As ugly as it may sound, head count reduction seems to be the new trend in big tech.
Many of these companies experienced unparalleled demand during the peak of the pandemic, and revenue, margins, and profits were steadily setting records. Companies subsequently reinvested these profits into new, non-core initiatives and increased marketing campaigns. As a result, they also hired more people.
Three years later, business finally seems to be normalizing. Growth is slowing down, demand is decreasing, and economists are ringing the alarm bell on inflation and potential recession. We're left with executives admitting that hiring got ahead of itself, and head count ballooned to unsustainable levels. Now the prudent choice for businesses is to scale back.
In the case of Meta Platforms (META -2.77%), CEO Mark Zuckerberg has made two things clear: Meta is going to reduce its costs, and head count will be the primary driver of its cost reduction. Amid the tough reality of layoffs, Wall Street appears to be applauding these efforts.
With that said, let's consider how this might change the investment thesis for Meta stock moving forward.
What Meta is doing and why
First, let's take a quick look at how Meta got here.
One of the most famous investors in Silicon Valley is venture capitalist Brad Gerstner, who operates Altimeter Capital Management. Altimeter owns large positions in Meta and other well-known technology companies like Nvidia, Microsoft, Uber, and Snowflake.
In October 2022, Gerstner and his team wrote an open letter to Zuckerberg and Meta's board of directors, urging Meta to cut back on costs and focus on free cash flow (FCF). Although the actual influence of Gerstner on Meta can't be truly determined, it's clear that Zuckerberg and the board are aware of the issues he illuminated and are implementing a cost-cutting strategy as a result. (Meta announced its initial head count reduction of 11,000 employees in November 2022, a month after this letter went public).
Zuckerberg doubles down on efficiency
Zuckerberg began the earnings call for Meta's fourth-quarter and full-year 2022 results saying the company will focus on efficiency in 2023. (This need for efficiency is clearer with a quick look at its income statement, where costs and expenses increased 23% year over year, totaling $87.7 billion in 2022).
Meta has since announced another round of layoffs last week in accordance with its goal to improve efficiency. This time, the company will be reducing its head count by an additional 10,000 employees and won't be filling 5,000 open positions.
If this doesn't scream "getting back on path," I don't know what does.
Although Meta announced its first round of layoffs in November 2022, it still ended the year reporting roughly 86,000 employees. In other words, its final headcount for the year included the majority of the 11,000 employees that were laid off in November.
Before investors get caught up in the hype, they should remember that Meta hasn't yet recognized the impact it anticipates from either of its announced workforce reductions.
What does this mean for your portfolio?
So how might investors approach Meta stock with this news in mind? It depends on the investor's outlook and investing approach. Meta stock is up 64% year to date. Moreover, the stock is up roughly 20% in just the last month, with most of that uptick occurring the day after Zuckerberg's note about round two of layoffs.
If you're a momentum trader, you have likely recognized some nice gains so far in 2023. But that the uptick in Meta's stock price is largely due to the news of cost savings, and not the actual reported, tangible financials themselves. In other words, Meta's stock has rocketed because investors are enthusiastic about the company's cost reductions, but investors have not yet seen the concrete results from these efforts.
Chief Financial Officer Susan Li assured investors that Meta "expect[s] the vast majority of impacted employees will no longer be captured in ... [its] reported headcount figures by the end of the first quarter of 2023." It's likely the impact of the newly announced round of layoffs will take even longer to manifest in earnings results throughout the year.
For investors with a long-term horizon, the most prudent action would likely be to assess first-quarter earnings and management's guidance on how the cost synergies are being executed. Long-term investors should also look closely at the growth (or lack of it) in free cash flow.
So while Meta presents an interesting investment, right now it seems to be more of a case study. If management executes on cost reductions and forges a path to consistently growing free cash flow, then the stock likely deserves a harder look for your portfolio.