Meta Analysis: What is Facebook's Future? (w/ Divya Narendra @SumZeroInc)

Take a look at this. This is the one-year stock price chart for Meta, the world's biggest social media company. As you can see, it doesn't look so good at the time of recording, down 44% year-to-date. But if you look at, say, revenue or net income or free cash flow over time, this company has shown nothing but success again and again.

So, being a confused Meta shareholder myself, I thought it best to get a second opinion. What is going on behind the curtain, and should we be worried? So, to help me out, I reached out to Divya Nendra, the guy that originally thought up the idea for Facebook. You remember the social network? How Mark Zuckerberg rips him off as well as the Winklevoss twins and goes off and starts the Facebook.com? Yeah, Divya is the guy.

Interestingly, he's been a Facebook shareholder for a very long time. So, we sat down for a 2-hour chat the other day, and the first question I wanted to ask him was around Apple and Google's clampdown on app tracking, which is limiting Meta's ability to serve relevant ads. The question I asked him was, do you see that as a fundamental problem for Meta's business going forward?

"Well, there's no question that it's a problem. Like, you know, I think that's indisputable. The question is, is it priced in? And I think a related question is, will they solve that problem? The most recent headwinds are part iOS 14.5, you know, this whole Apple App Tracking Transparency framework that Apple has developed, but also kind of just the fact that TikTok has become as popular as it has.

There’s a lot of stuff going on that's completely macro-related, has nothing to do with Facebook directly, just inflation, how the cost of capital has changed and risen, which has affected, you know, really all of tech. A lot of the higher multiple equities have gotten absolutely smashed. But I think if you put yourself in the position of a marketer, somebody who is putting ad dollars to work, ultimately you're going to spend where your audience lives. Like, where is your audience spending the most time? Facebook is, despite all of the, you know, I think all of the negative headlines, still far and away the largest, you know, sort of collection of humans.

So look, with iOS changes, ad relevance probably takes a hit. At the end of the day, I still think marketers on the margin are going to go with like the best ad they can find on a platform with their audience; that's still Facebook. Really, the question is like, has anything changed about the overall network effects of the business? And I don’t think they have. I think that's the key question here.

Have the network effects changed? Because the thing is Apple and Google can put out more and more restrictions on privacy and app tracking, and sure, that sucks for advertisers like Meta, but Meta's apps all have one key advantage that separates them from the rest of the pack, and that is the raw user numbers—currently 2.82 billion daily active users within their family of apps. As stated, Meta has the largest collection of humans. They have the biggest network effect, and that is a very strong competitive advantage that is very difficult for other businesses to topple.

But of course, you never want to get complacent, right? So, how does Facebook ensure they keep their number one position? Zuckerberg, love him or hate him, the guy is very much attuned to existential threats, and he's very, very quick to react to competitive threats. When he bought Instagram, the company had like 12 employees, zero revenue. I don’t even think the board knew about the fact that he had negotiated a deal to buy Instagram for a billion dollars. People thought he was crazy.

You know, when he bought WhatsApp, same thing. They were like, maybe a few dozen, if that, employees, zero revenues. They actually had, okay, they had a $1 subscription model, right? And he nicked the sole source of revenue that that WhatsApp had. If you think about that, like that’s very unintuitive. It's very counterintuitive that like, okay, my company's doing a million dollars a year in sales. You know what? Let's ditch that product entirely, and let's just forget about it. Let's just fund the business ourselves until we get to a scale where we can then figure out the optimal way to monetize that.

It's very interesting insight into how Meta has been able to keep their top position over the past 10 years. They constantly watch for competitive threats, and then they act decisively to protect themselves. In the case of WhatsApp and Instagram, that came in the form of acquiring those businesses to ensure WhatsApp had the best possible chance to grow into the big messaging player that it is today. They ditched the monetization of the platform. You know, sometimes it's counterintuitive, but if you zoom out, then their actions always serve the overarching goal.

But what's interesting is that now in 2022, Meta faces two rising competitors in Snapchat and TikTok, and they can't simply acquire them. So, talking about responding to competitive threats, what's Meta's strategy here? I think what you'll see is that Facebook will be that much quicker to incorporate new use cases into their existing apps. Reels being kind of the current talked-about use case, which is, you know, kind of their version of TikTok, their version of short-form video.

And I think, you know, if you can think of TikTok as this, like that’s kind of their focus. That’s their bread and butter. That’s kind of where it started: short, you know, these like short-form viral videos. That’s like one of a dozen use cases on Facebook’s ecosystem, right? Like you go to Facebook because you're, you know, maybe you want an update on your friend's newborn child, or maybe you want to like message your buddies in India on WhatsApp, or maybe you want to like buy a used chair on Marketplace.

If you think about Snapchat, yes, like they had sort of built a little bit of a niche with ephemeral content, like ephemeral messaging, but now that’s actually also on Facebook Messenger and Instagram. So, if you think about it, like, are you going to ditch your network on Instagram to suddenly use Snapchat just because they have ephemeral content? Like, probably not.

I found that though there’s been a proliferation in other apps, I mean there's no end to it. There’s no single app family that has the breadth of use cases in combination with the network size that Facebook does where I’m worried about Facebook not existing five years from now. That is a good point.

While Snapchat and TikTok have their niche characteristics that make them popular, Meta’s ecosystem is a lot more broad and offers many more use cases other than simply entertainment. That's how they're going to maintain their dominant market position moving forward: act quickly to offer new features that other rivals think of, but at the core of the business, offer functionality that has real-world use and solves real problems.

But I think the key word that Divya mentioned there is ecosystem. Right now, Meta has an app ecosystem, a software ecosystem, but what they’re being taught right now is that being software only actually leaves them vulnerable. And as a result, they're now suffering at the hands of those that control the hardware or operating systems that their apps are accessed through.

This has prompted Meta to spend billions of dollars on developing AR and VR devices to expand their ecosystem to also include hardware. Meta will soon open its first physical retail store. The new store in California will display Meta VR headsets, video chat devices, and smart glasses. They jumped into the hardware business, as Divya is about to explain. This is strategic in more ways than one.

There is no question that Meta sees Apple as a direct competitor. When you're a company that has publicly stated that the iOS headwind is a $10 billion annual headwind, it's pretty obvious that there’s a lot at stake. Facebook knows that they cannot be beholden to a company like Apple or a company like Google or any company, right? It’s like they don’t want to be deplatformed, and the best way to avoid that or circumvent that problem is to build your own ecosystem.

By doing so, you acquire and can rely on much more first-party data as opposed to third-party data. Obviously, hardware—if you're on a Quest 2 or any of their future, you know, if you're on the Ray-Ban glasses that they wear—they have a partner that puts them in a good spot because now they can leverage the fact that you're on their hardware to sort of target services.

"No question. I think the hardware opportunity is massive, and the way I think about it is your typical person really only carries a cell phone on their person, right? I mean, some people have a watch; like, they might have a smartwatch. But I would say most people, as far as electronic devices go, they're probably carrying one electronic device. Over time, I think that changes because of Meta, right? Like, they are working on smart devices, wristbands, glasses, VR headsets, and there could be others that we don’t even know about.

But if you just think about the prospect of, you know, the cell phone market being disrupted, and you think over the years, like if there's a viable product, like, let’s say it’s the story glasses that they have, if that form factor is delivering the same information that you can get from your cell phone in terms of it being as digitally connected to the internet as your cell phone would be, but it’s delivering you that information in your field of view.

So suddenly, when you're driving and you can't find, you know, your destination, you can talk to your glasses; it will just tell you in your field of view, 'Hey, here’s where to go.' That’s solving a real problem. It’s not just a gimmick. I think hardware is probably the number one way Meta can respond to all competitive threats at the same time.

You know, as Divya just described, one: they can allow their advertising business to flourish unimpeded and won’t have to worry so much about the new iOS or Android update. But also, two: they can then tailor the hardware to unlock the full magic of what their software could be. They aren't limited by other manufacturers.

Divya uses the example of navigation systems being overlaid on top of the road while you're driving through your AR glasses. Or imagine building a new home and being able to walk through it and customize it in VR before it gets built. There’s a lot of extremely practical use cases to Meta's AR and VR hardware development, which does actually open up a lot of new businesses and new revenue streams, as opposed to just hardware acting as a shield for the ads business.

But interestingly, he mentioned that beyond hardware, there's an even more critical technology that Facebook is implementing that's going to unlock all of this future value. I think really what people should focus on is, like, what are the technologies that they are investing in that are going to create like new communication use cases and solve real problems? And AI is a big part of that. A big, big part of that. Like, virtual assistants are heavily dependent on AI, right? So being able to have a device on your person that is actually smart and can kind of get you what you want, right? Capable, yeah, yeah.

As opposed to like Siri or some of the stuff that you see with Alexa, you know, like stuff that’s like genuinely smart, you know? Yeah, that is a big part of, I think, what the future holds, and I think Meta is at the forefront of that tech. Here's another great example: there’s clearly been a trend towards virtual work because of COVID.

But now imagine you're at a—let's say you're working at a large company, maybe you have a colleague or maybe you have a customer who happens to be in Africa or they happen to be in Latin America, but maybe you don’t know Spanish. Right? To be able to talk to that person in English and have him understand you in Spanish—that translation technology is exactly the kind of artificial intelligence that Facebook has already developed.

So it's just a matter of time when these technologies get incorporated into their device, which I'm very confident and bullish on a lot of this stuff. Because again, it’s not about like, 'Oh, is it a cool thing?' like for example, like an emoji or something like that or like filters. But is it solving a problem or not? If it is, suddenly you’ve got, you know, I think a big market in front of you. And look, if the cell phone market is disrupted even by 10%, where, you know, some meaningful subset of people are like, 'You know what? I’m gonna leave my phone at home because I’ve got this other thing,' you're going to see a complete rewriting of Facebook or Meta, and that stock is going to rip.

So, once you factor in the total strategy, it seems pretty smart: develop the next-gen hardware of the internet, and then develop strong AI that helps solve real-world problems and unlocks the full potential of that hardware. The result is cell phone industry disruption, multiple new untapped revenue streams, and thus diversification to the business model. And then, bonus, you also have a protective mechanism for your cash cow ads business.

What’s even more interesting is that from a value investing standpoint, at this moment in time you’re seemingly paying a very reasonable multiple for this tech giant. Even as it stands today, Meta is interesting because though it is a mega-cap, it’s an extremely controversial name with quite a bit of volatility.

So you know, I think one of the things that Buffett talks about a lot is this idea of like Mr. Market, you know, this construct that you know, you've got to do your own homework to figure out what intrinsic value is for a given asset. But then it’s like the question is, well, what does it actually trade for in the markets? And just like, you know, going shopping for shoes, like every now and then Mr. Market is on sale, or a specific stock might go on sale.

It’s in those moments of like greatest volatility where you have a decision to make: is this a real opportunity or is this a value trap? You know, like, did a stock tank 50% because it deserved to, or was it an overreaction, right? Or was it an underreaction, right? Like these are the questions that, you know, start to come to mind.

So, I think Meta, because the stock's been a, you know, a little bit of a roller coaster, has, I think, perked people's ears and attention. Even value investors, even like Monish Pabrai, who, you know, we had a lengthy conversation with him about it. He is a deep value investor. So a company like Meta like would historically never be on his radar, right? Because he’s used to paying, you know, five times earnings for something.

Yeah, not 50 times earnings, not even 20 times earnings. I think for him it started to get interesting because, okay, like now the stock's at, you know, 10, 11 times, 12, 15 times earnings, depending on what metric you want to look at. You know, has anything structurally changed here? There's a lot of reason to look at it now just given that the multiple has compressed as much as it has.

So there you go, guys. That was my discussion with Divya Nendra on Meta's stock. I hope you enjoyed it. He was extremely generous with his time, so I want to say a very big thank you to him for, you know, going through all of this stuff with me and, you know, even just being open to chatting on YouTube and discussing his ideas with all of us here on the channel.

Divya actually runs a business called Suzero, which is an online platform where you can access really extremely thorough research reports written by a community of professional investors like fund managers and value investors. So, you know, as a way maybe to say thank you to him for the interview, if you wanted to head over to Suzero and sign up or even just go over and check it out and let them know that you saw this interview, I’m sure Divya would really appreciate it, and I would appreciate it as well.

This video definitely isn’t sponsored by Suzero or anything like that. There's no money involved or affiliate program or anything like that, but you know he’s a good guy, and he’s doing great work, so I did want to give him that plug. But apart from that, guys, that will just about do us for this video. Thank you very much for watching. Leave a like on the video if you did enjoy it. Subscribe if you're new around here. You can check out further links down in the description to all my other stuff. But guys, that'll do us for today. Thanks for watching, and I’ll see you guys next time.

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