Doubling down on ‘Metaverse’ is a very risky strategy
In its early days, Facebook used the motto “move fast and break things” and was coined by its founder Mark Zuckerberg and worked fantastically for a young and fast-growing software company. Over the years the motto came back to haunt the company as the mentality can also be seen as a process that opens up a lot of vulnerabilities and less well thought out ideas. But Meta (the new name of Facebook) seemed to have adopted the concept once again, but instead on its products, it seems it is applying the strategy on its free cash flow generation.
Meta shocked investors yesterday by doubling down on its ‘Metaverse’ strategy. The advertising business did actually a bit better than feared despite Q3 revenue was down 5% y/y and the initial brief reaction in its share price was positive, but then investors saw that operating income was 46% from a year ago with the operating loss in its Reality Labs (division name of its ‘Metaverse’ bet) hitting $3.67bn. Meta has lost $12.7bn from operations of Reality Labs which means that operating expenses over the past year has $15.2bn for the business unit (adding back the $2.4bn in revenue) which is more than half of NASA’s entire annual budget of $25bn. Meta even said that operating losses in its Reality Labs division will increase in 2023.
Capital expenditures year-to-date has gone from $13.7bn a year ago to $22.8bn this year as Meta is investing in expensive computing equipment to run its ‘Metaverse’ and capitalizing some of its development costs on the Metaverse. Investors were also shocked about the Q3 revenue figure for Reality Labs which came in at $285mn down from $558mn a year ago and down for the third straight quarter. Not exactly the trajectory of exponential growth and blockbuster hit with consumers.
Meta’s gigantic bet on the ‘Metaverse’ combined with pricing pressure on mobile advertising from Apple’s recent data privacy change and the general slowdown in online advertising have caused the free cash flow to plunge to almost zero in Q3. Back in Q4 2021, Meta reported its highest free cash flow in the company’s history and three quarters after the lowest in more than 10 years. Investors are scared about the reckless spending compared to a year ago. Revenue is down 4% for the first nine months compared to the same period last year while operating expenses are up 19%. Why did Meta’s management not see the world changing and rein in costs much faster?
The irony of the motto “move fast and break things” is that it was meant as if something does not work then skip it and move on to the next thing. We must experiment at a fast pace to survive and grow. But in the case of the ‘Metaverse’, Mark Zuckerberg is doubling down on his vision in a sign of vanity and price, and investors are terrified. In fact, so terrified that shares are trading around $100 in pre-market trading down 27% in just two trading sessions. In our equity note yesterday we wrote that “Zuckerberg has one mission tonight” and that was to rein in his ambitions, but he failed to listen and now the stock is breaking apart.
One potential long-term casualty, if Meta’s bet on the ‘Metaverse’ turns out to a gigantic miscalculation, is governance of technology companies. The long victory march of Silicon Valley technology companies starting with the IPO of Google has led Wall Street to accept dual-class share structure allowing technology founders to retain full control of the voting shares despite not controlling the majority of the equity capital. An epic failure by Meta because its founder could not be reined in by the board of directors could cause a seismic shift in investors attitude to dual share classes.
If Mark Zuckerberg does not listen to the market and continues down the “move fast and break things” mentality on his company’s finances in his quest to create a new computing platform for the future, he could end up breaking things so much that Meta gets constrained so severely that it will go on to lose future battles against its competitors.