Not like that, Zuck. At least, not with our money.

Puedes leer el artículo en español aquí.

The decision

• We invested in Meta Platforms (by then, Facebook) in April 2018 for the first time. Over the next several months we built a position in the company at a net price, net of puts sold, of around $160 per share.
• Since then, it has been an important position in our fund’s portfolio, always being in the Top 10 and in a good number of cases reaching the Top 3.
• Today we publicly announce that, on August 1st, 2022, we made the decision to sell all the META shares, at a very similar price to that of our entry into the company 4 years ago.
• Although we do not make specific publications about purchase and sale decisions of the fund beyond periodic communications that we send to partners, in this case since it is a position that we have openly discussed in various podcasts interviews, articles, letters and quarterly factsheets, we consider it is fair that the decision to sell and our arguments for making that decision to be in the same way public.

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General thoughts

Although we haven’t lost any money on this investment (which is unusual when the management team’s execution repeatedly performs worse than you initially expected), the downside here is that we have lost 4 years as investors. The opportunity cost has been enormous, over a significant % of our money as well. From April 2018 to August 2022, the holding period of our META shares during which we have earned 0%, the MSCI World has returned +32% (or +7% per year compounded) and the SP500 has returned +55% (+12% compounded).

We do not believe that the additional drop in the stock from our exit level (-22% at the time of writing) makes our sell decision a wise one. The market has continued to fall further since, and META has continued to drop with it. That’s all. We will only be able to assess our decision over the years, in case the company’s performance from now on is much lower than the market (or even ends up becoming a value trap), in a few years we will be able to conclude if the decision we are making now has been the right one. If from current levels META performs well above benchmarks, over a multi-year period (which is possible if management execution and/or the digital ad market improves and/or if the Mark Zuckerberg’s increasingly binary bet ends up well), then our decision will turn out to be wrong.

The risk we are wrong selling META here is high, as we agree with part of the investment community that shares are cheap. We believe that they are cheap, both absolutely and relatively, and hence the enormous difficulty of making this decision. Obviously we think that the risk of keeping the shares in our portfolio, either because it would lead us to lose money in the future or because the under-performance continues and our opportunity cost increases, is much higher than the risk of selling them, for that reason we make this decision.

Of course, we are not closed to come back to META’s shareholding base again in the future. When you have spent so many hours analyzing and monitoring a company (hundreds of hours that make it even more difficult to change your mind), you know well which drivers should improve in a way that the company would be able to get back into our portfolio. We hope that the management team straightens the course of its decision-making since we would like very much this story to be successful in the long term and us to be a part of it. But in the current situation, we think it is more prudent to watch from the sidelines.

Learning

Wasting time as an investor is bad (only surpassed by wasting money and time), but it’s even worse if you don’t learn from that process to serve you in your future career. I have always thought that before the age of 40, despite having been in the markets for more than 20 years, I was simply training myself as an investor (and in view of the age in which many great investors have made a very important part of their fortune, maturity as an investor is probably even further away…). To obtain something clear out of our investment in META that will serve us along our way, I think it is important to review the decision-making process, remember what the situation was when we made the initial decision, the evolution until now and, of course, we will also have to monitor the situation in the future. That’s why this post is important to me. Of course, I must inform all the partners of the decision to sell, but the process of writing my thoughts, putting my ideas in order and leaving them reflected in these lines for the future, I also believe is a healthy exercise that will be useful to all of us in the next years. As I always tell you, we are still at kilometer 5 of our investment marathon (now possibly already at km 6…).

The situation when we invested

We bought Facebook when I realized the speed at which marketing budgets were rotating from traditional to digital media, also considering that this tremendously atomized spending pool on a global level was going to lead on the Internet without physical borders and an increasingly globalized world, to concentrate on what would probably be an oligopoly of 2-3 large players with large scale, and possibly a smaller share segment spread out among niche players. It seemed obvious that the two big gorillas in the room, due to the flywheel that was taking place in the form of network effects, would be Facebook and Google. In addition, I also considered that this network effect was properly supported by some switching costs (large number of followers, groups of friends and family, and profiles built over the years with diverse multimedia content that is difficult to transfer to another social network and with an emotional burden that you never want to lose). And we also consider that the important investments that would be necessary to guarantee the correct treatment of the personal data of so many millions of people, would require a relevant scale, difficult to achieve for incipient players with fewer investable resources in their initial stages.

Of course we bought Facebook because it was managed by a founder-owner-operator, with many years to run and with his whole skin in the game, aligned with us as investors. And we bought Facebook because it seemed that beyond the investment and expense periods necessary to have the required infrastructure, it would be a highly scalable business with enormous incremental returns on invested capital, and operating economies of scale that would predictably increase margins (or at least, the ability to keep them flat, but deliberately invest for the future through OpEx).

We also invested in Facebook knowing that the advertising industry is inherently cyclical, but that the progressive transition from traditional to digital media would be a tailwind that would significantly reduce this cyclicality, at least during some years. The big brands will have to bid for advertising space and throughout a complete cycle the CPM’s should go up, and the owners of that space, maintaining a very scalable fixed cost base, should see how those increases are transferred directly to downline, to the cash flows generated for us as shareholders.

Finally, we considered that Facebook, from its dominant position and with a highly cash-generating business, would have the capacity to protect its competitive moat by investing internally in the development of new products and services, while at the same time it would be able to acquire small emerging competitors (as it had done very successfully in the past with Instagram and Whatsapp). And having practically the entire daily connected to the Internet world on one of its platforms (ex-China), would gave them various optionalities for future monetization, beyond the core business in advertising, mainly in e-commerce, entertainment and work connectivity. It was not the core thesis, it might or might not happen, but without a doubt the chances that one of those seeds would end up being real and substantial, were not negligible at all. A strong core business with a tailwind, and some free options, is a set up that is usually attractive to us as investors.

At the same time, we were fully aware of the two main risks at that time: Regulation (mainly regarding personal data privacy) and a high degree of dependence on the person of Mark Zuckerberg (which is an advantage if he is a visionary and aligned CEO, but it is still a risk that an investment depends so much on a single person).

Development since then

Beyond macro issues intrinsic to a business with a certain cyclical component such as advertising, the two exogenous factors that have mainly affected Facebook’s core business in recent times have been TikTok and Apple’s IDFA. On the one hand, TikTok showed that network effects can be achieved even faster than we thought and that the competitive advantages of META platforms are probably weaker than we thought. In addition, it now seems clear that regulatory risk has increased in recent years, as Zuckerberg now cannot acquire practically any incipient competitor, precisely because he is under the antitrust regulatory spotlight (thus having both sides negative, limiting regulation but at the same time going through a competitive process that is far from being a monopoly). He must develop features or new services internally. Here, we have a double aspect: On the one hand, the risk on the terminal value increases as it is easier that you find forced to share the market with new incumbent players, as TikTok has made clear; on the other hand, the risk that the company makes a false step when it’s trying to adapt one of its platforms to copy some new features that is driving the competition is also greater. It worked with SNAP Stories, and now they’re trying to do it with Reels on IG. Poor META if Instagram users are not too attracted by the idea that they try to become something similar to TikTok and start to leave the platform… What would META be without Instagram right now!

Probably one of the most bullish factors in the short to medium term for META’s stock would be the total ban of TikTok in the US (which is quite likely to happen for reasons that we all know and that are beside the point right now). And when I find that the performance of one of my investments begins to depend minimally on a political decision (or a geopolitical factor), I begin to feel uncomfortable.

The evidence for Zuck that its future verticals must be internally developed has come while he was suffering a direct impact on one of the main attributes of Facebook’s value proposition: the targeting of users to increase the return on investment (and its measurement) from advertisers. And this impact has come hand in hand with Apple’s IDFA policy, implemented in iOS 14 onwards (not without some good added marketing in the form of a «protective lock» towards its customers, as usual in the Cupertino company). 75% of Apple users (who are also the most monetizable for advertisers, the most valuable asset) have chosen not to share their personal data to receive more relevant ads since.

The fact is that the competitive landscape in digital advertising and the alternatives that compete for our daily attention hours have only multiplied in recent years. Beyond TikTok’s fast irruption as a black hole of absorbing time (or alienating) younger audiences, we are quite optimistic about the advertising capabilities for attracting a larger share of global advertising budgets of companies like Netflix, Microsoft, or Amazon. The panorama is increasingly far from the duopoly (or in the worst case, oligopoly) to which we thought the sector would tend when we invested in FB.

Besides the erosion of the core business moat… What is happening with the low hanging fruit options? What the hell happened to IG Shops? The market rubbed its hands in view of a commercial window in front of thousands of millions of people, for the big brands posting their products, with a direct payment gateway and shipping handling by the merchants, without leaving the platform owned by META (and no necessity of storage or logistic capacities), charging a take rate with potentially infinite returns on invested capital… And what is happening with the monetization of WhatsApp? Why have we had several conference calls without having any news of these two important and obvious assets? … How is it possible that a company with almost 90,000 employees, so many of them engineers, is so incredibly slow in developing its products? Aren’t they overly focused on something else, which we will discuss in the next point, missing out on these other opportunities in the meantime?

The Metaverse, according to Zuck

Mark Zuckerberg has found evidence that his future was in the hands of a superior company: The owner of the hardware that carries its own embedded operating system. Zuck needs proprietary first party data for its advertising campaigns to be effective… or even better, Zuck needs to be the owner of «the next big computing platform.» I recently read that Tim Cook, by now a worthy successor to Steve Jobs, would have to get his act together so as not to be left behind in the development of the new hardware platform (computers… mobile phones… glasses? –important question marks here-). I honestly think: Woe betide anyone who takes on Apple in hardware development. They should do very, very well. And since Apple’s strategy is totally unique in the marketing world (I don’t know any other company that has managed to reach at the same time premium segment margins but with massive volume), just hearing “We’ll sell the hardware at break-even to win the metaverse”, and I’m starting to shudder…

The risky thing about Zuck’s bet, apart from the size of the annual investment, is that it may succeed and that others become the beneficiaries of that investment. Because if today Facebook is in the regulatory spotlight and Zuckerberg succeeds in developing «the next big platform», does anyone consider it feasible that regulators will allow a single private company to own the platform, and «the virtual streets» in which we will circulate on the Internet of tomorrow? I have serious doubts… if it goes wrong, it will be a disastrous investment (or it could happen like with the iPhone, when it solved better a need for which the public was already prepared by other companies investments); but if it goes well, I don’t think he will be allowed to be the only beneficiary. Internet or Metaverse if it comes to be, have to be open to succeed. And I don’t think that’s what Zuck is thinking about. Because if he wants an open world but to win with hardware, I insist: He has to do very well to have any chance, and then META should be treated (and valued) with the multiple of a hardware company (who are also already saying that will sell it at low margin).

All in all, a bet that is too big, with an uncertain return, and that increases the risk of the company as a whole.

We have already talked about the regulatory limitation that META faces when it comes to deploying capital by acquiring other companies, and we have raised our doubts about their strategy of organic reinvestment in the core business and the options that they had… so within the possible destinations for generated capital, we would need to assess the capital return to shareholders. I believe that one picture reveals more than a thousand words, and back in the days I posted the image that summarizes META’s shareholder remuneration strategy in this tweet:

Ladies and gentlemen… with all of you, the new Chief Strategy Officer of Meta Platforms 🤡$META pic.twitter.com/YYtaqOUDjF

— Javier Acción, EAF (@AccionEAFI) July 28, 2022

Until we got the data for the second quarter of 2022, I did not have confirmation that the share buyback strategy did not serve any rational reason. It is true that already in the first quarter of the year it had decreased, but that quarter was still a YoY increase compared to the same quarter of the previous year, and I expected to see the same thing happen in the second quarter. Facebook business has a certain seasonality, with a stronger weight in the fourth quarter of the year, so seeing a smoother first part of 2022 than 4Q2021, which had been a real madness in terms of share buybacks, was within what is reasonable.

I still cannot explain how it is possible that in the most recent quarter for which we have data, the META management team with Wehner as CFO at the head, had repurchased the lowest number of shares in the market for 6 quarters, with the stock down 50% from 4Q2021 when they went all out to buy over $20bn of their own stock near all time highs. This was not only a sequential decline, but also a year-on-year decline, and with Facebook having four tens of billions in net cash, and also making it clear that its CapEx and OpEx needs are more than well served, I wouldn’t know if it’s due to simple randomness in the amount destined to return capital to the shareholders without even looking at the multiple at which the share is trading, or simply that they also have been frightened by the market movements and the deterioration of their business and they have suddenly decided to preserve the balance sheet (and I couldn’t choose which of the two reasons would be worse).

We will see what happens in the coming quarters with META’s capital deployment strategy, because we are not asking for a minimally opportunistic share buyback strategy, as MSCI for example, or absolutely «master timing» strategy typical of true family owners, as CPRT, but a nonsense like this in the allocation of capital makes me feel uncomfortable as a shareholder, especially when I also had other people’s money invested there… if moreover the person who has been such a headache for us during his time as CFO of Meta Platforms, sinking literally the stock with every statement he gave on conference calls, for later buying back of meager amounts, is promoted to Head of Global Strategy (replacing Sheryl Sandberg, whom we held in high regard and who leaves the company after 14 years at a rather delicate moment…), we have the complete photo we needed to prove our doubts about the decisions that the company is making and the total dislocation between Zuckerberg and the rest of the stakeholders.

I recently read a well-known businessman saying that if you invest in companies where the best engineers in the world want to work in, you will probably get good results in the following years (it is not difficult to know who I am referring to…). This statement does not come without a good dose of marketing in it, but it seems clear that today’s stock compensation is less “sexy” for engineers at META than it was a while ago (it is fair to say that in general this has been the case for all tech companies), but what seems more important to us, besides economic compensation, in terms of personal fulfillment and the possibilities of changing the world through innovation, we find it difficult to figure that the best engineers in the world want to work right now on Facebook.

Final thoughts

The decision to sell META after the amount of researching hours dedicated to the company during the last 4-5 years with a null return for our fund has probably been the most complicated decision that I have had to make in the third-party capital management stage (previous limited partnership established in 2008, public fund in 2016). I think that may be true that it’s objectively cheap if we look at its current financials, but I also think the market is right assigning a lower multiple on its earnings, as its risk profile has increased notably.

With hindsight, META’s purchase decision at the outset was probably not wrong given the information available at that time, and it may also have been reasonable to be patient with it throughout this time because despite the noise, the main fundamentals of the investment still remained. And with the current information, it also seems that the appropriate thing has been to sell it. So, has META been an investment mistake for us? Without a doubt we could say that it has been an absolutely mediocre investment, but perhaps the only serious mistake in my decision-making process was not reducing the position after the release of META as such (the announcement of Zuck’s plans regarding the Metaverse in a specific conference), because at that time the risk increased, and we could still have sold it at prices much higher than what we finally got. Not reducing the position at that time was clearly a mistake. But given that we would only have sold a small part of the position, the difference in the long-term return of the fund, if the decision we make now is the right one, is probably quite negligible.

A summary of the most important points of my sale argument is featured below:

• There is no a low enough multiple for a bad business (or more specifically in this case, a good business in the process of deterioration).
• I want the best management teams to grow our money and in view that the stock market ALWAYS puts you through bad times and questions your approaches, we need to have absolute confidence in the decisions that the directors of the companies in which we invest are making. When several repeated questionable decisions have undermined that confidence, we must accept the mistake and watch events from the sidelines.
• Our only argument for holding an investment cannot be some great futuristic investment for which we don’t know the odds of success. We should see investments today that assure the cash flow growth in the future, yes… but we should see how the competitive advantages of the core business are maintained or increased, not spoiled.
• Although we keep the focus on the long term, we should also take into account short and medium term goals, we should see how the managers take the low hanging fruit from the tree, and at the same time see how they work on future options, but without an important part of our investment relying on a coin flip. We don’t invest that way. We do not take binary risks. We want to put the odds much more in our favor.

As a positive final balance, the divestment in META has taken place in a very auspicious environment to put that money to work… I will tell you about the decisions that have been making in future communications.

Warm regards,

Javier Acción

Acción Inversiones