The Business Of

Eyeballs | Meta | What Do They Do With Their Profits?

Morning All!

Yesterday we put together Meta’s costs with their revenues. And we’ve covered a fair amount this week. So let’s have a quick recap…

• Pricing Power: As Meta’s apps have grown in popularity, the company has raised ad prices… by a lot! ARPU has grown from ~$5 (2011) to ~$45 (2023)!

• Glorious Growth: The combination of user growth and pricing power has seen Meta’s revenue grow at a ~45% CAGR from ~$777m (2009) to ~$135bn (2023).

• Monster Margins: As you’d expect, this asset-light, tech giant boasts some serious margins. How’s ~81% gross margin, and ~35% EBIT margin - not bad!

And speaking of margin. It is a Thursday morning. Which means it’s time to take a look at our famous TBO EBIT Margin ranking! Below, we can see our ranking updated to include Meta. And Mark Zuckerberg’s gang slots in at number 6… quite a bit higher than Alphabet!

However, whilst #6 on our esteemed ranking is clearly something to be proud of. There’s actually more to the story than Meta’s overall ~35% margin figure! Last time in The Business Of Alphabet, we saw that whilst Alphabet as a whole had a ~27% EBIT margin. Google’s Advertising division had a much higher EBIT margin of ~37%. And the reason for this difference was because certain Alphabet segments (like Google Cloud) are loss-making and drag down the overall EBIT margin figure!

And guess what…? It’s the same with Meta! In the chart below, we can see that whilst Meta’s overall EBIT margin in 2023 was ~35%. Meta’s Reality Labs division (their VR headsets, VR sunglasses stuff) had a EBIT margin of -850%! The division was hugely loss-making - losing ~$16 BILLION IN 2023!

And so, if we take this division out of Meta’s overall numbers, we can see that the advertising part of Meta (called Family of Apps) actually had an EBIT margin of ~47%! Which is super high! So high, that Meta’s advertising business would slot in at NUMBER 2 on our TBO EBIT Margin ranking… only behind TSMC!

Alrighty, let’s move on to how Meta spend all their profits!

Meta And Alphabet Basically Spend Their Cash On The Same Things!

So, to kick us off, let’s as always look at the waterfall chart below. Which shows us how Meta have spent their cash from operations (CFO) since 2009.

As we can see, Meta made a huge ~$350 billion in cash from operations from 2009-2023. And similar to what we saw in The Business Of Alphabet, Meta have spent most of their cash on just two areas - capex and share buybacks!

So today, we’re going to focus our attention mainly on these two uses of cash. But we’re also going to take a look at a third use of cash. Now, this third use doesn’t actually appear in the waterfall chart above… but it will do soon!

Why Do Data Centers Cost ~$1 Billion To Build?!

Alrighty, so let’s kick off with capex. And no surprises here - when we think about capex for Meta it is very much to do with data centers! These data centers are basically massive warehouses filled with TENS OF THOUSANDS of computers (servers). And these servers basically store and process all the data that is needed for Facebook, Instagram, and WhatsApp to function!

The image below is a reminder of what these data centers look like on the outside (left) and inside (right).

Now, in last week’s series, The Business Of Alphabet, we talked about the huge importance of data centers. And how companies like Alphabet and Meta, with all their data requirements, absolutely need to invest in these data centers. Check back to last week’s newsletter for more of this info.

But today, the question we’re going to touch on is - why do data centers actually cost so much to build? Like, Meta spend ~$1 billion to build one individual data center. But what actually makes up that ~$1 billion spend? Well, unfortunately there’s not many articles that give us exact figures. And so what I like to do in these situations is ask ChatGPT! And so in the below screenshot, you can see what ChatGPT says are the main expenditures for a ~$1 billion data center build!

Let’s look at the first 4 costs above which make up ~80% of the total data center costs. Of course, the first thing that’s required is land. Companies like Meta will need to purchase the land that the data center is going to be built on. And this appears to be ~5% of the overall ~$1 billion cost.

Next, is the construction and (network and cooling) infrastructure. And this appears to be the largest cost when it comes to data center capex (~40%). Constructing the walls and floors… like you would for any building! Putting in the network infrastructure (routers, switches, cables) so the servers can communicate with each other. And then installing all the cooling infrastructure (chillers, cooling towers) so the servers don’t overheat!

The second largest cost appears to be the equipment and hardware (~25% of the ~$1 billion price tag). And this is where the cost of the actual servers shows up. Meta will spend millions on buying rack-mount servers from companies like Dell and HP. And they’ll spend millions on buying GPUs from companies like Nvidia and AMD! And it’s these servers that power pretty much everything!

The final cost is labour and installation. And this is the cost of getting people to build, install and manage the things we’ve just talked about! Now, in the chart below, can see that Meta’s number of data center locations has grown significantly over the years. As the number of Facebook, Instagram, and WhatsApp users has grown, so too has the amount of data that needs to be stored and processed!

Now, as Meta’s apps continue to grow in popularity, and virtual reality and AI start to become a bigger part of Meta’s operations - there’s a strong likelihood that Meta will continue growing their data center locations to manage the extra data requirements. Check out this article to see how Meta have been re-designing their data centers to help them with their VR/AI future!

Meta Upping Their Buyback Game!

Alrighty, so that’s capex out the way. Now, let’s turn our attention to the other main way Meta have spent their cash - share buybacks! And again, there’s a lot of similarities here to Alphabet.

Last week, we saw that Alphabet waited a long time before starting share buybacks. It was only in 2015 that the company bought back their first shares! And whilst the initial buybacks weren’t a huge figure - relative to the amount of cash the company made every year - Alphabet have REALLY stepped it up since. In 2023, the company actually spent a massive ~60% of their cash from operations on share buybacks!

Okay so that’s a reminder of Alphabet. But what’s been happening with Meta and buybacks? Well, till 2017, Meta hadn’t done any buying back of shares. Like Alphabet (pre-2015), Meta were super focused on growing revenue and profit. Pretty much all the cash they were making was being reinvested into the business - in the form of capex (data centers) and acquisitions (Instagram, WhatsApp).

However, in 2017, Meta announced their first ever buyback plan - totalling ~$6 billion. And since 2017, Meta’s number of shares outstanding has fallen by ~11%. From 2,956 million shares to 2,629 million.

Note: The reason why shares outstanding doubles from 2011 to 2017 is because of share-based compensation. Check out this article to see why the settlement of equity options leads to an increase in shares outstanding!

Now, the interesting thing here is that Meta - like Alphabet - are looking to spend more and more of their cash on buybacks. And just last month, Meta announced a monster share buyback plan of ~$50 BILLION. But the question is - why are Meta doing this? Why are they - and Alphabet - buying back so many of their shares?

Well, the answer is to do with EPS (earnings per share). To understand this - let’s ask ourselves the question - what is Mark Zuckerberg’s duty as CEO of Meta? Well, his duty really is towards his shareholders. Meta’s shareholders have invested in the company. And what do they want to see for their investment? Well, they want to see Meta growing. And in particular, they want to see Meta growing their EPS!

But question - how do share buybacks help increase EPS? Well, let’s illustrate that now! In the graphic below, we can see that Meta’s 2023 EPS figure of $14.87 is calculated by dividing Meta’s 2023 net income (~$39,098m). By Meta’s 2023 number of shares outstanding (~2,629m).

Now, to see the impact of Meta’s $50 billion share buybacks, let’s assume Meta’s net income stays exactly the same for 2024. So the numerator stays at ~$39,098m. But will the denominator (shares outstanding) remain the same? Well, the answer is no - the denominator changes!

Let’s say Meta buy back their shares at yesterday’s close price of ~$500. How many shares will they be buying back? Answer: 100m ($50bn/$500). And so how many shares outstanding will Meta have in 2024? 2,529m (2,629m - 100m)! And what has this now done to the EPS in 2024? Well, it’s gone up by ~4% to 15.46!

Now, assuming the P/E multiple that Meta’s shares are valued at remains constant, Meta’s share price will also increase! That may be a little complicated to get into now. I’ll do a separate newsletter on that another day! But for now, check out this McKinsey article which explains how buybacks can lead to share price increases!

Why Are Some Investors Not Happy With More Buybacks and Dividends?!

Okay, let’s wrap up with a brief word on a third use of cash - which Meta hasn’t yet engaged in. But they will be soon - and that’s dividends! Last month, Meta announced that after 12 years as a public company, they will finally pay out a dividend!

So how big is this dividend? Well, for Q4 2023, Meta have said they’ll pay a dividend of ~$0.50 for every share someone has. And the chances are that they’ll continue to pay dividends from here on out! Now, whilst this is good news for all investors who own Meta shares. Arguably the biggest winner is Meta’s CEO… Mr Zuckerberg!

So, how much will Mark Zuckerberg make from this new dividend policy? Well, Meta’s CEO owns ~350 million Meta shares. And what’s $0.50 multiplied by ~350m shares? A whopping ~$175 million.

Yes, you read that right. Mark Zuckerberg is set to make a tidy ~$175 million this QUARTER from the new dividend policy! And if Meta continue to pay a dividend of $0.50/share every quarter, Mr Zuckerberg will make ~$700 million per year ($175m x 4) through dividends! Not too shabby!

Now, what we’ve looked at so far sounds like really good news for Meta shareholders right? The company are boosting their EPS by buying back more and more shares. And they’re also giving cash to shareholders through this new dividend. What’s not to love, right?!

Well, actually, wrong. Because whilst these buybacks and dividends sound great. They have left some investors not feeling so cheery. And the question to ask is - why? Why would some Meta investors not be happy with the increased buybacks and dividends?

Well, the answer is 2 parts. And the first part is based on the words of the great man, Warren Buffett. Uncle Warren’s stance on buybacks is that they’re a great tool to use when management feel a company’s shares are undervalued. But for a lot of observers, Meta’s stock really doesn’t look that undervalued. In fact, Meta’s stock is up ~450% in just the last 16 months! So, it doesn’t APPEAR undervalued at all. But who am I to argue with Mr Zuckerberg - maybe he feels they are still undervalued!

Now, whilst some investors may feel like Mr Zuckerberg shouldn’t be buying back shares when they’re not clearly undervalued. That’s not the biggest issue here. The second reason that investors are concerned about the buybacks/dividend is because of what it means for Meta’s growth. It could be a sign that Meta is maturing! Or in other words, Meta may no longer be a growth stock. Which is a terrifying reality for some investors!

14th Mar 2024

Nigel Jacob CFA