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The Ratings Game: Analysts slash their ratings on Meta as costs balloon. ‘The bad news is you suck, the good news is you can only get better.’

Analysts were downgrading their ratings and price targets on Meta Platforms after the tech giant reported burning its cash on the metaverse and weak digital ad sales.

Meta’s
META,
-5.59%

stock declined 19% to $104.78 in premarket trade following the publication of third quarter results from Facebook’s parent company.

Meta reported a 52% drop in profit to $4.4 billion, or $1.64 a share, falling well short of analyst estimates of $1.90 a share. Revenue fell 4% to $27.7 billion.

The big issue was the 19% surge in costs and expenses.

Mark Shmulik, an analyst from Bernstein, said his team was “incredibly frustrated to see expenses balloon with an almost total disregard for investor expectations.”

“Our old swim coach once crudely said ‘the bad news is you suck, the good news is you can only get better.’ There was some truth to those words, and perhaps the same holds true here,” he added.

The firm kept an outperform rating but lowered its price target to $135 from $195.

Justin Patterson from KeyBanc Capital Markets downgraded Meta’s rating to sector weight from overweight.

Patterson explained that “Meta appears to have limits on how fast it can pull back expenses.”

Meta Platforms said capital expenditure will range from $34 billion to $39 billion, up from $32 billion to $33 billion this year.

Spiraling VR expenses

A person experiences the new Meta Quest Pro VR headset.

-/Agence France-Presse/Getty Images

The company has poured a huge amount of money into its ambitious virtual reality project so far, and has yet to convince investors of its success.

Meta’s Reality Labs segment, which operates its metaverse platform, posted operating losses of $3.7 billion in the third quarter and those losses will “grow significantly year-over-year” in 2023, it says.

CEO Mark Zuckerberg defended the move. “I get that a lot of people might disagree with this investment but from what I can tell, I think this is going to be a very important thing,” he said.

“For what it’s worth, management did acknowledge that 2024 should see a return to Facebook Reality Labs spending tied to core performance, if anyone can wait that long,” Shmulik added..

Read:  Facebook and Google grew into tech titans by ignoring Wall Street. Now it could lead to their downfall

During the analyst call, Meta executives were questioned on its priority to recover its ad sales model. The company has previously predicted it would lose out on $10 billion in projected ad revenue this year, due to changes in Apple privacy policies from last year. Zuckerberg highlighted its click-to-messaging ads platform has a $9 billion annual run rate.

“There’s a lot of competition,” CFO David Wehner added. “There’s ads challenges, especially coming from Apple. And then there’s some of the longer-term things that we’re taking on expenses because we believe that they’re going to provide greater returns over time.”

“I appreciate the patience. And I think that those who are patient and invest with us will end up being rewarded.”

Also: Meta fined $24.7 million for campaign finance disclosure violations

In terms of competition, Meta’s fierce head-to-head with TikTok has overshadowed its effort with short video form content. Nevertheless, Meta users are consuming 140 billion Reels a day, a 50% increase from six months ago, and they generated $3 billion in annual ad revenue. Zuckerberg told analysts it is attempting to close the gap to monetize reels at the same rate as the Instagram Feed or Stories.

Analyst at Raymond James maintained its outperform rating but clipped its price target drastically to $171 from $215 per share.

The team led by Aaron Kessler rationalized the move due to its expectation that Meta’s long term ad-growth will rise between 5-10%, it will continue to monetize its Reels platform and that Meta’s valuation is “attractive.”

Meanwhile Brian Nowak at Morgan Stanley cut his price target to $105 from $205 per share and lowered the rating to equal-weight from overweight.

In a client note, he said, “while these investments could make Meta stronger over 5 years, we see 2023 free cash flow heading 60% lower and high risk to prove ROIC and incremental growth.”

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