The Long and Short
Lower costs should improve margins, cash flow at Meta
Meredith Contente | February 3, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
After a difficult 2022, Meta Platforms Inc. (META, A1/AA-) unveiled plans for the current year, deeming it the “Year of Efficiency”. Management will focus on becoming a nimbler organization, which will include further reducing overhead and fostering faster decision making. In a departure from previous years, META looks to vastly improve productivity in order to bring down the overall operating cost structure of the business. Management’s historically conservative financial policies means META is armed with a strong balance sheet, setting the stage to return EBITDA margins to pre-pandemic levels. Free cash flow generation will benefit from reduced capital spending surrounding its new efficiency measures.
With the single-A Media sector only containing two credits, The Walt Disney Company (DIS – A2/BBB+ (p)/A-) and META, we are highlighting the trading differential between the two. While DIS and META trade relatively in-line with each other in the front end of the curve, the differential in the long end is roughly 40 bp. This should collapse as META executes its transformation and margins and cash flow are restored to historical levels.
Exhibit 1. Single-A Media Curve
“Year of Efficiency” to Reduce Operating and Capital Spend
META closed out 2022 with a workforce reduction of ~13%, a facilities consolidation project and a new data center design. However, management noted on its earnings call that this was the just the beginning of its efficiency focus. The data center design will reduce its construction spend as the new data center architecture can support both AI and non-AI workloads. META is also now looking to flatten its organizational structure further with the removal of some middle management layers. As part of the restructuring, the company noted that they will look to utilize AI tools that will support increased productivity for engineers, thereby enabling further staff reductions. Additionally, management will be re-evaluating all current projects and look to cut those that are underperforming or no longer deemed crucial for the development and growth of the company’s two major technology verticals, AI and the Metaverse. That said, META lowered its 2023 capital expenditure guidance from a range of $34 billion-$37 billion to the $30 billion-$33 billion area, while reducing operating expenditure guidance by roughly $5 billion.
Strong Cash Position and Credit Metrics
META benefits from a very strong balance sheet, underscored by a sizeable net cash position. META ended 2022 with cash on hand of $40.7 billion relative to $9.9 billion of total debt, translating to a net cash position of $30.8 billion. This compares favorably to its media peer DIS, who ended fiscal 2022 with cash on hand of $11.6 billion, relative to $48.4 billion of total debt. META’s leverage metric remains well below a turn, as it ended the year with total debt leverage of 0.2x. Despite some improvement to DIS’ leverage this year, total leverage remains high for the current ratings at 3.5x. We note that META’s total leverage is more than two turns lower that DIS’ net leverage of 2.6x.
Exhibit 2. META vs. DIS Balance Sheet and Credit Metrics Comparison
No Near-Term Funding Needs
META’s debt maturity profile is also very manageable with no debt maturing until August 2027. While META tapped the debt market twice last year, the capital structure remains small with only four public debt issues. DIS, on the other hand, has 140 debt issues outstanding and just over $14 billion of debt maturing through 2027. We believe META’s strong balance sheet provides for good financial flexibility to execute its efficiency measures, with no maturities to refinance and no funding needs required for any cash outlays associated with the restructuring. Additionally, reductions in operating and capital spend provides for stronger free cash flow generation, which will help to support shareholder remuneration. META has just over $50 billion of authorization under its share repurchase program, as the company announced a $40 billion increase to the program with its earnings release.
Ad Revenues Staging a Comeback
Despite a muted advertising revenue environment across the media sector, META has seen considerable growth with its click to message ad product. As one of their fastest growing advertising products, click to message ads have now hit a $10 billion revenue run rate. The growth is helping to drive incremental demand, as more than half of click to message advertisers are exclusively using META’s platforms. META credits this to its AI investments which have made it easier for advertisers to both develop and deliver more relevant and engaging ads. This has grown the conversion rate by more than 20% in the last quarter alone. When coupled with a declining cost per acquisition rate, this has translated to higher ROIs on advertising spend.