Drew Angerer
We’d say Meta Platforms’ (NASDAQ:META) mixed third quarter results, which combines a sales beat and sustained modest user growth, offset by a slight earnings miss, delivered on the low bar of expectations set by investors, yet sentiment remains largely fragile given the added uncertainty of elevated recession risks on the company’s already-complex set of problems at hand, spanning Apple’s (AAPL) signal loss and increasing competition from new social media formats like TikTok. Meta’s modest y/y revenue declines in the third quarter were largely due to prominent FX headwinds. On a constant currency basis, the return to sales growth – though moderate – brings some relief, indicating that the company is still able to capitalize on its sizable share of social media ad spending relative to rival Snap (SNAP), and is showing progress on addressing Apple-related signal loss challenges. The results are also consistent with our previous expectations that Meta was likely able to capitalize on its new Advantage+ advertising format through attractive pricing and ROAS (return on ad spending) metrics during the third quarter, with more momentum expected through the fourth quarter as ad dollars for the holiday season “ratchet up”.
Looking ahead, the Meta stock will likely face further volatility in tandem with the broader market given increasingly fragile sentiment ahead of the looming economic downturn, especially with the company still left with a handful of new and existing unresolved internal challenges – mostly from Apple. Yet, we believe the bottom is near, with the stock now trading closely with our projected steady-state value of $113 (approximately 9x forward earnings), meaning the bulk of Meta’s downside risks have likely been priced-in.
A Deeper Dive Into How Apple has Meta in a Deadlock
After regulatory barriers, Apple is the biggest roadblock to Meta’s immediate growth aspirations. In addition to the ruthless blow that the iOS 14.5+ privacy update had dealt to Meta’s core targeted advertising business, Apple’s upcoming launch of a mixed-reality headset also sparks debate on the viability of Meta’s “metaverse-or-bust” vision. And on the fundamental level, Apple’s recent decision to start charging commission fees on in-app purchases of “boosts” for social media posts via its updated App Store policy with iOS 16.1 also stands to add pressure on Meta’s profit margins. Yet, we continue to believe that Meta is progressing favorably, though gradually, on addressing these targeted challenges given its relative resilience during the third quarter’s tough macro and operating environment.
1. Apple Signal Loss
As discussed in our previous coverage, Apple’s newly implemented “App Tracking Transparency” (“ATT”) user data privacy feature last year via the iOS 14.5 update was a huge blow to all app-based digital advertisers – especially social media platforms like Meta’s Facebook and Instagram, Snap’s Snapchat, and Pinterest (PINS). Because a critical data pipeline has been severed – only about a quarter of iOS device users have given tracking permission to apps since ATT was deployed – Meta had guided a revenue headwind of about $10 billion for the current year, underscoring the material impact that the Apple-related signal loss has placed on the social media and digital advertising industry.
Yet, the company has continued to make positive progress on its multi-year fix aimed at addressing the ad performance and measurement issues post-ATT. As previously discussed, Meta has been working on immediate fixes that include a diversion of customer demand to its adjacent conversion products such as “click-to-messaging” ads, as well as the roll-out of various APIs and web-based ad performance measurement tools to help advertisers and merchants better pinpoint the delivery of ads to their target audience. Its latest introduction of Advantage+ in the third quarter, a new advertising format aimed at improving ROAS while also making advertising a simpler and easier endeavor for advertisers and merchants, has likely made positive contributions to third quarter results based on previous 3P data, and is expected to place a more evident impact on fourth quarter results given the anticipated pent-up in seasonality-driven demand. We believe that Meta’s ability to increase its daily average user count in the third quarter also bodes favorably with its improved advertising formats aimed at reinvigorating its core advertising business. Sustained DAU/MAU growth and rising ad impressions, paired with attractive ROAS with lower price per ad further proves to advertisers that have reconsidered allocating ad dollars to Meta during the third quarter and amid an economic downturn that there is increasing value in doing so.
Advantage+, which relies heavily on AI/ML-enabled capabilities, also implies positive progress on Meta’s longer-term fix for post-ATT signal loss – namely, AI-enabled “Privacy-Enhancing Technologies” (“PETs”). And Meta’s focus on allocating the bulk of planned 2023 capex investments of $34 billion to $39 billion into “data centers, servers, and network infrastructure” to drive AI capacity expansion is favorable to further strengthening its core advertising business in our view, assuaging investors’ concerns that the company’s increased focus on metaverse ambitions in recent years might tip the scale over. As previous COO Sheryl Sandberg had shared, AI-enabled PETs will ultimately aim at driving more relevant ad delivery to targeted users and better performance measurements to advertisers, without requiring much access to user data.
Building on its continued development of AI and machine learning (“ML”) capabilities, PETs will be a multi-year project for [Meta]. Specifically, fields like cryptography and statistics will be leveraged in [Meta’s] PETs to “minimize data that is processed while preserving critical functionality like ad measurement and personalization”. PETs will ultimately help [Meta’s] ad business bypass the roadblock currently posed by Apple’s ATT feature, while improving user privacy without compromising on the effectiveness of ad measurement and personalization.
Source: “Meta Platforms: Overcoming Short-Term Pains for Long-Term Gains”
2. The Metaverse Debate
Meta’s increasing investment into the immersive future for social experiences is an expensive and risky bet. And CEO Mark Zuckerberg recognizes that by acknowledging Meta faces a “philosophical competition” with Apple, as both companies hold a diverse view on the future of immersive social experiences.
On one hand, Meta touts a future where social experiences from gaming to working can be done through a virtual world with VR headsets, while Apple believes that immersive experiences does not need to be wholly within a “virtual realm”, hence its focus on mixed-reality instead. Although Meta currently commands the largest market share in the sale of VR hardware following its acquisition of Oculus in 2014, many remain skeptical that it can remain the market leader once Apple enters the room, given the latter’s reputation for disrupting status quo (e.g. iPhones’ replacement of legacy smartphones, iPods’ replacement of MP3 devices, etc.). Even Apple SVP of Worldwide Marketing Greg Joswiak as recently claimed “metaverse is a word [he’ll] never use”, favoring possibilities of mixed-reality instead, which underscores the diverging views between two of the largest influences on the future of the internet.
Nonetheless, Meta continues to press towards its metaverse ambitious, with the latest development being the launch of its newest Quest Pro VR headset capable of “mixed reality experiences”. With a hefty price tag of $1,499.99 – almost 4x of the Quest 2 – the Quest Pro targets high-performance applications across professional settings, spanning corporate collaborations like meetings to industrial simulations. The Quest Pro shows potential for displacing legacy industries critical to the commercial segment – like PC makers – by allowing access to many screens and high computing power within one set of goggles. This also explains how and why Meta has managed to get Microsoft’s (MSFT) CEO Satya Nadella on board, with his brief appearance at Meta Connect ’22 to introduce the software giant’s collaboration with Meta to make mission-critical Office 365 collaboration tools available on Horizon Worlds.
Despite uncertainties over whether Apple or Meta will win the race on the future of immersive experiences, we remain optimistic that Meta’s foot in immersive gaming with Oculus Quest 2 and new inroads made in the corporate setting with Quest Pro – as observed through core partnerships recently forged with Accenture (ACN), Autodesk (ADSK) and Adobe (ADBE) – are positive developments that underscore the social media giant’s crucial role in building out the future of social experiences, and a step in the right direction towards capitalizing on a $100+ billion market opportunity over the longer-term.
3. Ad Revenue Sharing
Meta has barely made it past the one-year mark since ATT-related signal loss began, and Apple is already imposing new challenges to the profitability of the social media giant’s core advertising business again. While positive y/y revenue growth on a constant currency basis in third quarter sales signals Meta might be entering early stages of overcoming ATT-related challenges within its core advertising business – a hard-earned achievement in our opinion – Apple’s recent change of its App Store policy to levy commission fee charges on in-app purchases of “boosts” for social media posts risks hemorrhaging Meta’s advertising profit margins.
Apple, which has long charged commission fees of up to 30% on all in-app purchases – something that developers have fought long and hard to bypass without avail – has recently extended the policy to cover in-app purchases of social media post “boosts”. Boosts, which content creators on Facebook and Instagram buy from Meta to promote a certain post for greater reach, engagement, and potentially conversion, were previously considered an ad format by Apple. And ad formats / campaigns purchased within apps were previously exempt from Apple’s in-app purchase commission fee framework. Yet, Apple now considers boosts a “digital service” instead, which falls under the App Store commission fee guideline for in-app purchases.
Effective immediately with the roll-out of the iOS 16.1 update this week, Meta will now likely have to fork out a portion of its ad revenues earned through the sale of boosts within Facebook and Instagram to Apple to comply with App Store policy. While this does not bode favorably for Meta’s recent trend of declining profit margins – a result of a myriad of reasons, spanning FX headwinds, impairment charges pertaining to workspace consolidation, lost advertising scale with ATT and broader macro weakness, lowered ad prices charged to advertisers to salvage demand, and increased R&D spend on Reality Labs – we believe its current positioning as the leading social media advertising format remains a core competitive advantage to help it stay afloat better than peers over the longer-term.
Final Thoughts
Meta continues to reel from a myriad of internal challenges, and Apple is a common threat amongst many of them. Yet, the social media giant continues to trek through with gradual progress, getting back up with resilience every time Apple throws a lemon its way.
However, we believe there is still heightened focus on how the company will progress through the unresolved business challenges in addition to broader market-wide risks pertaining to macroeconomic weakness ahead – essentially, execution risks remain elevated. This is further corroborated by the stock’s steep decline (-12% at the time of writing) in post-market trading following the release of its mixed third quarter results and conservative 2023 outlook on Wednesday (October 26).
But considering the stock now trades at a significant discount of about 15x forward earnings compared to the large cap peer group of about 28x, we believe said risks have largely been priced in at current levels, especially as it finds support at our projected steady-state value of $113. This is further corroborated by the deceleration in the pace of the Meta stock’s declines in tandem with the broader market selloff in recent months.
Bear case $113: The bear case PT is computed by applying a forward P/E ratio of 9.3x. The P/E assumption is derived based on the formula “1 divided by cost of equity” to gauge Meta’s steady-state valuation, which represents the company’s estimated intrinsic value when it reaches a point of indefinitely sustained profits , where any “incremental investments will not add, nor subtract, value”…We expect Meta’s stock to find support at $113 at the bear case, even considering near-term macroeconomic deterioration which has been factored in the computation of its cost of equity used in deriving the steady-state P/E ratio applied.
Source: “Meta: A+ for Advantage+“
Though volatility remains given the fragility of market sentiment still, we believe the company’s current market valuation is nearing bottom, especially with the bar of expectations now lowered for Meta after a punishing selloff in the first half of the year, and positive, though modest, progress delivered by the company that implies a pathway to gradual recovery over the longer-term.
Be the first to comment