messaging is in an earlier stage, but management has mentioned that they are seeing good momentum for paid messaging and positive results from Meta's updated pricing model. Thus, Meta should focus on monetizing messaging on Messenger and WhatsApp in the future. Reality Labs. Currently, Reality Labs only contribute 1,5% of the revenue. It was expected that Reality Labs would take a long time to become profitable because management believed they would need to develop full displays, holograms, and deliver a sense of presence before smart glasses became a mainstream product. However, management now believes that it seems quite possible that smart glasses with AI assistance built in could have a significant market before the next generation of smart glasses with holograms and a sense of presence. There is also the metaverse that management believes will be profitable in the 2030s. It is still difficult to predict what the Metaverse will become. According to Morgan Stanley, they believe that the Metaverse has the potential to be an $8,3 trillion addressable market. In other words, it could be enormous, and Meta is the pioneer. Meta is shareholder-friendly. Meta repurchased $20 billion worth of shares in 2023. By the end of the year, they still had $30.9 billion remaining from their prior authorization. Recently, they announced a $50 billion increase in their stock repurchase authorization. Meta has also just announced its first dividend. While the annual payout is currently just $2 per share, Meta could increase its dividend quickly since the payout ratio is low and Meta is increasing its free cash flow. Meta will continue to be shareholder-friendly moving forward, as management has stated that returning capital to shareholders remains important to the company.

Now it is time to calculate the share price of Meta. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 14,87, which is from the year 2023. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 116,8% in the next five years, but 15% is the highest I use. Additionally, I have selected a projected future P/E ratio of 30, which is double the growth rate. This decision is based on Meta's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $446,10. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Meta at a price of $223,05 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 71.113, and capital expenditures were 27.266. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 19.086 in our calculations. The tax provision was 8.330. We have 2.561 outstanding shares. Hence, the calculation will be as follows: (71.113 – 19.086 + 8.330) / 2.561 x 10 = $235,68 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Meta's free cash flow per share at $17,05 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $269,15.

I believe that Meta is a great company with multiple moats and excellent management. Meta had a rough 2022 but bounced back in 2023, which demonstrates the quality of the company. Meta is facing some risks that could potentially impact its business in the future. Regulations will pose a continuous risk if investing in Meta. Management has mentioned that the Federal Trade Commission is seeking to substantially modify Meta's existing consent order and impose additional restrictions on Meta's operations. However, we will have to wait to see how it unfolds. Meta has also faced challenges due to product changes made by mobile operating system and browser providers, which is partly why Meta encountered difficulties in 2022. We may expect more advertising developments in the future that could be detrimental to Meta. Meta is facing its strongest competitor ever in TikTok, which may affect Meta's growth. However, Meta may also benefit from a TikTok ban if it were to occur. Meta's Family of Apps is a cash cow, and if Meta manages to monetize messaging, it will make Meta even more profitable in the future. Reality Labs has often been seen as a weakness of Meta, which is understandable as it isn't profitable. However, the smart glasses may become popular sooner than expected, and the Metaverse has great potential if it ever materializes. It is also nice to see Meta rewarding shareholders with continuous buybacks and now dividends, which should grow rapidly. I will consider adding Meta to the portfolio if it is priced below $400 as it will provide me with a minimum 10% discount on intrinsic value in all my calculations.

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