Time to Get Fit — an Open Letter from Altimeter to Mark Zuckerberg (and the Meta Board of Directors)

 

October 24, 2022

Dear Mark,

As you know, we are long-term shareholders. Despite public skepticism — at times warranted — we have been supporters of the company’s strategy to continuously reinvest in a product-led future and its mission to make the world more open and connected. Moreover, I am a strong supporter of founder-led companies especially when they have your successful track record of seeing the future.

So, its with some hesitation, but significant conviction, I am sharing an open letter strongly encouraging Meta to streamline and focus its path forward. Like many other companies in a zero rate world — Meta has drifted into the land of excess — too many people, too many ideas, too little urgency. This lack of focus and fitness is obscured when growth is easy but deadly when growth slows and technology changes.

At the same time that Meta ramped up spend, you lost the confidence of investors. The conventional wisdom — press and investor — is that the core business hit a wall last fall. As a result, the team hastily pivoted the company toward the metaverse — including a surprise re-naming of the company to Meta. Worse, this skepticism seemed to be affirmed with a nearly-immediate and sizable miss in financial results and continued under-performance throughout 2022.

The facts are startling. In the last 18 months, Meta stock is down 55% (compared to an average of 19% for its big-tech peers). Your P/E ratio has fallen from 23x to 12x and now trades at less than half the average P/E of your peers. And notably, this decline in share price mirrors the lost confidence in the company, not just the bad mood of the market.

The silver lining is that unlike many companies, this popular narrative obscures the truth. Meta’s core business is one of the largest and most profitable in the world with over $45 B in operating profits last year alone. Moreover, Meta has industry leading capabilities in key future technologies like artificial intelligence and immersive 3d that will help drive new products and future growth. And Meta certainly has abundant financial resources to invest and / or return to shareholders.

But Meta needs to get its mojo back. Meta needs to re-build confidence with investors, employees and the tech community in order to attract, inspire, and retain the best people in the world. In short, Meta needs to get fit and focused.

To accomplish this goal, we recommend a three step plan that will double FCF to $40 B per year and focus the company’s teams and investments:

1. Reduce headcount expense by at least 20%;
2. Reduce annual capex by at least $5 B from $30B to $25B; and
3. Limit investment in metaverse / Reality Labs to no more than $5B per year.

Getting Fit — Headcount Reduction / Expense Control

The last 10 years have been a unique time in tech and for Meta. Rapid mobile adoption helped market leaders blaze through the s-curve with astounding growth rates and a historically low cost of capital made investments in people and things the rational economic decision. At Meta, the number of employees is up over 3x from 25k to 85k employees in just the last four years! After all, why not hire more people and invest in more things when the cost of capital was near zero and growth seemed unlimited?

Today, the cost of capital has radically changed, and so has Meta’s growth rate. It is a poorly kept secret in Silicon Valley that companies ranging from Google to Meta to Twitter to Uber could achieve similar levels of revenue with far fewer people. I would take it a step further and argue that these incredible companies would run even better and more efficiently without the layers and lethargy that comes with this extreme rate of employee expansion.

As such, we would encourage the company to move aggressively and cut at least 20% of employee-related expenses by January 1, 2023. Why 20%? To put that in perspective, it merely takes the company back to mid-2021 levels of employee expense — and I don’t think anybody would argue that Meta wasn’t sufficiently staffed in 2021 to tackle a business that looks similar to how it looks today.

We do not take job reductions lightly. These are not numbers on a spreadsheet. They are people with families and kids to support. With that said, we have a shortage of talent in Silicon Valley. Meta and other large companies have made it very difficult for start-ups to hire. We are confident that these employees will find replacement jobs and quickly be back to work on important inventions that will move us all forward.

CAPEX — Investing Aggressively and Responsibly in the Future of AI

Over the last three years, Meta has also dramatically increased its capital expenses. Even excluding its large metaverse investment, Meta has gone from $15B in annual capex in 2018, 2019, and 2020 to $30B in annual capex in 2022. To put that in perspective, excluding your large metaverse investment, Meta is investing more in capex than Apple, Tesla, Twitter, Snap, and Uber combined!

Some companies require tremendous capex investment to maintain their existing business. Our best guess is that maintenance capex for Meta is less than $10B annually. The vast majority of the capex has been an essential and high-returning investment in data centers, Nvidia GPUs and other AI resources to solidify the company’s position as one of world’s leaders in AI.

We believe the future lies in AI. In fact, we believe that augmented and artificial intelligence has the potential to drive more economic productivity than the internet itself. And, while most companies will struggle to monetize AI, we believe Meta is incredibly well positioned to leverage AI to make all of its existing products better. Whether it is making Whatsapp more seamless or making content and ads more useful on Instagram, Reels and Facebook — AI is a globally scarce resource that already is driving noticeable improvements for Meta’s three billion customers and advertisers.

We also believe Meta’s investment in AI will lead to exciting and important new products that can be cross-sold to billions of customers. From Grand Teton to Universal Speech Translator to Make-A-Video, we are witnessing a Cambrian moment in AI, and Meta is no doubt well positioned to help invent and monetize that future.

With all of that said, we believe the company can responsibly and reasonably reign in capex while continuing to invest aggressively in AI and other critical areas. As such, we think during this period of growth transition and economic uncertainty, the company should decrease capex by at least $5B and maintain this discipline until revenues re-accelerate bringing our capex as a percentage of revenue more in line with our large cap peers. At $20-$25B of annual capex, Meta will still be investing market leading amounts to help invent the future of AI.

Focusing the Metaverse: the Next Generation of Communication and Collaboration

While the increased AI investment was clearly well timed, Meta’s investment in the metaverse, while smaller than the AI investment, has gotten the most attention and has led to much confusion. Perhaps it was the re-naming of the company to Meta that caused the world to conclude that you were spending 100% of your time on Reality Labs instead of AI or the core business. Whatever the reason, that is certainly the perception.

In addition, people are confused by what the metaverse even means. If the company were investing $1–2B per year into this project, then that confusion might not even be a problem. You would simply do R&D quietly and investors would focus on the core business and the breakthroughs in AI.

Instead, the company has announced investments of $10–15B per year into a metaverse project that largely includes AR / VR / immersive 3D / Horizon World and that it may take 10 years to yield results. An estimated $100B+ investment in an unknown future is super-sized and terrifying, even by Silicon Valley standards.

With all of this said, we truly believe that the company should be making some of these important investments. Dave Baszucki of Roblox describes the metaverse as the natural evolution of communication — a multi-device world, including the phone, that is best thought of as a better version of text, video, and voice that will make us feel more connected. Of course, a company that connects nearly three billion users on phone and text must be investing in the next generation of communication.

But what is the right amount? By any normal company or start up standard, $5 B per year would seem like an extraordinary amount. I have been told that Amazon spent far less in total to build AWS. As such, we think Meta company should cap its metaverse investments to no more than $5B per year with more discrete targets and measures of success, as opposed to today’s much more ambitious and open-ended strategy. We have little doubt investors and others would happily support scaling up these investments as the ROI becomes more tangible — even if still long-term.

Conclusion — A Leaner, Faster, More Successful Meta

The cumulative benefit of the recommended adjustments outlined above would increase FCF by at least $20B in 2023 ($10B from people-related expense reduction, $5B from capex reduction, and $5B from reduced metaverse spend). This would double annual FCF and put FCF as a percentage of revenue more in line with Google, Microsoft, and Apple.

There is no doubt that doubling annual FCF will improve share price. And, while that ultimately is an important long-term measure of success for all of Meta’s stakeholders, it would be imprudent to make short-term bad decisions just to improve the share price. But far from being a bad decision, we think the recommendations outlined above will lead to a leaner, more productive, and more focused company — a company that regains its confidence and momentum.

I have spent over 20 years investing behind some of the world’s great founders who are helping to invent the technologies that move the world forward. I have deep respect and admiration for founders that continue to grind, inspire, and invent long after the financial motivation is gone. There isn’t a day that goes by where I don’t find myself using Meta’s products to communicate, to connect, and to entertain — still amazed at the power of these services.

We don’t have any demands. We simply wanted to further engage and continue sharing our thoughts as an interested shareholder. We believe in this team. We know Meta has more reach, more relevance, and more incredible opportunities for growth than almost any platform on the planet. And we are confident that your long-term investments in AI and the next generation of communications will continue to drive us all forward.

As always, happy to connect with you and your team.

Best,

Brad

https://medium.com/@alt.cap/time-to-get-fit-an-open-letter-from-altimeter-to-mark-zuckerberg-and-the-meta-board-of-392d94e80a18