panida wijitpanya
As we move into 2023 and look forward to the year ahead, I think it is time to take another look into a big tech company that is down almost 65% since its highs. Meta Platforms (NASDAQ:META) experienced a drastic change in sentiment, turning from a market darling and part of the FAANG group of stocks to a contrarian investment in the past two years.
Investment thesis
As Meta changed its name from Facebook to Meta, it marked a new era in the company’s history as it was experiencing some issues that were hindering growth and the company wanted to pivot towards a new vision, which founder and CEO Mark Zuckerberg has a huge conviction in: the metaverse.
The issues will be addressed in greater detail later, but it includes the privacy changes at Apple (AAPL), the market recognizing a new threat to Meta’s Family of Apps and the introduction of the focus on metaverse which not many investors were on board with.
That said, I think that in 2023, things are starting to look better for Meta. Sentiment seems to have reached rock bottom or at least somewhere near it, as the selloff in Meta shares has likely shaken out most of the investors that do not believe in Meta’s ability to continue to generate great products and engage users. The catalyst for 2023 will come in the form of continued improvements in engagement, especially on its newer products, as well as greater clarity on the pace of investment into Reality Labs.
I have written extensively on Meta in the past, including an article that illustrates Meta’s metaverse ambitions, an article that highlights the new products that will drive growth for the company in the future, and an article more about the plans and monetization of Reels.
Key problems Meta faced in 2022
The first problem that Meta faced was undoubtedly Apple’s privacy changes. Apple’s changes in its privacy policies allowed users of Apple’s products to opt-out of sharing their Identifier for Advertisers (“IDFA”) tag. What this means is that Apple users can now have the option to opt-out of sharing their personal data tied to their unique IDFA tag. While this helps improve data privacy for individuals, companies like Meta are hurt badly as this makes it impossible for advertisers to target users of platforms like Meta’s Facebook if they are using an Apple product.
The second problem was one that was likely in the making for years, but only acknowledged and priced into the markets more recently. The market recognized the threat from short-form video format platforms like TikTok as Meta’s management acknowledged these competitive threats in their own earnings call. Market share in the advertising space started to fall for the first time in 2022 as Meta was increasingly threatened by newer, emerging platforms. As TikTok grew in popularity and more consumers started to use the platform, the management of Meta recognized that they too needed to combat this rising threat, which resulted in the launch of Meta’s own short-form video format, Reels.
The last problem came from a shift in focus away from a social media company to a metaverse company. The company’s name change to Meta signaled a change towards what it wants to be known for, pivoting away from its brand image as a social media giant. This new metaverse although relatively new is supposed to bring a huge addressable market to Meta.
Green shoots from new products
In the recent quarterly earnings call, Reels seemed to see better engagement. As a reminder, Meta launched Reels, its own short-form video format to counter the growing threat of TikTok. This was launched on Instagram in 2020, on Facebook the following year, and the feature was launched globally in 2022. The focus for most of 2022 was to really prioritize the short-form video format in a bid to continue to remain competitive as a social media platform.
Since prioritizing Reels, the next step would be to ramp it up and gradually improve monetization of the new feature. This would take time as even Stories took four years to monetize and reach parity.
Recently, management also highlighted that the format is growing across its apps as more users are producing and consuming Reels, resulting in more than 140 billion Reels being played across both Facebook and Instagram each day, an increase of 50% from just half a year ago. This highlights to me that management prioritizing Reels has made a significant impact to the format and looks to have accelerated the path to monetization as more users consume Reels and more Reels videos are produced.
More importantly, Reels is incremental to the time spent on Meta’s Family of Apps. This is significant, in my view as the initial drawback to Meta’s Reels was that this would draw time spent from one app to another app or one feature to another feature within Meta’s Family of Apps. However, my belief was that Reels as a format would bring a net positive impact to engagement and time spent as it is the key drawing factor into the app and also a key engagement tool within Meta’s Family of Apps. This is essentially a much-needed feature to both attract and retain users, in layman’s terms.
The important thing about Reels is its ability to compete with competitors like TikTok. The company has seen that with the roll-out of Reels, Meta is finally seeing that they are gaining time spent share from TikTok. This is a good early step for Reels as a relatively new format compared to TikTok. Ultimately, Reels is necessary for Meta because of the important role it plays in engagement and bringing users to the platform due to the engaging format of Reels.
Another new product pivotal to the Meta story is the business messaging. This is an area that management has mentioned in multiple earnings call and certainly a key investment area for Meta. It is estimated that almost 1 billion people communicate with a business account on one of Meta’s Family of Apps, and that almost 40% of the company’s advertisers use click-to-message ads which will direct users from Meta’s apps like Facebook or Instagram into Meta’s own messaging service. As a result, business messaging is in my view one of the low-hanging fruits to monetize to reaccelerate growth in Meta’s ad products.
Metaverse ambitions
The ambition for the metaverse I am referring to here really is for the longer term, but the opportunity to invest in it is today. I like that Meta is looking for the next frontier and attempting to innovate in ways that nobody else is willing to.
To a certain extent, Meta and Mark Zuckerberg are contrarians themselves. The fact that they believe in a different future from others and remain committed to it shows that they believe in the true future of the metaverse. Despite intense skepticism from investors, the company continues to double down on investments in the metaverse, developing technologies for augmented and virtual reality to create new medium for people to socialize, work and play.
With the launch of Horizon Worlds and a metaverse-ready virtual reality headset Quest Pro, I think you should get the idea that the metaverse will not be built in a day. It will take time, there will be failures, but at the end of the day, what the team at Meta is doing is trying to take innovation to the next level, bring new development to the technologies we know today to enhance our experiences for the future.
While there has been lots of negative sentiment around the focus on the metaverse, this remains to be a side project. Meta continued to commit to spending only about 20% of its costs and expenses for the metaverse initiative. This is roughly in line with the 18% that was spent in the third quarter of 2022 and ultimately, 80% of the costs and expenses are still going to the main core business and that is Meta’s Family of Apps. As a result, to frame this and put it to context, the company continues to invest a large majority into the current business, while spending only a fraction on its Reality Labs segment. However, the market seems to have priced in that Meta has gone all in on Reality Labs and abandoned the Family of Apps segment. At the end of the day, I think that we will never know if its pursuit and investment into the metaverse today will be worth it 10 years down the road. That said, I do know that without bold ambitions and constant innovation, Meta will only follow the downward trend in the future. As such, I think that the company continues to be doing what it should be doing to fend off competitors and be the first mover in a very large market. If it succeeds, the payoff could be huge.
Valuation
When looking at Meta from a relative valuation perspective, the company has really seen multiples compress, with 1-year forward P/E multiple at 16x and the 2-year forward multiple at 13x. Ultimately, the low multiple reflects investor sentiment around the stock as the company fell from once a FAANG stock to one which investors have low conviction in. The debates continue on where Meta will head in the future, and this is for good reasons. The success of Meta hinges on the taking off of new products in Meta’s Family of Apps and increased engagement and time spent on its platforms, as well as the increased traction in its metaverse initiatives. As a result, these are rather arbitrary and difficult to predict. That said, I think that for 2023, we will likely see improved fundamentals for Meta as it finally finds the bottom. Trends for its apps appear to look better and continue to improve, while management has somewhat tamed its metaverse ambitions to continue to focus on its core advertising business.
I used a mix of DCF and P/E multiple methods to derive a price target for Meta. I assume a target multiple of 16x P/E for Meta and use a discount rate of 9.4% to discount future cash flows. At the end of the day, my price target for Meta is $230, implying an upside potential of 77% from current levels. Based on the current relative valuation and taking into account the price target, the risk-reward perspective for Meta appears positively skewed and it will likely be a good contrarian play for 2023.
Key Risks
Macroeconomic environment
The main Meta business is ultimately still an advertising business and worsening business sentiment due to a slowing global economy will result in a difficult and challenging environment for Meta to operate in. As a result, this may lead to lower global advertising budgets which will affect Meta’s Family of Apps.
Competition
Social media platforms fight for time spent and need to engage users to maintain at the top. While TikTok appears to be a competitive threat to Meta currently, there remain to be risks that new social media apps could take up market share from Meta and pose a threat to the company given Meta’s very large base. The company needs to invest and innovate to tackle the threat of new entrants.
Reality Labs capital expenditures
The market is very sensitive on the Reality Labs and metaverse topics revolving around Meta as some investors remain skeptical whether these investments will yield returns for investors in the future. As a result, if management decided to spend more on Reality Labs than the market expects, this could lead to downside revisions from the market.
Conclusion
For 2023, I prefer idiosyncratic characteristics in my investments, which includes contrarian plays and Meta fits in this category. Having been beaten down so much in 2022, I would argue that most of the negatives have been priced in. The trends are looking more positive for the company, and I think that the company is heading the right way in developing new features like Reels and business messaging and prioritizing it to ensure that the company tackles challenges from competition in a timely manner. In addition, the company continues to invest in Reality Labs, although the majority of costs and expenses will still go to Meta’s Family of Apps business. At the end of the day, Meta needs to innovate to stay relevant and the bold ambition of the metaverse could be the change in fate that Meta needs. With that, the valuation for Meta remains depressed and presents a contrarian opportunity for investors. My price target for Meta is $230, implying an upside potential of 77% from current levels.
Author’s note: I am starting a marketplace service, Outperforming the Market, which will be launching on 10 Jan 2023. Outperforming the Market aims to help investors identify high-conviction growth and value stocks to form a barbell portfolio that outperforms the market.
Mark your calendars, because early subscribers can reserve a spot as a Legacy Discount Member, which gives you generous introductory prices. Thank you for reading and following my work. See you there!
Be the first to comment