Three Scenarios from Our Risk-Benefit Analysis for Meta Platforms, Inc. (NASDAQ:FB)

Today we will try to get a better understanding of some qualitative risks surrounding Meta Platforms, Inc. ( NASDAQ:FB ), and compare them to the long term benefits of the stock. In order to make good investment decisions, we must find our way out of the fog of the moment and evaluate the future prospects of a stock.

Current Outlook

The company's stock dropped to US$217.7 , making current investors feel the pain of a fast 33% drop, which also prompted the interest of people who think the stock might be in value territory. The question is, has FB changed that much in the last quarter, and should investors expect a drain or recovery?

In general, when things start deteriorating, traders and investors are reluctant to bet on the opposite side of a trend, and risk being the lone trader that has to explain to their supervisors why they bought an "obviously" declining stock - People often get judged in hindsight on the decisions they made with limited available info, and it is no different in investment.

So, investors who are expecting a quick-rebound, might want to wait out the current sentiment and sacrifice finding the "bottom" in order to be on the right side of the trend.

There are a few important points to make regarding the short-term developments in a stock.

Price swings can to happen before significant news or catalysts, so we can outline a rough expectation on when and what that might be. A shakeup like this prompts management to reevaluate and even make some deep internal changes. At Meta, there are arguably late night meetings being held in order to mitigate the situation. Management has a few options here:

• They can release a strong update, that will regain investor confidence. A task not so easily accomplished, since investors apparently weren't even impressed with the US$19.2b in CapEx for 2021 (p. 9) . Meta, will need to deliver a sound forward strategy if they want this approach to work. "We will see how it turns out" might not cut it.
• They can choose to "shrug off" the loss and stick to the plan. With this, they would signal that they have confidence in their chosen projects (such as the Metaverse), and wait for the next earnings call.
• They could even "double-down", on their projects and further increase funding. If we look at the health section for FB , we can see that the company is all equity funded. They can easily take out a loan while financing is still cheap and invest even more in capital projects and compliance needs. Their current financing approach, seems to be a reflection of internal philosophy more than it represents financial logic. For investors, increasing the debt level, even a little, can be seen as a positive step, as it transfers value from taxes to shareholders.

In that regard, we can be sure to expect meaningful swings around the next earnings session, and investors should keep an eye on important updates for FB.

If you use our price history, you can see how meaningful events impact the stock, and putting it on your watch list will help you get influential updates.

Now let's dive into the risks and benefits of FB stock!

Risks Factors

• General Litigation: Meta has multiple class actions and derivative actions filed in the US courts and elsewhere, with allegations centered on privacy, security and other issues ( Annual report, p. 46-47 ). Meta recognizes that these processes can adversely impact the business, via fines, decisions to modify business practices or other means.
• GDPR and compliance: Meta is currently under review for its compliance with EU GDPR regulations regarding user data transfer to the U.S., the company expects a final decision on the matter by the first half of 2022 ( Annual report, p 47 ). In popular media, this has circulated as the tension between Meta and the EU, regarding the continuation of Meta's platforms in the EU. The risk here is that Meta may be forced to modify business practices and adopt less invasive data policies.
• Antitrust: On January 11, Meta was denied a motion to dismiss an FTC amended suit regarding their acquisition of Instagram and WhatsApp, which means the process will continue. The FTC is intent on proving that Meta is a form of monopoly, and may push for a spinoff of Instagram or other apps.
• 2022 cases: Cases are also being initiated against Meta in 2022, such as the Texas vs Meta suit over "facial recognition practices" , and a UK class action suit alleging a breach of competition law .
• User growth deceleration: FB lost 1 million users for the 1st time, as outlined in their last quarterly report (p. 13) . While the company may regain user growth moving forward, it is clear that they have saturated most of their market share, and further growth will cost more to obtain.
• Reduction of data signals: This results from the changes Apple made to their latest iOS , which allows users to "opt in" for cross site data tracking, rather than the previous default option that favored Meta. The company must find a way to either offset this effect or find an alternative mechanism that would allow it to track users or optimize the ad targeting algorithm.
• Dual share structure: The CEO, chairman and founder of Meta are one person with an absolute majority of voting power. This is considered to be a bad governance structure, because the leadership has no effective pushback on decisions that might be bad or unproductive for the company.
• Engagement and Advertisers : Meta is competing both for users and the time they spend on the platforms, which is why a decline in these key areas can impact advertising revenue and discourage advertisers from using it.
• Competition: New and rising social media platforms that provide a different, targeted and better experience for users are putting pressure on the Meta ecosystem. These competitor platforms include: TikTok, Reddit, Twitter, Discord, Twitch, YouTube etc.
• Acquisitions: companies can grow organically and via acquisitions. In the case of Meta, we can argue that new acquisitions are not viable given the pressure from regulatory bodies and the current media spotlight.
• The Metaverse : The project requires large capital investments in a developing technology. It is tied to the Oculus which promised VR experiences back in 2016. However the project did not get the desired traction, and now Meta is developing the software side of it, hoping to pair virtual reality worlds with their headset.

What we listed above are a select set of risk factors that may be able to affect company operations now and in the future. However, Meta may subsequently overcome them to a varying extent.

There is one more risk that I would like to note, and that is the risk of complexity - When something gets hard to interpret (such as the sum of all material risks), we revert to using mental shortcuts in order to make decisions. These mental shortcuts (heuristics) are made with limited info and are often emotional. In the case of FB, one such shortcut, is to stay away and wait out for someone else to make the first step.

Investors, may want to take some time and try envisioning how and where they see Meta in the future: Is it more widely and enthusiastically used than today? Which aspects will develop (groups, events, messenger/communications)? Will it be crippled by competitors and regulation? Etc.

After we do this, we can talk about the financials!

Incorporating Risks into Value

One way to incorporate risk into value is to build a model, and estimate the impact of the risk factors to the business operations.

At Simply Wall St, we already have a general standard model for a stock, and it currently values FB at US$1.7t or $641 per share. This implies the stock is 66% undervalued. You can view our standard model Here .

However, here is the important part.

We can also say that FB is in an unusual situations, and we can tweak our model in order to incorporate the above-mentioned risk factors.

In our Beta Labs, we have a Stock Valuator , where you can go and estimate your version of the intrinsic value of FB.

Go to https://stockvaluator.co/ and give it a try.

If it's your first time, just keep it simple by tweaking how much you expect profit to grow in the future.

You will immediately see, that the value of FB changes, by how you think things will pan out. If you think that the company will optimize profits, you can assign a medium growth rate of 7%-15%, if you think users are jumping ship, and regulators are pilling on, you may have a negative outlook and assign a value less than 0%.

In order to help you navigate, the tool has some info on the company's history, so that you can get a better perspective of how much you are dubbing this to be an unusual situation. You can also view our latest analysis for Meta Platforms.

Remember, that even if you are right about FB, the market may not agree or it might take a long time before the stock converges to your valuation!

Benefits

In order to provide a better overview of the company, we need to consider the benefits of FB stock, and what is it that might make it attractive to investors again. 

In this section we will focus on the fundamentals, as they are a large part of what made FB a strong company for investors.

Currently, Meta has:

• $38b in free cash flows, about the same as profit - which grew 35% last year and 23.7% annually in the past 5 years. The future forecasted growth is 9% in the next 1 to 3 years.
• 33.4% profit margin and a 40% operating margin.
• $118b total revenue, up 37% from last year, and an management's expectation of 3% to 11% revenue growth next quarter.
• Expected CapEx of $29-34b in 2022, up from $19.2b in 2021 (about 65% growth).
• 31.5% Return on Equity and 32.3% return on capital employed, industry ROE is at 18%.
• Lowest P/E in years, at 15.1x.

In the chart below, we combined the past performance with future expectations, so that investors can form a more complete image of the financial performance of the company.

We can see that the financials are arguably the strongest point of the company, and even if growth stops and Meta continues operating in a steady state, the current cash flows seem to be significantly undervalued.

Conclusion

The current price seems to reflect regulatory, brand perception and other qualitative risks more than it reflects the value of the financial performance.

Investors can use the Stock Valuator Tool in order to estimate the value of Meta according to their vision of the future.

Qualitative risks are hard to state as numbers, but we can create scenarios.

For Meta, in my estimation, the worst case scenario is that the company gets piled on by regulators, pays large fines and ultimately is forced to spinoff a part of its business. There is some probability, that in this extreme scenario, the company is currently overvalued.

The best case scenario is that the company manages the storm, continues growing the bottom line and turns the metaverse into a success story. A bit on the optimistic side, but should this turn out to be the case, then FB is massively undervalued.

In the middle we have a scenario where regulators fine the company, and impose some changes in business practices. The company adopts and recovers in a few years, while the metaverse morphs into something else which takes a long time before it actually breaks profit. Even with the drawbacks, in this scenario the stock is reasonably undervalued.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.