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While Meta Platforms (NASDAQ:META) has a decent shot at dominating the metaverse medium, which is still in its earlier stages of growth, investors should rather focus on the performance of the company’s core business. Although it’s true that the revenue from the metaverse field could potentially have a meaningful impact on the company’s overall performance, as the medium increases in size, we’re still years from it. Meta’s management clearly understands this given the shift in rhetoric during the Q1 earnings call, so even the long-term investors should understand it as well.
In the meantime, it’s far more important to look out for opportunities within the traditional digital advertising market, which will continue to be the main source of income for years to come. Even though we’re on a brink of a recession, which will likely have a negative impact on the overall market in the short to the near term, Meta has everything going for it to continue to offer attractive growth opportunities to advertisers. This will undoubtedly help the company to better tackle the upcoming economic and regulatory challenges and thrive in the long run. Therefore, now could be a good opportunity for investors to start looking at opening a small position in Meta and increase it later on based on the economic data and the market price over time.
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Last year when Facebook was facing pressure from Capitol Hill, failed to reach a deal with regulators to launch its own stablecoin Diem, and has been accused of not preventing the misinformation to flow through its social platforms, the management decided to change the company’s name to Meta Platforms. This was made to prevent a further PR disaster and at the same time to announce to the world that the company plans to look for opportunities to expand into other mediums one of which is the metaverse.
Metaverse itself looks like a promising medium where Meta can establish a solid presence and use its hardware and software capabilities to create a significant source of income. Various reports show that the metaverse could be a $13 trillion market by the end of this decade, so the opportunities there could be enormous for companies such as Meta. Let’s not ignore the fact that the company is already one of the leaders in the VR market thanks to the purchase of Oculus in 2014, and at the same time, its metaverse project Horizon World surpassed 300,000 users earlier this year.
The only problem is that Meta’s metaverse projects won’t be able to generate meaningful returns anytime soon. In the Q1 earnings report, Meta showed that Reality Labs revenue, which includes revenue from its VR and AR projects, accounted only for 2.5% of the overall revenues, while its loss stood at $2.96 billion. Considering this, the metaverse is not the main story today when it comes to Meta, so it’s far more important to focus on the company’s core business at this stage, which includes the placement of ads within its main social platforms that generate nearly all of the revenues.
Meta Q1 Segment Results (Meta)
However, despite this, nearly half of the world continues to use Meta’s products and in Q1 alone the number of daily and monthly active people increased by 6% Y/Y and 6% Y/Y to 2.87 billion and 3.64 billion, respectively. At the same time, Meta’s main platform Facebook has also increased its DAU and MAU by 4% Y/Y and 3% Y/Y to 1.96 billion and 2.94 billion, respectively. On top of all of this, the company’s global average revenue per user in the first three months of the year increased to $9.64, up from $9.27 a year ago, while its US and Canada average revenue per user increased to $48.29, up from $48.03 a year ago. Those numbers look quite impressive considering that the company managed to increase its ARPU despite all the challenges that it faced.
What’s also important to note is that while Meta’s Facebook is constantly portrayed in a negative way by various media outlets, the company continues to innovate and ensures that advertisers don’t move to other platforms to place ads. Back in the day, the company introduced Instagram Stories to prevent its competitor Snap (SNAP) from attracting more users, and now it has done a similar thing by introducing Instagram Reels to tackle the rising threat from TikTok. While Reels is a relatively new feature for Instagram, its biggest advantage is that it makes it more efficient for advertisers to improve their conversion rates in comparison to other features currently presented.
There’s already data, which shows that Reels now accounts for 20% of time spent on Instagram, which is a significant number considering that the feature is relatively new. On top of all of this, Meta is also in the process of changing its Facebook app to prioritize Reels and Stories and at the same time, it wants to give content creators more tools to work with their content, as video now accounts for 50% of time spent on Facebook. Since the rampant rise of TikTok showed that video content is the new king in town, by doing all the video-related changes Meta has an opportunity now to increase engagement on its platforms, which in the end should lead to an even greater growth of its main metrics.
In addition to all of this, it’s also safe to say that Meta will continue to be the most attractive social media play on the market, as it will take a long time if ever for its competitors to improve their main user metrics. Snap for example had a global ARPU of only $3.20, a North American ARPU of $7.77, and 332 million daily average users in Q1. Pinterest (PINS) on the other hand had an international ARPU of $1.33, USA and Canada ARPU of $4.98, and 433 million monthly active users in Q1. Considering those numbers, we can be pretty sure that no other social media company will be able to outperform Meta in the digital advertising space anytime soon.
Making Sense of Meta Platforms’ Numbers
Meta’s Q1 earnings results overall were not as bad as expected. Its revenues during the period increased by 6.6% Y/Y to $21.91 billion, below the estimates by $310 million, while its EPS of $2.72 was above the Street estimates by $0.17. Its net income declined by 21% Y/Y to $7.47 billion, even though the street expected a 24% decrease, while at the same time it generated $8.5 billion in FCF during the period.
Despite the decent results, the stock itself experienced a major decline in recent months. As a result of this, Meta now trades at a forward P/E of 14x, while its big tech counterparts Amazon (AMZN) and Alphabet (GOOG)(GOOGL) trade at a forward P/E of 128x and 19x, respectively. Considering this, we could safely say that Meta is not overvalued in comparison to its peers at the current levels.
To find out Meta’s intrinsic value, I made a simple DCF model where for the revenue growth rate I used the street estimates that are presented here on Seeking Alpha. Unlike other less known companies, Meta is covered by a wide variety of advisory firms, so it makes sense to use their consensus growth rate for the base case, as it has been mostly in line with the actual results in recent years. CapEx in the model is significantly increased in comparison to previous years since the management aims to increase spending to expand its metaverse presence, and we know for a fact that in 2022 Meta should spend between $29 to $34 billion in capital expenditures. The rates for other metrics are mostly averages of the previous three years.
Meta’s DCF Analysis (Historical Data: Seeking Alpha, Forecasts Are Made By The Author)
One of the upsides of Meta is that it has no long-term debt or short-term borrowings on its balance sheet, which makes it easier for it to weather economic challenges. However, due to this, it has a higher WACC, since the cost of equity acts as a cost of capital in this case. In my model, WACC is at 9.5%, while the terminal growth rate is at 2.5%. The model shows that Meta’s enterprise value stands at $510 billion, while its equity value is $554 billion, which brings us to a fair value of $202.29 per share and represents an upside of over 20% from the current market price.
Meta’s DCF Analysis (Historical Data: Seeking Alpha, Forecasts Are Made By The Author)
The model shows that Meta is undervalued, yet there are several major risks to the bullish thesis, which could stop Meta’s stock from getting out of the distressed territory anytime soon. The first one is the obvious one, which is a recession. During an economic downturn, advertising dollars are pulled out and the marketing expenses by firms are cut to weather all the upcoming challenges that come with a recession. The U.S. GDP in Q1 has shrunk Y/Y for the first time since 2020, and if in Q2 it declines as well, then the United States economy will officially enter a period of recession that will more than likely negatively affect Meta’s performance in the future, since North America is its major market.
The other risk is severe regulations. Currently, Meta continues to face various data-related lawsuits in the United States, while in Europe it would likely need to comply with the Digital Markets Act, a new EU proposal to regulate how the data of the EU users is collected and shared by companies. If approved by the European Parliament and the European Council, and later implemented around 2023, then it will make it harder to Meta to collect new data and as a result of it, there’s a risk that it won’t be able to meet advertisers’ needs, which will force the latter to look for alternatives. That’s why Meta has been vocal against this new regulation and there were even talks about pulling the business out of Europe. However, I don’t see it happening since Europe is Meta’s second-biggest market, so the company would need to adapt to the new reality or continue to pay fines. In both ways, this could negatively affect the company’s stock as well.
The Bottom Line
Meta is a growth stock, and growth stocks are the first to be slaughtered in the current economic environment where inflation is soaring and the recession is around the corner. Nevertheless, the company has several advantages that should help it to thrive in the long run. First of all, it has no real competitors in the social media space, as it takes a long time if ever for its peers to achieve the same user metrics performance that Meta has. At the same time, the company has no exposure to China unlike its big tech peer Apple, so in case of some sort of a trade war, its business won’t be affected whatsoever. In addition, while the advertising business is likely going to be negatively affected if the economic data worsens, in the long run, advertisers are not going to disappear and will return once the dust settles down. Once it happens, Meta would be one of the first companies to significantly benefit from this.
At the same time, it’s important to understand that it’s impossible to time the market. A possible improvement in CPI numbers next month alone could push the stock market higher. Therefore, while there’s still a risk of owning Meta at the current levels, it’s nevertheless significantly lower than when the stock was trading above $300 per share not so long ago. If the company manages to successfully deal with all the headwinds, then it will be able to thrive in the long term.
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