Meta’s Earnings Report, The Dividend, and What That Means for Other Tech Companies
by
PJ McNerney
Feb 5th - Meta’s Earnings Report, The Dividend, and What That Means for Other Tech Companies (Spoiler Alert: Expect More Layoffs)
On February 1st, 2024, Meta had its earnings call. Amidst the standard reporting of revenue growth, user #s (more on that later on), profitability, etc., there was one big announcement: Meta will start paying out a dividend.
This is a big deal. Not just for Meta, but for the wider tech industry as a whole.
And if I am being honest, my (unfortunate) prediction is: it will lead to more layoffs in 2024.
To understand my perspective, let’s back up and talk a little bit about stocks and dividends. What the hell is stock anyhow? (I know it is a bit remedial economics 101…but it is still worth talking about).
What is stock anyway?
Stock represents ownership in a company. That is, by owning one or more units of stock(i.e. shares) in a company, you are, in fact, and owner of that company. In a classical formulation, that stock gave those owner the opportunity both to exercise control over that company (i.e. through voting rights) as well as participate in the profit of the company. This latter bit was paid out through the dividend, which is amount paid out per share.
In a really naive example…if you own 20% of the company…you would have 20% of the voting rights…and get 20% of the profit.
Simple, right? Well, in practice, not so simple. Because, if you’ve hit this point in time, you might be asking the questions…why is it a big deal that Meta is issuing a dividend? Haven’t they always been doing this?
Well, as you might have figured, things might be as simple. Let’s take voting rights for a moment.
Voting Rights
Not all stock shares equally participate in voting rights. A stock share might have voting rights…or it might not. Or it might have outsized voting rights.
Alphabet (Google) is a great modern example of this, which has not one, but three different types of voting shares. If you trade them on the public markets, you might notice there are only two GOOG and GOOGL, denoted as Class A and Class C, respectively. While both carry ownership in the company, only GOOG has voting rights associated with them. This was done to prevent dilution of control over company.
Hmm, I’ve mentioned “A” and “C”, but what about “B”? Alphabet’s B class stocks are (a) not traded on the public markets and (b) carry 10x the voting rights. These were created so that the founders, Larry Page, Sergey Brin, and Eric Schmidt (and a few others) could maintain control over the company.
Also, Alphabet it hardly alone in this…Meta carries two classes of stock as well, A and B for much the same reasons (i.e. company control).
(Also, before anyone gets too bent out of shape… multiple stock classes are hardly new instruments. Many companies have had differences between “preferred” and “common” stock for decades.)
Tech Employee Compensation and Stocks
But…with all that said, why was there a concern for dilution of the company voting shares anyway? For that, we have to talk a little bit about how compensation in the tech world operates.
It is hard to imagine a world where Alphabet(Google), Apple, Microsoft, Amazon, Meta(Facebook), and NVIDIA are not the juggernauts that they are today. With both combined and individual market caps measured in trillions of dollars, these companies are incredibly successful.
And yet, there was a day where that was not always the case. Each of them once was a small fry…and some of them (especially Microsoft and Apple) had to undergo significant revamping to arrive at where they are today (Apple nearly went under just before Steve Jobs came back).
In fact, there was a point in time where each of these companies were, in fact, risky to join, with no guarantee of success. In order to lure talent from more well established companies, tech companies would offer stock (and often more precisely, stock options…but let’s chat about that another time) to its employees. The premise behind this was, the initial salary might be low, but the stock would align the economic interests of the employee and the company in the same direction.
That is, if the company did well, then the employees would do well. If the company went under, the employee ended up empty handed. That just represented the risk of the venture.
Even as the companies became more successful, the stock grants stayed around to help lure employees from one company to another as well as to continue to align the economic interests of the employees to the company (i.e. as the stock goes up, the employee gets richer).
Of course, granting out this stock is part of the cost to the company of employing its people. Keep that one in mind as we move forward.
Why avoid the dividend?
So, while the stock share may grant the opportunity to receive a portion of the profits in the form of a dividend, it is not a foregone conclusion that the company will in fact issue said dividend.
Which leads you to ask: “why?”
Let’s look at a very naive example. When profits start coming into a company, owners have a basic choice…do they return those profits back to the owners…or do they decide to invest back in the company (or some combination thereof)? And who is deciding this, again?
Let’s answer the second question first…remember, the owners are the ones who are making this investment decision and are doing it through some kind of shareholder vote. This is where the voting rights come into play. Founders very often are the keepers of the long term vision and may be less motivated by short term return of profits to investors. So, they may often decide to reinvest those funds into growing the company.
This is especially true if this company is still in its growth stage. That is, there is still a lot of upside to be had and it is necessary to reinvest that money in things like (for tech companies) more computers, more data centers, and….more head count.
The amount of money for investment for a company is another far reaching topic (e.g. involving corporate debt, etc.), but, suffice it to say….by not paying out a dividend, the company is able to invest the money that would have gone into the dividend into other things. And those other things are often aimed at bringing long term success.
Why start issuing dividends?
Growth doesn’t go on forever. As a consequence, investment in growth may no longer make sense at certain stage of a company. Furthermore, without that growth to justify new avenues, companies start looking at how to become more efficient.
From Meta’s earnings call:
“In Q4, we saw continued community growth across the Family of Apps, as well as Facebook specifically. We’re sharing today that, as previewed when we first introduced our Family metrics, we are transitioning away from reporting Facebook-specific metrics. As part of this transition, we will no longer report Facebook daily and monthly active users or Family monthly active people. In Q1, we will instead begin reporting year-over-year changes in ad impressions and the average price per ad at the regional level, while continuing to report Family daily active people.”
Why not keep reporting the Facebook-specific metrics? Likely because that segment is no longer in a growth phase. By collecting it in the larger family of apps, it is possible to express the overall growth without focusing too hard (or even knowing) what the Facebook particulars might be.
(To be sure, Ben Thompson from Stratechery already picked up on this, so full credit to him for highlighting this section).
Across tech within 2023 and (continuing in )2024, after a hiring frenzy up to 2022, tech started shedding jobs. Meta called 2023 its “year of efficiency” and participated with many other tech companies in reductions-in-force (RIF).
From previously, companies can choose to take profits and invest them into growth, such as hiring more people. With years sclerotic headcount growth now followed by shedding of jobs while companies are reporting gangbuster numbers…those profits now can go elsewhere.
But again…why do dividends?
Companies that are still in their growth phases are viewed by investors as having upside in their futures. That is, there is still room to have increased success in the future. Tech has occupied this space for a long time.
Companies that are profitable, but are no longer growing like gangbusters, are viewed by investors as being stable. Traditional companies like investment banks, car companies, etc. often fall into this category.
Many times this classification is expressed through the price-to-earnings ratio, which represents a multiple of the stock price to the amount of earnings from the company. Traditionally a “growth” company had a P/E ratio of 30:1; otherwise there would be something closer to 15:1 as the P/E ratio.
(Obviously these are not hard and fast numbers…it was easy to see ratios of 100:1 or even higher for tech stocks, which expressed the perception of the investors for the future of that company).
When a company is no longer in its growth phase, the stock can go down by virtue of the fact that there is not as much expansion expected. Bear in mind, the company can still be reporting profits…they just may not be growing as much as they used to.
Now, one way to make the company more profitable is to reduce its costs…which is seen in the set of layoffs seen recently. This makes the stock more valuable.
Another way to make the stock more valuable…is to start paying dividends. Now investors can get money simply by owning the stock and never trading it. Typically this is a sign of a maturing company but keeps the stock valuable since, this is effectively free money.
(It isn’t quite “free” and it may be taxed differently…but again, discussion for another time).
But there are knock-on effects…
Dividends and Stock Based Compensation.
By paying out dividends…this means that the cost of stock based compensation effectively goes up. That is, not only are you issuing out stock as compensation to employees…but you are also now paying dividends to them on top of that.
What are some possible effects from this?
One obvious thing might be…you stop issuing as many stock units to your employees as compensation, since holding onto these stock units has continuing value associated with them through the dividends. Of course, the dividends are never guaranteed, since they have to be voted on. But this reduction in number of shares can be a convenient way to reduce ongoing compensation costs.
Another thing might be…you reduce the total amount of headcount. This commensurately reduces the cost of compensation by having fewer people.
Obviously, these are not mutually exclusive things and one can do all of the above if desired…and certainly there might be other means (e.g. issue yet another type of stock that doesn’t pay dividends?) to the same ends.
But it leads to…effectively lower costs associated with compensation…and likely higher numbers of layoffs.
Where Is This Leading?
Companies of these sizes do not turn on a dime and the year of 2023 was likely necessary to prepare Meta to make this kind of announcement. Which means that it was likely planning this for a while.
Looking at the tech stocks on the top of the heap, who else pays out a dividend and who doesn’t? Microsoft does. Apple does (even though Steve Jobs was vehemently against it…but it took only about 6 months after his death to initiate it). NVIDIA does it. And Meta just joined the club as well.
Who seems to be missing? Oh right, Alphabet (Google) and Amazon. Neither of these companies have ever paid out a dividend.
Now, just because Meta has decided to join the dividend club doesn’t mean that this will force anyone else do to the same. Indeed, the voting shares of Alphabet and the number of shares Bezos owns of Amazon likely means that the founders can resist making any changes if they wanted to based on shareholder pressure.
That said…the RIFs seen by both of these companies (and, of course, others) do signal that the days of insane growth are numbered. Efficiency is on everyone’s mind and shrinking costs is a common theme.
Is it possible that the RIFs seen by Alphabet and Amazon are precursors to them following Meta’s lead? Maybe.
On the other hand…everyone seemed surprised by the Meta announcement, as seen by the whopping *20% stock price increase** the next day. Now that can’t *all be attributed to announcing the dividend…but its effects can’t be denied.
If Alphabet and Amazon have been planning similar moves, then perhaps the RIFs seen to date have been towards that and they will calm down.
On the other hand…if market pressures start to bear down on these companies to issue a dividend and they have not been preparing as such…then the layoffs option might look increasingly attractive…
And indeed, it was leaked that Alphabet expects more layoffs later on this year.
Closing It Out
All companies go through seasons. This has been true for time immemorial and will continue to be true. What may be more shocking to some folks is that the party couldn’t continue on forever. Tech companies, which tried for decades to be “not a conventional company” (and tried to continue to reassert this, even as recently as 2019), revert back to tactics that have been used by conventional companies for all time.
That isn’t an indictment of the aspirations of those founders and what they were aiming at. It is, however, a reality of the world of business. By avoiding the fiscal responsibility required to create self sustaining businesses, these tech companies have become the conventional companies they sought to avoid.
And the people that are most affected: the folks laid off…and the folks left behind.
Which is a conventional result as well.