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How Facebook's failure to address its' social impact' could turn investors off the stock

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Evercore ISI Senior Managing Director and Head of Internet Research Mark Mahaney joins Yahoo Finance to discuss Facebook's investment in its metaverse, its recent earnings, and the intense scrutiny Facebook has faced.

Video Transcript

JULIE HYMAN: We are watching those Facebook shares that have now turned lower in the wake of the company's numbers. Initially, it looked like investors were weighting the growth in daily active users, as well as an expanded share buyback, heavier or more heavily than they were the miss on some other issues here.

And let's bring in Mark Mahaney to talk more about this. He is Evercore ISI senior managing director and head of internet research. Mark, it's good to see you. So as you look at not just this quarter for Facebook, but what they're going to be doing going ahead in terms of their investment strategy, do you think they're on the right track? I know that you do not have a very high investment rating on the stock.

MARK MAHANEY: OK, so look, I do have an outperform rating on the stock. You know, I've been-- we've been flagging Facebook as having issues and, really, the internet advertising system as having issues because of IDFA. That came through in spades with Snap and with Facebook, too. I know the stock is essentially flattish, up a percent, down a percent. But it is pretty well off, like, 15% off of its recent highs and precisely for this risk. This was the weakest fundamental quarter the company's put up in quite some time.

They had a sequential decline in ad revenue. They've never had that before in a quarter, other than the March quarter, which is due to seasonality. So there was a negative inflection here. There were some offsetting positives. But the biggest thing is that the stock-- the company, to their credit, had gone out for quite some time and warned people about this impact. So there is something to be said here about you warn people about an impact, they'll be ready for it. And then they also reported after Snap. So the stock was largely de-risk-- not completely, but largely de-risk.

Anyway, in terms of the new investment spend on this metaverse, the number is bigger than we thought it would be. We thought it was more like $6 billion. It turns out it's $10 billion. And so is that an appropriate sized investment? I'm not sure. Should they be spending at least $5 billion, something like that, in that ballpark? Yes. $10 billion, maybe. That's out of the outer edge of the park as far as I'm concerned.

But to invest in the metaverse, I like companies with big tech platforms that invest in option value, like Google with autonomous. This is Facebook and metaverse. I think it's a reasonably smart investment to make. We don't know what the return is. Neither does the company.

BRIAN SOZZI: Mark, are you bullish ultimately on the metaverse? And when Mark Zuckerberg says the metaverse, how do you view the metaverse?

[PHONE RINGS]

MARK MAHANEY: Um, sorry.

JULIE HYMAN: The metaverse is happening right now.

BRIAN SOZZI: We're all in the metaverse now.

MARK MAHANEY: I apologize. Let's see. What are they-- we're talking about a virtual reality or augmented reality world in which people can interact with each other virtually and via augmented reality. It's kind of like it's virtual reality, but I call it GVR, like Group Virtual Reality. So it'd be a way for you and I to engage. We kind of do this with Zoom, but maybe even something more interactive, like-- so that's kind of the idea behind it.

I've spent a fair amount of time with the virtual reality, the Oculus devices. You take that forward a few generations, boy, that could be really interesting, really compelling. It's too much of an individual experience now, but could you turn that into a group experience? Probably.

So anyway, I think if anybody can do it, Facebook's one of the two or three companies that's best positioned to do that. How's that for an answer? You know, it's very unclear. Like, this company should be investing in long-term growth initiatives. I like companies that do that. That's a smart thing to do. I don't think they get any financial credit for it today, nor should they. But I like to see these option values. So that's my best answer to your question.

BRIAN CHEUNG: Hey, it's Brian Cheung here. I want to ask about the kind of political challenges that they've been facing, obviously, with some of these leaks and the whistleblowers out there. Now Mark Zuckerberg playing defense basically in the first minute of the call, coming out of the gates strong, saying that he feels like it's being used to paint a false picture of their company. But he said, look, it's not just Facebook that's doing this. It's a lot of other social media companies as well. Is there a regulatory risk here that he's inviting, the antitrust hammer to really come down here?

MARK MAHANEY: Well, there's definitely regulatory risk. I think it's already there in the stock. I think Facebook trades at something like a 25% discount on a PE basis or a free cash flow multiple basis, precisely because of perceived regulatory risk.

Brian, I don't think it's antitrust. I just think it's going to be more kind of business practice regulations around what kind of ads, if any, could be shown to young people, what kind of content could be shown to minors. It's that kind of-- that's where the regulation could come in. I'm kind of vague in answering it because I think it's a very hard thing to regulate. It's a very hard thing to figure out. If it was easy, the US Congress would have figured this out a while ago.

I do think that Facebook-- the criticism has become excessive. I think some of the headlines miscaptured, mischaracterized the internal research that Facebook has put out. I give them credit for doing a lot of this internal research. By the way, they should because, you know, you're a media platform, too, but you're not as influential as Facebook is. So with greater power comes greater responsibility. They should be doing this kind of research.

Anyway, that's my take on it. But there is this concern, and I'll throw out one existential risk I have on Facebook, which is ESG. I mean, Facebook could be the first real ESG poster child, not because of environmental issues or governance issues, but because of its social impact.

I think they really have to show that they can somehow address some of the social implications of social media. And I don't know quite how to do that, but they have to show it or else they'll continue with that discount, and I wouldn't be surprised to see some large funds within a year from now saying, if they're not going to address it, we can't hold this in our port-- amongst our portfolios.

JULIE HYMAN: Mark, I just want to put a fine point on what you're saying because I pulled this morning the forward PEs for Facebook and some of its competitors, and we're showing them up on the screen now, not even its competitors, but just some of the largest tech companies in the markets here.

So Tesla, we can kind of throw that one out. That one has an unusually high forward PE. And obviously, it's not a competitor to Facebook, but in terms of competing for investors' money, I think you can put these all up in the same basket. And Facebook, to your point, trades at a lower multiple than those other companies do.

But I also want to ask, to the point you were just making, you know, when you see companies like, say, an ExxonMobil, you see more activist pressure on these giant companies. Do you think that there's any danger of that happening at a Facebook? Or do you think it is immune to that because of its ownership structure?

MARK MAHANEY: Well, OK, it is-- you know, we do have dual class stock here. So it's Zuckerberg's company, and he's always told you that. You didn't have to buy in his company. And you have this with other media assets. You had this at Google. You don't have this at Amazon. You don't have this at Netflix, but you do have it with other companies. I think Tesla is run that way, too. I'm sorry, I don't know.

So you do have this-- so it does make it harder. But, you know, it does-- I think about four-- let me just step back. I think there are four risks here when you have these kind of PR issues. And I don't mean to minimize it. Like, these are serious issues that are swirling around the company. Does it impact users? No evidence of that yet. Does it impact advertisers? I don't think there's evidence of that yet.

I think this pullback is IDFA related, but, you know, it's possible that there's something else going on. Does it impact employees? I think that's why Zuckerberg made all of those comments at the beginning of the earnings call last night. I think he wants to make sure that the employees feel like he's presenting that the company's been mischaracterized. He wants to be aggressive in saying that what we're doing here is good.

I asked him a question about AI, and he went out of his way to answer the question by praising his employees who are working in AI. And then the fourth group is, of course, investors. I think there's risk across that group, but we haven't seen it show up yet in users, advertisers, I don't believe in employees. And I think it has shown up, actually, in investors now that I think about it. I think they do have this, and you pointed out the PE charts.

Facebook trades at about a 25% discount to Google, a company with very similar growth rates, very similar business models, very similar market opportunities. That's the market saying, we believe that there is risk here, and we're going to discount your earnings because of that.

BRIAN CHEUNG: Now one other interpretation of that is the market is saying, you have-- you're still a growth company, right? I mean, make no mistake. It's still in the tech space. But at the same time, you have reliable cash flow now. So based off of that kind of interpretation, is it time for Facebook to pay dividends?

MARK MAHANEY: Well, that's a good question. I don't think so yet. I think they're doing the next step, which is buying back a good chunk of their stock. So I think there was $14 billion of stock they bought back in the quarter. I think that's a record high, and they've committed to $50 billion more share repurchase authorization. I'm assuming that they do about $10 billion a quarter. It could be a little higher, it could be a little lower, but something like that.

And, you know, that's an appropriate use of cash. This company, like Google, is a cash machine. They have very high margins, even under investment scenarios. They're still doing 30% to 40% operating margins while growing the top line 20%. That's-- there are very, very few companies in the world that do that. That's why it's such a beloved stock. I mean, beloved maybe is too strong of a word, but that's why it's such a widely held stock because it's an unusual business model-- that size, that scale, that growth, those level of profits.

So they're doing the appropriate thing. As these companies get more mature, they should be returning that cash to shareholders. And they're doing that. I think that's one of the reasons why there's a decent bid for the stock. I don't think the stock tanks on a quarter like this. If they hadn't had the share buyback, if they hadn't disclosed the virtual reality labs and all that investment spend, I think the stock would be down more than it is or more than where I guess that it ends up at the end of the day, which is down a percent or two.