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Is Facebook dead? What about Instagram and WhatsApp? Will the metaverse be the future? These are questions that Meta Platforms (NASDAQ:META) investors have to ask themselves as they steer their way through the social media company going through a transformation.
Investment thesis
I think that the investment thesis for Meta is really quite simple. The Family of Apps business remains to be its core business with Instagram, Facebook and WhatsApp delivering a strong suite of social media platforms for Meta to deliver growth. For the Family of Apps business, it is really about optimizing the business, using the artificial intelligence discovery engine across its products, while continuing to innovate and monetize Reels, its emerging and fast growing short-form video format. For Reality Labs, I see this as an optionality given management is investing additional resources into this initiative as the company plans to continue to grow operating income of the company over the long-term without over investing in Reality Labs. Reality Labs undoubtedly is a long-term investment opportunity and there are debates about whether the expected benefits from these investments will materialize in the future. I take the view that Meta is well positioned in the metaverse given its first mover advantage and huge financial resources available to invest in the business.
I have written an earlier article on Meta detailing the progress the company has made on the metaverse and Reality Labs front along with the opportunities this brings, which can be found here.
Not likely the end of an era
The key debate around the core Meta business today lies in whether its Family of Apps social media business is starting to see a decline or whether it continues to remain robust. The main cause of this is due to increasing competition from other players like TikTok as well as the impact of Apple’s (AAPL) privacy changes on Meta’s core business.
In my view, I do not see that Meta’s Family of Apps are at the end of an era and I even think that the views around this are rather pessimistic given what the facts show.
First, Meta’s management reiterated in their recent quarterly earnings call that engagement on their apps has been more positive and that speculation around engagement on their apps are not true. Specifically for Facebook, the number of people that are using the app each day is actually the highest it has ever been at almost two billion users each day using the app and the trends around engagement for Facebook has been strong. For Instagram, it has more than two billion active users monthly while WhatsApp has more than two billion daily active users, with North America being its fastest growing region. I think what is important to note is that across the three apps, Facebook, Instagram and WhatsApp, there are some markets, countries or demographics that may be more saturated than others, but when blended together, there are still opportunities for the combined family of apps to grow from its current large base.
Second, Meta continues to innovate and change with the times to help improve engagement on their apps. As a result, I think that the pessimism that the market has on Meta’s family of apps is unwarranted given that Meta continues to bring new features and update older ones to keep up with the changing social media landscape. In particular, Stories was launched to counter the threat of Snapchat (SNAP), which was hugely successful in my view, and now, Reels is what Meta has come up with to counter the rising threat of TikTok.
As a summary, the Family of Apps business looks to be just fine as critics point to speculation that the engagement in the business seems to be deteriorating when the core of the business remains resilient and continues to grow despite the large base.
Reels will revitalize the Family of Apps business
Reels is the fastest growing format on both Instagram and Facebook. Both the production and consumption of Reels continues to grow quickly in its apps and there are more than 140 billion Reels being played each day across both apps. To put this into perspective, this is a 50% increase from six months ago. Clearly, in my view, there is something that Meta is doing right with Reels as creators are producing Reels and consumers are consuming Reels at a faster pace than half a year ago.
Most importantly, the biggest comment made by management was that Reels is incremental to the time spent on Meta’s family of apps. This means, in my view, that Reels is taking TikTok’s share of time spent and as such, does skew the competitive environment into Meta’s favor as Reels looks to be able to take on TikTok like how Stories took on Snapchat.
Reels is great for engagement across the Family of Apps as it helps people discover new interesting creators and businesses as well. For businesses, the main goal for Reels is to help businesses increase their return on investment in Reels. One of the businesses that Meta helped add Reels as a marketing strategy was Corkcicle, which saw an increase of 34% on their return on ad spend and a 34% increase in sales as a result of using Reels. These testimonies do help assure investors and businesses alike that Reels continues to help advertisers to increase their return on investment, even in the current challenging times. In addition, I think that Reels is certainly heading in the right direction today as Meta continues to invest in this key business and bring the return on investment that advertisers seek.
The monetization journey for Reels will take time, just as how Stories took four years to reach parity. At the moment, Reels does not monetize at the rates that we see for Feed or Stories yet and in the near-term, this brings challenges as increasing usage and engagement of Reels would displace some of the revenues Meta would have generated from the higher monetizing Feed or Stories. That said, management said that their priority will be to close the gap between the monetization rates between the different surfaces. With this shift, there is about a $500 million revenue headwind each quarter, as explained by the dynamics above. Management also said that they expect to reach a more neutral position by about 12 to 18 months. The combined run-rate of Reels across Instagram and Facebook is now at $3 billion, and Meta continues to scale monetization across these two platforms. This run-rate is up from what Meta disclosed as a $1 billion annual revenue run-rate for Instagram Reels last quarter.
All in all, I think that Meta is executing really well with Reels and this is likely because of their track record in innovating to meet changing trends in the market for almost a decade. Reels will be key to increasing engagement and improving user trends on Meta’s Family of Apps and more importantly, is a key counter towards the increasing threat of TikTok.
Start of a new era
I think of Meta’s work into the metaverse and Reality Labs as a huge optionality for the company in the future given that it is building something really big, visionary and it is the leader while doing so.
Essentially, Meta’s goal here is to build the next computing platform that is centered around their work with their VR and AR hardware. The recent launch of the Quest Pro in its Meta Connect conference set the tone for what could be Meta’s direction for Reality Labs going forward. While it is still early days, Meta’s new generation hardware could reshape the way we game, work, socialize, and create new types of experiences we could never do before. One example of the opportunity is the potential for work to be transformed with the new Quest Pro. Given that there are about 200 million to 300 million people who get new PCs each year for work, I can imagine the opportunity set for Meta as it continues to refine its new VR and AR hardware that could potentially help people get their work done in mixed reality or virtual reality. With their recent partnerships with Microsoft (MSFT), Zoom (ZM), Adobe (ADBE) and Autodesk (ADSK), this signals a new beginning for Meta to bring digital transformations to the way we work.
The key thing here is that while it is an experimental business for Meta, the company is clearly investing heavily into the concept of the metaverse and as a result, it has the lead in the space with the number of resources and dedication into the business. If it were to succeed in this massive undertaking, it will have a very strong competitive advantage and high barriers to entry over peers who are many years behind it. As such, I think that the focus on Reality Labs is understandable given the huge opportunity that it can bring, while management continues to monitor and taper the pace of the investments into the business in line with the core Family of Apps business.
In terms of investments into Reality Labs, the main goal for Meta is to grow the operating income generated from the Family of Apps business so that even with the investments into its artificial intelligence infrastructure and Reality Labs, the company will still grow its operating income in the long-term and do so meaningfully. This is something that investors and the market has not yet grasped when it comes to Meta and its investments into the metaverse and Reality Labs. In my view, what this means is that the capital expenditures into Reality Labs will be calibrated according to the pace of growth in operating income of the Family of Apps business. As a matter of fact, most of Meta’s current capital expenditure increases are due to the building of its artificial intelligence infrastructure and management expects the percentage of capital expenditures of revenue will be reduced in the long-term. While there is likely going to be an increase in investments for Reality Labs in 2023 as Meta launches its next generation Quest headset, beyond 2023, I expect that the pace of investments into Reality Labs to follow the capital allocation strategy mentioned above, and as such, bring a continued return of capital to shareholders regardless of investments into Reality Labs.
Valuation
Based on relative valuations, Meta is currently trading at 15x 2023F P/E and 12x 2024F P/E. This reflects some of the uncertainties and risks that investors perceive about the business as there are debates between both bulls and bears about where Meta will head in the future. That said, I think that the company’s multiples do suggest that Meta is trading at a discount as management remains committed to adjusting investments into Reality Labs in accordance with the growth in operating income of the Family of Apps business, while the company still prioritizes the Family of Apps business, as Reels shows strong initial engagement and traction.
My price target for Meta is $225, implying an upside potential of 92% from current levels. This is based on the assumption that Meta will see its multiple expand as uncertainties around the business subside with better dynamics for its Family of Apps business and early indications of success in the Reality Labs business. I assume a 16x P/E multiple to my 2024 EPS for Meta and thus, derived a target price of $225 for the stock.
Key Risks
Global macroeconomic environment
Meta’s main risk is that the worsening of the macroeconomic environment may lead to reduced advertising demand and spend. This will affect Meta’s Family of Apps business materially as it depends on the global advertising budget.
Competition
While I think that Meta’s Reels show early promises of being able to tackle the rising threat of TikTok, there is a risk that Reels does not live up to its expectations and is unable to compete meaningfully with TikTok. In addition, the social media world is evolving rapidly, with consumer trends changing quickly. As such, Meta needs to innovate and change with the times to ensure that new competitors do not threaten its dominance in the social media landscape.
Reality Labs capital expenditures
The main issue with Reality Labs is that Meta needs to calibrate their spending into the new emerging business in accordance with the performance of the existing Family of Apps business. If management gets too excited about the metaverse opportunity and overspend in the near-term, this may have adverse impact for shareholders as the return on capital will be reduced with the significant Reality Labs investments.
Conclusion
I think that this is not the end of an era for Meta. Its engagement and user trends on its Family of Apps (Facebook, Instagram and WhatsApp) shows that Meta is heading in the right direction with its social media apps as users continue to actively use these platforms in their daily lives. In addition, Meta is investing heavily into the future by focusing its priorities on the artificial intelligence discovery engine and Reels. Reels in particular, brought incremental time spent to the Family of Apps, meaning that it took time spent share from TikTok during the period and Reels is scaling up well, in my opinion. Lastly, while management is excited about the opportunities from the metaverse, the investments in Reality Labs will be contingent on the operating income generated by the Family of Apps business and can be lowered if the Family of Apps business does poorer. This assurance by management ensures that they do not overspend on Reality Labs at the expense of return of capital for shareholders in the long-term. My price target for Meta is $225, implying an upside potential of 92% from current levels.
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