Meta Platforms and Spotify Give Investors a Lot to Chew On

This is one of those times when almost no company is going to get the benefit of the doubt from Wall Street and investors in general. Meta Platforms (META 0.43%) and Spotify (SPOT 0.20%) are two timely examples. Meta Platforms faces headwinds in the form of inflation, its own investments, and Apple's new iOS privacy changes. Spotify is showing growth, but guidance has unsettled some investors and the latest controversy involving podcast host Joe Rogan isn't helping matters. Motley Fool analyst Tim Beyers analyzes both companies and discusses the very public roles that CEOs Mark Zuckerberg and Daniel Ek are taking as their companies deal with varying challenges.

Plus, Motley Fool analyst Dylan Lewis and Motley Fool contributor Brian Feroldi do a deep dive on Digitalocean, a cloud company some are comparing to a young Shopify.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Feb. 3, 2022.

Chris Hill: Warren Buffett said the stock market is a device for transferring money from the inpatient to the patient. Today is another day that's testing investors patience. Motley Fool Money starts now. I'm Chris Hill, joined by Motley Fool Senior Analyst Tim Beyers. Thanks for being here.

Tim Beyers: Thanks for having me man, fully caffeinated, ready-to-go.

Chris Hill: Likewise, before we get to the companies we're going to talk about, let me just say this for the dozens of listeners, we're in the middle of earning season?

Tim Beyers: Yes.

Chris Hill: Two things are clear to me. Whatever company you own shares of, don't expect them to get the benefit of the doubt, that is the environment that we're in right now. It happens from time-to-time. There are other periods of time where we've seen the opposite, where everybody gets the benefit of the doubt.

Tim Beyers: Unicorns for everybody.

Chris Hill: Exactly, and more storing. The other thing that's clear to me is there are two types of challenges that companies face: One is just individual to the company and we'll get to that in a second, and the other is the big bucket challenges, things like global supply chain, inflation, labor, and hiring. I think it's worth everyone taking a moment looking at the stocks in their portfolio when saying, in terms of the big bucket ones, which companies do I own are affected by global supply chain? What do I think about? Which leads me to Meta Platforms because this is a business that is dealing with a lot of challenges. I would argue that inflation is one of them. They've got a big bucket challenges just when you think about ad spend. But they're also dealing with Apple's change to its operating system, the whole privacy changes Apple did, that's going to hit Facebook to the tune of $10 billion, they are investing heavily in their own Metaverse aspirational operations, they are dealing with a lot, the stock is down more than 20 percent. Before we get into Mark Zuckerberg because I do think this is a moment for the CEO. When you look at Meta Platforms at this moment in time, what stands out to you?

Tim Beyers: This is going to be a reckless statement, Chris. I fully expect to be challenged on this one. What stands out to me is that the company formerly known as Facebook is no longer the hypergrowth company, and maybe even just say growth company that it once was, those days, for now, are over. Because when you look at the data, this is growing a little more like an American manufacturing company than it is a Silicon Valley big tech company. I'm looking forward, I'm talking about the guidance there, I recognize year-over-year they had some really strong growth. But looking ahead, Chris, growth story is over.

Chris Hill: I was with you right up until the end. Because even with the drop today, this is a $900 billion company. Even if they weren't dealing with the challenges that they are dealing with, you get to a certain size and it's reasonable to think, "Okay, the go-go growth days are over, we're moving into a different phase here and investors should factor that in." Really, we're going to put them in a category with 3M? I'm not knocking 3M, but like really you're going to put them in that category?

Tim Beyers: Well, like I said, it's a reckless statement. [laughs] The reason it's reckless is because there are other companies that have been there. We're going to talk about Apple in a minute here, but it wasn't that long ago that Apple was enjoying just single-digit growth and it was seeing serious stock returns primarily thanks to its cash flow generation and massive buybacks. It was growing, I'm going to make up a number here, like seven percent a year on the top-line revenue, but it was growing. The bottom line massively because they were just fewer shares, smaller pizza. That's not what's happening at Facebook, I will just call it Facebook for now, but the year-over-year growth expected coming in fiscal Q1 of 2022. We just ended and overall growth was up what? During the quarter 20 percent, roughly 20 percent. If you are going to take the midpoint, let's just take the midpoint of next year, which is $28 billion for the coming quarter, if you take that year-over-year, you are talking about, Chris basically, I'm sorry seven percent, you're talking seven percent year-over-year growth heading into the next quarter. 

Now, there are some reasons for that, but I'll give you two other numbers here and then just pause for a second. Both daily active users, these are Facebook daily active users and Facebook monthly active users barely budged sequentially, definitely up year-over-year, but you had basically 1.929 billion daily active users, that's a lots, that's up from 1.845 billion, so there's a little bit of growth there, single-digit growth. But versus in the prior quarter, 1.93 billion down on a daily basis. Monthly active users, 2.912 billion, that was up slightly from 2.91 billion in the prior quarter. I'm not going to say it's 3M, Chris, I think you're right, it is a reckless statement. However, it is verifiably true that Meta Platforms' growth is slowing. They have hit, it's not a speed bump, they have hit the curb and now they need to change a tire.

Chris Hill: They're making a lot of investments. Mark Zuckerberg has made it very clear what he wants this company to be five, 10 years from now. If you believe he can do it, it looks like an opportunity to buy the stock if you have the patience, but it really depends on that. There are times when we focus on the underlying business, there are times when we focus a little bit more on the person leading the company. This seems like one of those times that if you are a believer in his aspirations and his ability to pull this off, the stocks down 25 percent, [laughs] it seems like a buying opportunity.

Tim Beyers: I acknowledge that, I want to give two points of context here to get people thinking about this because it's not just. Well, the ad market comes back and things get a little better and we're talking about some fine-tuning, and when that fine-tuning take shape then this company will double or triple from here. Possible, but I think we're talking about something different, Chris. You want to judge this accordingly. The ad market may get more robust, like inflation, you pointed this out, this is a fair point, inflation may be impacting ad pricing and that has an impact directly on Facebook. That's a fair point. There may be some upside that they can get from that when things start to normalize. They also have to fix the problems that they have with this change that Apple created in terms of privacy and privacy permissions. It did take a toll. Facebook talked about this, they talked about it a lot during their call, I'll get to that in a second. 

That had a drag on the revenue as well. Let's say they fix that. Even if you assume those two things, Chris, the main thing you're talking about that drives real returns from here is creating a real business around the metaverse. That is different. We have to recognize that that's a big lift. There is no business model that we know of other than selling really interesting, I will call them interesting-looking Oculus headsets, there's nothing other than that for a metaverse business model right now for Facebook. They have to build that from the ground up. Before you get too excited about calling this a potential value, a beaten-down stock that's going to double or triple in the next five years, recognize there is a complete business model shift that has to be erected from the ground up to bolster that advertising business that's been a little bit compromised, that probably is going to be OK. But the other thing is not built yet, Chris, so I wouldn't go too far yet.

Chris Hill: I acknowledge all of that. I will just remind everyone that when this company went public, the amount of revenue they were making from mobile advertising was precisely zero dollars.

Tim Beyers: It's a good point.

Chris Hill: That was a huge question that's about the underlying business, can they pull this off? They proved that. This is not exactly the same thing, but it does remind me of that moment in time. Before we move on to our next story, you would post a question to me and producer Dan Boyd before we started recording. How many times Apple got name-checked in the conference call, Dan guessed 15 times, I'm guessing 12 times, how many was it?

Tim Beyers: If we're playing by prices right rules, then Dan gets the pum-pa para ba.

Tim Beyers: But he's still closest. Dan, you're still closest, it's 14.

Chris Hill: Yeah, I like closest to the pin, those are the rules I go by.

Tim Beyers: I will go by that too, prices right rules feel patently unfair here, but yeah, 14 times. It's overwhelmingly the Facebook/Meta Platforms executives that brought up Apple. In fact, I would say, it was primarily Facebook enforcer, this is what I call her, Sheryl Sandberg bringing this up, there was a lot of blame-shifting to Apple. To be fair, they do have a point. We know, and they've been talking about this, that the Apple privacy changes would be a drag and they did bring it up. The one thing I'm a little disappointed with from that call is they kept saying that Apple is hurting small businesses. Really, is Apple really hurting small businesses, or is this you and you are blame-shifting? I think it's more of the latter, Chris.

Chris Hill: I was talking about Zuckerberg, it seems like one of those moments where investors need to look at him and think, "Okay, how much do I believe in this person?" I think it is somewhat similar with respect to Daniel Ek, who is co-founder and CEO of Spotify because their fourth-quarter growth was strong, their guidance for future growth is what has shares of Spotify down, 15 percent. We'll get to the Joe Rogan and stuff in a minute. But this goes back to what I said at the top, in this environment, Spotify's not getting the benefit of the doubt.

Tim Beyers: I completely agree with that. The overall numbers here are good. Let me just hit a couple of them. Total monthly active users up 18 percent year-over-year. I'm not going to give the sequential changes here because I don't think that matters too much. Four hundred and six million total monthly active users, that's a pretty impressive number. Premium subscribers, up to 180 million, that was up 16 percent year-over-year. But there's a couple of numbers that I think are the drag here, in addition to the guidance, Chris, 19 percent growth in ad-supported monthly active users, so that was 236 million. 

Here's the differential that I think as investors, at least when I look at Spotify, I've thought what's great about this business is that it's not overwhelmingly ad-driven because that can be a little bit more. We just saw from Meta Platforms, you can get whipsawed in that market. Spotify is starting to be a little bit more ad-dependent here. Here are the numbers. Year-over-year, €2.295 billion, up 22 percent, that is for their premium revenue, but their ad-supported revenue up to 394 million, that is up 40 percent. Chris, we're both very familiar with the job of PR and that words matter. Let me read this to you and you tell me whether or not you think this is a nice bit of clever wordsmithing here. "Ad-supported revenue reached a record 15 percent of total revenue in Q4." Now, if you read that, Chris, that sounds great, right?

Chris Hill: Who doesn't like a record?

Tim Beyers: Who doesn't like a record? I don't think that's great. I think that is a little bit of spin on Spotify's behalf to try and say, "Hey, look, it's not so bad." But as you point out, the guidance in terms of their expectations for growth in monthly active users not as good as the street wanted to see. There is this belief that maybe some members are canceling, maybe you pointed out the Rogan comments and just some of the hubbub around there, maybe that's having a little bit of a drag. We don't really know, but there's some concern there.

Chris Hill: I watched Daniel Ek on CNBC this morning. He was getting questions about the quarter, about the growth guidance, and about Joe Rogan. He talked about they have a balancing act that they're trying to pull out there. The creative expression, along with the safety of people who use the Spotify platform. Ek struck me as impressive in the sense that he wasn't really docking tough questions, he is clearly an engaged leader of this business, he is engaged with all the appropriate parties. It reminded me a little bit of Neal Brennan, who is one of my favorite stand-up comedians, had this [laughs] thing where he was talking about, he was talking about entertainment media, but I think it applies to the investing world as well as, just the whole notion of story bubbles up and it's like this seems like it's a problem. Brendan said, "If I ever get in that situation where someone is going to write an article like, 'Neal Brennan's take on this topic is problematic.' I'm just going to say to the reporter, 'Do me a favor, wait one month, and if a month from now, you still want to talk about this, yeah I will talk to you about this.'" I'm not equating the Rogan stuff with that, but we were talking before about Facebook and there was a point in time, where Cambridge Analytics was the hot topic, and what is this going to mean for the business? People boycotting Facebook. These things often have a small shelf life, I think it benefits Spotify that the guy who is running the company is taking everything very seriously, he is out front, he is not sending out a PR person, he's out there himself. I think that matters and I think it's to their benefit.

Tim Beyers: I think so too. I also would say that you get credit for being thoughtful, balanced, and willing to address tough questions. I think in Spotify's instance here, they're not going to get credit for being on the right or wrong side of the issue, they would get punished no matter what side of the issue they chose to be on. The only thing that matters is we're business, we've hired this person, we want to hear concerns, we're going to be as balanced as we can be, and please give us your hardest questions so we can address them. If they do that, I think they are going to be OK. But we shouldn't presume that this is going to be easy, that it'll blow over quickly. I think they've probably done a decent job so far. 

But this also speaks broadly, Chris, to one of the underlying, I will call it a weakness, it's a weakness in Spotify's business model is that it's two-tiered: They have the ad business and then they have the premium business, they've really favor one, they want the premium business, that's what they really want. The future of the business really can't be too influenced by that ad-supported business because as we know, podcast ads are just different and Spotify handles them differently, so that ad-supported side of the business, that's largely music, that has really not that much to do with the podcasting, not from what I can see. But podcasting is a big part of the future of the business, so they have to figure this out and ride this out. The structural weakness is, the more we see Spotify relying on ads, the more it raises questions about the investments they're making in podcasting. I'm going to be paying a lot of attention to that revenue mix. I know they spun it positively. I want to start see it reversing, let's get more premium revenue.

Chris Hill: Before I let you go, give me 30 seconds on Align Technology, this is the maker of Invisalign dental braces. Good looking fourth quarter, they said, revenue this year is going to rise by 20-30 percent, I get that's lower than last year's growth of 60 percent, but come on?

Tim Beyers: The problem is that that's such a huge deceleration that it raises questions. I'll just mentioned this one thing, there are questions about Align that's coming from inside of our Fool community. One of the things I love the most about the Motley Fool community, this is inside our premium discussion boards, we have at least one, I think it's a couple of professional orthodontists who have said, "We're looking at ways to get away from Align Technology." I thought that was fascinating. I don't think it's really happening yet. The way these orthodontists we're describing it is that, what we really want, those Invisalign aligners, essentially what they are is something that you design and then you send it out, and Align makes that for you and then the you get it back. You pay pretty big premium for this, could we figure out some of these designs and do it ourselves in the office with 3D printing. I thought, well, now that's interesting. I don't think Align Technology is being disrupted yet, but you see that large decline in the growth and you start to wonder, are some dentists making different decisions about how much they want to rely on Align Technology? I don't know, but this feels like something to watch Chris. Feels like an area to just be cognizant of. Don't presume that the sell-off is entirely unjustified. Maybe do a little bit more digging and the Motley Fool discussion boards are as good a place as any to do it.

Chris Hill: Tim Beyers, great talking to you. Thanks for being here.

Tim Beyers: Thanks, Chris.

Chris Hill: When it comes to the Cloud, there are obviously the major players, but that doesn't mean smaller competitors don't also provide opportunities for investors. For a closer look at one such business. There's Dylan Lewis.

Dylan Lewis: Thanks, Chris. When people think about the Cloud, their head tends to go to names like Amazon, AWS, Microsoft, Azure, and Google Cloud. Today we are diving into a much smaller Cloud player, DigitalOcean. Joining me is Brian Feroldi. Brian, a lot of people may have heard DigitalOcean recently. Let's talk a little bit about where they exist in the Cloud market and who they are.

Brian Feroldi: You mentioned that they were smaller and they're smaller in numerous ways. For first-off, DigitalOcean's market cap is about $6 billion. That's obviously several orders of magnitude smaller than the big players in the space. But they're also interesting in that they focus on the smaller end of the market. The company is focused on providing infrastructure as-a-service, and platform-as-a-service, primarily for small and medium-sized businesses.

Dylan Lewis: When it comes to as-a-service, I think people are used to hearing us talk about software-as-a-service. They can probably surmise what infrastructure and platform-as-a-service might mean. But let's actually define it here because I think it's important.

Brian Feroldi: Sure. Infrastructure as-a-service or IAAS as this is basically the back-end IT infrastructure for running applications and workloads in the Cloud. This would include things like Cloud-hosted servers, whether their physical or virtual, as well as the storage and networking platform as-a-service is everything that's built on top of infrastructure as-a-service, you need to actually run the applications. This would be the operating system, storage, databases of middleware. Then on top of that would be the Software as itself. That's where we include in the software-as-a-service category. That's just ready-to-use cloud hosted application software.

Dylan Lewis: When it all comes together as a customer offering, what exactly is DigitalOcean providing to customers, and what is the relationship with our customers look like?

Brian Feroldi: Sure. DigitalOcean is focused on the infrastructure as-a-service and platform as a service. As you teed up, like Amazon Web Services, Microsoft Azure, and Google Cloud. However, they are focused specifically on small and medium-sized businesses. You wouldn't think there would be room for them to compete in that market given some of their competition. But they've done a good job about carving out a little niche for themselves. By niche, I mean, they already have nearly 600,000 customers that are spread across the globe. What's interesting about that is already the company, about 65 percent of the company's total sales come from outside the United States. Developers and small businesses hire and rent from DigitalOcean to handle all of their basic website functions. That can include hosting it, compute power, providing a Cloud-based VPN, maintaining a database that basically everything that they need from the back-office perspective to have their software up and running.

Dylan Lewis: You mentioned before that this is a company that is operating in the space of Titan's. I think it's safe to say that this is a David, too many companies, Goliath. It is easy when you look at those market dynamics to say, how does this company standard chance? These big companies have this wrapped up. I think it would be tempting to say that for Infrastructure-as-a-Service and platform-as-a-service. But I think the way this market breakdown and the way that the customers exists and those relationships shows it's actually a pretty good opening. That's often a misguided way to look at some of these bigger tech markets.

Brian Feroldi: Yeah, that was my initial inclination to be like there's no way a company can compete against the cloud-type consider out there. But digital oceans numbers clearly suggest It's doing just that. I think it's focused specifically on small and medium-sized businesses, as well as allowing it to stand apart. The company points out that small and medium-sized businesses just have different needs and different pricing sensitivity than the big cloud providers can offer. A lot of small companies just need very simple runtime environments and they want to get it at an affordable, straightforward price. DigitalOcean really prides itself on simplicity as well as low cost. In fact, if you go to the company's main website and price things out, they have a price comparison tool where they can show you how much your needs would be a hosting on DigitalOcean versus all three of the major tech titans. Just to give one number out there, bandwidth on DigitalOcean's platform costs about $0.01 per gigabyte per month. For comparison, the nearest, closest big boy would be about $0.05 per month, so about five extra costs. DigitalOcean is really going after customers that want simplicity and low pricing.

Dylan Lewis: That direct comparison is so effective for storytelling for them and being able to acquire customers. I think I've heard some people like in DigitalOcean too, in early Shopify in the sense of when the company was maybe a 2-$4 billion company, not the $100 billion company we know it to be today. A big part of that Brian is, It's easy when you look these markets to ignore the needs of those smaller players because it takes a lot of small fish to become worthwhile for some of these businesses to go after. The reality though, is if you can create an option that works for those small players and then grow with them in a symbiotic way. It can become a very large business as we've seen, the likes of Shopify.

Brian Feroldi: Yeah. For sure the comparison to Shopify isn't exactly one-to-one, but the company is following a similar pathway. Shopify initially got its start by really catering to the needs of small individuals and small businesses that just wanted to set up a shop online. For a lot of reasons, some small businesses didn't necessarily want to have to rely on huge e-commerce players like Amazon and Walmart for everything. For them, building a site on Shopify in order to build a direct relationship with their, customers really made sense. You can make a similar argument for DigitalOcean today. Some small and medium-sized businesses that don't want to have to deal with the complexity and the power, and they don't need everything that Amazon Web Services or Microsoft Azure has to offer. They've really just want to get a website up and running, or a platform up and running globally. They want to do so, cheaply and affordably. That niche is providing DigitalOcean with an area to carve out market share for itself.

Dylan Lewis: All told, the company has turned a lot of small businesses into a pretty decent top-line number, just about 400 million over the last 12 months at a 58 percent gross margin that grew revenue at a 37 percent clip last quarter. We know that the Cloud in general is a very high-growth space. When we look at the growth at this company experiences Brian in typical as-a-service fashion. This is a mixture of new customer acquisition and growth in spend from the existing customers that they have.

Brian Feroldi: The company is doing very well. To throw some other metrics out there that we like to track with companies like this. The company's gross retention, which is just keeping a customer from one year to the next. That figure is currently hovering at 86 percent. But what that means is that they're losing about 14 percent of their customers any given year, you might be alarmed by that, but that actually it's just the nature of the companies that DigitalOcean is going after and servicing. Small businesses and medium-sized businesses have much higher churn rates than they do in the enterprise grade. Which is why the big players really aren't designed to go after them. The good news is, if you look at net retention, which not only includes churn but includes upselling, that figure has historically been hovering around 100 percent. The company is keeping from a revenue perspective a 100 percent or more in any given year. What's particularly interesting about that number is that it's grown quite rapidly over the last couple of quarters. In fact, in the most recent quarter, that figure jumps to 116 percent, which suggest that DigitalOcean is doing a better job about keeping its customers and upselling them even faster.

Dylan Lewis: Brian, when we look at businesses, we like to say, if they don't work out, it's not from a failure of opportunity. I think that that's certainly the case here. You want massive tailwinds that are pushing a business forward. The combined Infrastructure-as-a-Service and platform-as-a-service markets are estimated to be worth a 116 billion by 2024, up from 44 billion in 2020. Huge opportunity here, particularly because the small business piece overall is massive as well.

Brian Feroldi: The company points out that around the globe there's about 100 million small and medium-sized businesses. Just as important, about 14 million new small and medium-sized businesses are started every single year. Employed by those businesses are about 45 million total developers, or at least they are estimated to be by the year 2030. Again, for comparison, this company has attracted so far about 600,000 total paying customers. The market opportunity that this company is going after, even though it's focusing on small and medium-sized businesses is gigantic.

Dylan Lewis: When we see big opportunity, we also know that means heated competition. We've already talked about the fact that there are some deep-pocketed players in the space, Brian, that's probably one of the more obvious risks for this business, but it's not the only one.

Brian Feroldi: For sure. That's going to be something that investors always have to think about. It is possible that Microsoft Azure or AWS or Google could try and go down-market and provide a lower-priced, simpler offerings that would more effectively compete with the likes of DigitalOcean. To say nothing of the fact that there are other more direct competitors out there, such as a company called vulture, Heroku, and Alinity. There's a lot of competition in this space. However, if that competition has always been there in DigitalOcean, has still been able to grow. In spite of that. One of the risks that's worth noting is that we at the Fool loved to invest in founder led businesses. DigitalOcean was founded in 2003, by two brothers. Those brothers have since moved on and are no longer involved in the day-to-day operations of the business. The company actually handed over the CEO reins in 2018 to as CEO named Mark Templeton. He only lasted about one year before the show in the door and a new CEO, the current CEO named Yancey Spruill, was brought in. Now, he is exactly the CEO that I think that you want. He was formerly the CFO and COO of a company called SendGrid, if that name sounds familiar, that's because it was recently bought out by Twilio and it will become a hugely popular company. But leadership transitions and having a new leader in the corner office is always a risk for investors to keep in mind.

Dylan Lewis: The ticker is D-O-C-N the company DigitalOcean, an interesting business if you want to study where the Cloud is going, particularly infrastructure-as-a-Service and platform-as-a-service. Also, a good company to challenge some of your commonly held beliefs about market dynamics and who can rise in markets dominated by big companies. Brian, thanks so much for help me breakdown.

Brian Feroldi: Thanks for having me, Dylan.

Chris Hill: That's all for today, but coming up tomorrow, we'll have the latest on Amazon Pinterest, and a lot more. As always, people on the program may have interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against. Don't buy or sell stocks based solely on what you hear on Chris Hill. Thanks for listening. We'll see you tomorrow.