Meta Platforms Stock: Firing Season Begins (NASDAQ:FB)

Meta Platforms (NASDAQ:FB) stock has seen very high volatility in the last few months. After the prior quarter’s earnings call, there was a massive correction in the stock. One of the key metrics announced in this earnings call was the dip in the bottom line. In the year-ago quarter, Facebook reported $11.4 billion in income from operations. This declined to $8.5 billion in the recent quarter.

Close to 60% of the decline in profit was within the Family of Apps business which saw profit decline by $1.7 billion compared to the year-ago quarter. The main reason behind this dip is the difference in headcount growth and revenue growth. Facebook reported headcount growth of 28% compared to the year-ago quarter while revenue growth was only 7%.

The management has already announced that they will undertake some belt-tightening and reduced the full year expense outlook to $87-92 billion from prior estimate of $90-95 billion. Reining in headcount growth is a relatively quick process and we should see positive results in the next quarter or two. This should lead to a rapid jump in EPS estimates and also improve the sentiment toward the stock.

Don’t blame Reality Labs

Facebook has spent billions of dollars to establish its metaverse business. Any decline in overall profits is usually blamed on Reality Labs alone. However, recent earnings report shows that it contributed 40% of the total decline in profits. The remaining 60% decline was due to core business of Family of Apps.

Figure 1: Decline in profit within Family of Apps business in the recent quarter. Source: Company Filings

We can see from the above image that Facebook’s income declined by $2.9 billion compared to the year-ago quarter. The incremental decline in income from Family of Apps business was $1.7 billion and another $1.1 billion in Reality Labs. The main reason behind the big dip in income from Family of Apps business has been a mismatch in the revenue and headcount growth in the recent quarter.

Impact of higher headcount

Facebook’s median salary is one of the highest in the tech world and any mismatch in the headcount and revenue growth can lead to massive fluctuation in income. In the recent quarter, YoY change in revenue was 7% while costs and expenses increased by a whopping 31%.

Figure 2: Massive difference in growth rate of revenue and costs. Source: Company Filings

Interestingly, Facebook reported YoY headcount growth of 28% which is very similar to the increase in costs.

Figure 3: Increase in headcount growth is close to the increase in costs. Source: Company Filings

Relatively quick process

Synchronizing headcount and revenue growth is a relatively quick process that Facebook’s management should be able to achieve in the next few months. We could see a reduction in new hiring and optimization of the current manpower in the near term. This should help the company match the growth rates in its headcount and revenue. The management has already reduced the outlook for total expenses in 2022. The total expenses are now expected to be in the range of $87-92 billion, down from $90-95 billion as mentioned earlier.

Figure 4: Reduction in outlook for total expenses. Source: Company Filings

Hence, we can already see a $3 billion savings in total expenses which will help in boosting the bottom line. It is likely that we might see some further belt-tightening as the company optimizes its current resources. Historically, there has been a very close correlation between revenue and headcount trajectory.

Figure 5: Close correlation between revenue growth and headcount change. Source: YCharts

Impact on EPS and stock

Facebook is facing a number of challenges which include new privacy policy of Apple (AAPL), competition from TikTok, lower monetization of videos, higher investment in metaverse, and others. At the same time, if Facebook is able to undergo the current transformation, it will be in a much better position to leverage its social media platform to add new revenue streams. During this time we might see volatility in revenue and income growth. This is already reflected in stock price swings of the last few months.

However, the current dip in income and EPS is likely to be a short phase. As mentioned above, most of the decline has been due to the rapid growth of headcount. We should see a more synchronized growth in revenue and headcount within a quarter or two which should help rapidly improve the bottom line.

Figure 6: Dip in EPS projection led to a rout in stock price. Source: YCharts

Facebook’s lower forecast in the previous quarter led to a stock correction. However, we are already seeing signs of a more prudent approach by the management in terms of managing expenses in the next few quarters. This should help in rapid improvement in EPS which will be a big boost to the sentiment towards the stock. Facebook also spent close to $50 billion on buybacks in the trailing twelve months. If this pace of buybacks continues over the next few quarters, it will lead to a major tailwind for EPS growth.

Facebook stock is trading at only 15 times its PE ratio while the challenges for bottom line are short-term. We should see a sharp improvement in bottom line and EPS over the next few quarters as the headcount optimization takes place. The long-term fundamentals of the company are still strong, and the stock is quite cheap compared to all other peers which make it a good bet at the current price.

Investor takeaway

Facebook reported 7% YoY growth in revenue and 31% growth in costs which led to a decline of 25% in income from operations. At the same time, the company reported 28% growth in headcount compared to the year-ago quarter. In the past few years, the management has done a good job in showing similar trajectory of revenue and headcount growth. It is highly likely that we will see rapid optimization of headcount in the near term which should help in cutting expenses and improving the bottom line.

The recent dip in EPS is likely to be brief as the company stabilizes revenue growth and cuts expenses. Massive investment in buybacks should also be a tailwind for the EPS. The stock is trading at a cheap valuation when we look at the long-term growth potential in various businesses and the ability to improve margins.