Mark Zuckerburg destroyed Orkut and MySpace thus making FaceBook a big part of the emerging social media space. He deserves a lot of credit for that. In 2021, Zuckerberg rebranded Facebook to Meta to signify its foray into the MetaVerse and AI.

However, before I get to what happened after that and all the pivots, I would like to point out that there was Metta before Meta.

I leave it to you to read about the “Malice at the Palace” incident and how this guy’s name changed to Metta World Peace from Ron Artest.

All joking aside, let’s look at how Meta’s financials have evolved from the end of 2022 and what one needs to look for in the SEC filings in the future.

Streamlining Operations

In 2021, to fuel future growth, Meta embarked on a multi-year journey to build out new offerings and enhance its existing apps such as:

• AI discovery engine - The primary recommendation engine.

• Better integration of Reels, the TikTok competitor, with Facebook and Instagram.

• Enhance messaging capabilities including better monetization of WhatsApp.

• Increase ad conversions for advertisers across offerings.

• Metaverse

  • Quest Pro - A high-end VR (Virtual Reality) headset allowing a mixed-reality experience between the physical and virtual environment.

  • Meta Reality System

    • Nanome for 3D modeling molecules and drug development.

    • Arkio is for architects and designers to create interiors.

    • Enhanced gaming capabilities.

• Reality Labs creates future computing platforms such as glasses, headsets, and the software that runs them and enables the Meta Reality System.

All of this, obviously, required enormous amounts of CAPEX. As we can see below the growth in CAPEX grew exponentially in FY2021 and FY2022.

As Meta was ramping up CAPEX its growth plateaued in 2022 as advertisers started pulling back due to economic headwinds. Then there was a public spat with Apple after Apple changed how app-makers and advertisers could track users’ behavior on iPhones. Apple’s changes ended up further slowing down Meta’s growth. The results are self-evident in how Meta’s EPS started plummeting in 2022.

Goes without saying that investors were none too happy about it as Meta’s stock tumbled. Meta however plugged along with its plans well into the fourth quarter of 2022 hoping the macroeconomic situation would get better and that as they got in line with Apple’s new policy, things would be back to normal.

The Big Bath

As one can see, Meta’s shares showed no signs of rebound. By Q4 2022 Meta had no choice but to change course to soothe investors’ nerves. Hence, Meta did what every listed company does in such situations; “Take the Big Bath”

As far as I can remember that is one biggest restructuring exercises in recent times. If you refer back to the stock chart, investors rejoiced and the shares rebounded.

So, why are investors so happy about a company taking such huge charges due to massive restructuring? If the plan is credible:

1. From an accounting perspective, restructuring charges are below the line, i.e. the entry for the charge is below operating income.

2. Net income does suffer, however, investors ignore the charge as long as the charge wouldn’t materially impact the company’s very existence.

3. Investors look ahead and start factoring in the expected cost savings and the enhanced EPS growth the company would deliver in the future.

Also, during this period, the management has complete freedom to slice and dice, make changes, and bombastically tout the progress made. Along the way, if the operating income starts improving the better for the stock.

Meta followed the playbook to perfection. It didn’t hurt that the world was enthralled and extremely bullish about the emerging AI craze. So, let’s look at the restructuring charges, Meta took, in 2023 over and above the initial $4.61 billion and its operating income. The improvement is quite perceptible and even with the restructuring charges, diluted EPS grew.

You will see such language used by CEOs during a massive restructuring exercise. This is the standard norm and Wall Street loves stuff like this.

The Future

In Q1 2024, Meta reported a QoQ fall in operating income and despite Zuckerberg declaring victory the earlier quarter, it still took a restructuring charge of $246 million. In its 10Q for Q1 2024, Meta wrote that they are substantially done with the restructuring started in 2022.

Meta reports Q2 2024 earnings on July 31. If it shows a continued decline in QoQ operating performance and takes another restructuring charge it is a big red flag. One should become very skeptical and look deeper into what is happening.

What to Look For?

Currently, as it stands, based on all the 10Qs and 10Ks filed since Q4 2022, everything is in order. Meta has been transparent about what was done in a quarter and how the plan evolved. Among all the other things, here is how Meta has been showing the reconciliation of the execution of the restructuring program. (Source: Meta’s 10Q for Q1 2024).

Essentially what started as a $4.61 billion exercise ballooned to $7.11 billion.

The whole point of this investigative exercise is to look for a reversal of some charges. For example, look for negative numbers in the image above. So, $186 (168 + 18) million of revenue was created out of thin air in Q1 2023. That is a 0.6% upswing. Is it material? Different people will have different opinions on it. However, Wall Street will love a 0.6% topline beat.

So, how does it work? Management uses its best judgment to ascertain the amount of charge it would take to achieve its restructuring goal and then sticks it below the line in the Income Statement as is allowed under GAAP. Wall Street could care less about it, and it doesn’t hurt the key metrics. However, where do those reversals of charges go? They go straight to the top line. Magic!!! Imagine what a crooked management can do with this.

Examples? Look up Sunbeam and its CEO, Al “Chainsaw” Dunlap. Then there was Whirlpool, who did this every quarter for almost two decades in the 1990s and 2000s before SEC had enough.

Conceptually, a company should not be taking restructuring charges every quarter. It could be a sign of financial shenanigans. So, here is a high-level list to work with to detect what is happening.

1. Why was another charge taken? The answer should be in the 10Q or 10K, or if the management is of the friendly kind, they will put out a nice jargon-filed press release. The easy way to look for it is to search for “restructuring” in the SEC filings.

2. Does the reason make any business sense? Does the reason pass the smell test?

3. Once we know what the charge is for; did the company pay for the restructuring in the same quarter or are the charges dumped into a liability reserve item in the Balance Sheet? Only to be reversed to meet Wall Street’s expectations when things go bad sometime in the future.

4. Is the company dumping operational expenses below the line to boost operating income and hide operational weakness?

5. Also, one would need to see if they are dumping the charge into the balance sheet and then summarily making it vanish as an investing or financing outflow in the Cash Flow Statement to show better Cash from Operations.

Just keep in mind that all the line items or buckets in all three financial statements can be abused. You would wonder, “But what about the board and the auditors?” LOL. In all seriousness, the blatant abusers eventually get caught, however, a lot of them get away as the SEC couldn’t care less.

However, if Meta comes out clean and can impress with its glasses and the ecosystem around it, it would be a roaring buy. Until next time.

Disclosures: Here are our internal governance rules to ensure no conflict of interest. For companies we write about:

1. No existing position.

2. If we have an existing position, we exit and wait seven days before publishing.

3. Wait seven days after publishing before initiating any new position.