Could Meta Be Risking Another Sell Off With Its New "Threads"?

Key Points

• Meta Platforms has announced its latest move to compete for even more eyeballs; its new short-form written content platform seeks to compete with Twitter. 
• The last time the company allocated a significant portion of its free cash flow into new ventures, investors severely punished the stock with a 77% sell-off from its all-time high.
• This time, executives have waited for a swift price recovery in the stock to announce the strategic move and broader markets seem to believe that lessons were learned.
• These performance gaps, aligned with valuation preferences, can give way to a bullish case in Meta. Investors can only hope that this time around, free cash flow is better invested.

Mark Zuckerberg has started a battle on more than one front. He has chosen not only the company that has most effectively dominated short-form written content but also an adversary known to be a massive risk taker now and again. Eccentric Tesla NASDAQ: TSLA CEO Elon Musk bought Twitter a few months ago in his latest stunt to diversify and amplify his empire as one of the wealthiest people in the world.

Twitter, the entrenched go-to choice for users to write and share short-form written content, will now have to consider the potential competition that Meta Platforms NASDAQ: META can represent. 

The scandal between the two CEOs started with a proposed cage-style MMA fight, where even the UFC CEO, Dana White, speculated on the potential setup for the fight. This 'friendly' competition has now turned into a more escalated rivalry, as Meta announced the release of its new 'Threads' platform, where users can now create short-form written content.

The question now becomes, will this be a repeat of the millions spent during the Metaverse project? When investors lost patience over the thinning free cash flows and no clear path to returns in the Metaverse, the stock sold off by as much as 77% from its all-time high price of $384.33.

Previous History 

Starting in 2021, Meta Platforms announced that it had planned to invest as much as $10 billion into building the necessary platforms and technology development, which would serve as a gap closure between the company's old name (Facebook) and its new identity as Meta.

$10 billion is a considerable amount by any measure, and by taking a deeper look into Meta financials, investors can begin to make sense of why the stock sold off during the period. 2021 saw an all-time high price of $384.33, which followed a steady twelve-month decline to bottom out near the $88.0 per share level. 

Free cash flow (computed as operating cash flows minus capital expenditures) is the lifeline of any business, as free cash flow can fund debt repayments and other critical strategic moves like investing in new areas and even making acquisitions. Therefore, as free cash flow is spent, investors are as judgmental as ever of where management decides to allocate these funds since a lousy investment could have been replaced by share repurchases to enrich investors.

This is precisely why the stock sold off during the period, as $10 billion (representing more than 60% of normalized Meta free cash flow) was invested into an area with no clear path to profitability.

A more than 77% decline in the stock can be a prime example of how unforgiving investors can be, primarily when something as precious as free cash flow is being invested into areas that are not yet popular or well understood. Now that the stock has gone on a rampant bull run, the price is nearing the previous 'Bear Market' level, defined by Wall Street as a 20% retracement from previous all-time highs.

Now that this crucial level is reaching $307.5, Meta executives have decided to unveil the newest project into which the company may consider plowing a few more billion. Could history repeat itself and act as the start of another sell-off?

Directional Hints

What are markets perceiving now that executives are pointing to the next round of significant investments for new business segments, and where do broader investors think the stock will be headed next? An excellent place to start would be to look at the initial reaction to the news in the stock price.

Meta stock rose by as much as 3.2% during Wednesday's trading session when the U.S. FED pointed to more rate hikes for the remainder of 2023, making a positive reaction all the more critical for the company. However, there are other ways to figure out the bigger picture as far as perception.

Comparing valuation multiples between Meta and other big technology companies in the U.S., names like Alphabet NASDAQ: GOOG can give investors a few bullet points about what is happening.

Meta stock has outperformed Alphabet by as much as 67.3%, clearly distinguishing what the sector 'likes' more. Furthermore, valuation multiples, like the commonly followed price-to-earnings ratio, also point to where the future growth of earnings may rotate. Trading for a 36.6x P/E ratio would place Meta above Alphabet's 27.5x.

Despite being one of the highest in the sector, it is still significantly below the historical ranges of 50.0x to 80.0x, leaving a massive gap for upside potential to be enjoyed by investors.