Why We Think Meta Platforms’ 25% Decline Is Fear Driven (NASDAQ:FB)
It has been a challenging year for Meta Platforms (Nasdaq: FB) as it continues to grapple with intensified scrutiny from both its users and regulators over privacy and antitrust concerns across its platforms. Meanwhile, Apple’s (Nasdaq: AAPL) newest “App Tracking Transparency” (“ATT”) feature rolled out in the latter half of last year through its iOS 14 update has, at the same time, severed a critical source of user data in which FB’s flagship targeted advertising services had previously relied significantly on. And now, FB’s “wobbly revenue outlook” is further pressured by rising competition as users shift from communications in text and images to short-form videos, a space currently dominated by TikTok while FB’s equivalent, Reels, remains in its rival’s shadow. Paired with mounting macro headwinds that have roiled the broader market this year, the FB stock has been traded down by about 25% since late-trading Wednesday after reporting fourth quarter earnings, bringing total year-to-date losses to as much as 28%.
While FB may be showing signs of decelerating growth based on its performance in recent quarters and weak forecast for the current period, the challenges it currently faces are seemingly temporary and does not materially alter the consolidated business’ growth trajectory. While Reels’ monetization power through ads and commerce continues to trail TikTok’s and FB’s other digital advertising outlets, the platform has already generated favorable traction. Reels was the “biggest contributor to engagement growth on Instagram and Facebook” during the fourth quarter, indicating potential for greater scaling of monetization opportunities in the long-run to maintain sustainable revenue growth.
FB has also launched both short-term and longer-term innovations to overcome ongoing impacts from Apple’s newest privacy feature, which will help its targeted ads business regain effectiveness without significant reliance on personal data over time. On the regulatory front, FB’s recent troubles with rising competition serves as a defying factor to mounting scrutiny over its dominance within the social media sector, while the company’s increasing efforts in bolstering user privacy across its platforms also addresses concerns raised by users and regulators. The company’s recent pivot towards the metaverse strategy is also starting to take off with growing adoption across industry peers, indicating significant growth opportunities ahead for FB.
Considering the company’s continued prowess and influential power within the social media and digital ads sector, and emerging strength in pioneering nascent technologies like the metaverse, the latest FB stock sell-off appears to be a reflection of overblown investors’ angst amidst the increasingly uncertain macroeconomic outlook. Coupled with FB’s strong balance sheet, which remains debt-free and cash-abundant, we remain bullish on the stock with expectations for potential upsides of at least 30%.
Brief Overview of FB’s Recent Earnings Call
As mentioned in earlier sections, FB’s value plunged by about 25% overnight following its Wednesday report of weaker-than-expected user growth and a disappointing forecast for the current period’s performance. Key themes include rising competition for users’ time, especially in the cohort of younger users, as well as other challenges across its digital ads business stemming from recent iOS changes and weaker advertising budgets ahead due to cost inflation and supply chain constraints. These impacts are reflected in FB’s stagnant user growth reported for the first time in 18 years, which showed mild sequential declines from 1.93 billion daily average users (“DAUs”) across its platforms in the third quarter to 1.929 billion DAUs in the fourth quarter. FB also provided a flat guidance on current quarter revenues of $27 billion (3% y/y growth) to $29 billion (11% y/y growth), which falls short of consensus estimates of $30.3 billion.
Near-Term Headwinds are Only a Small Price to Pay for Greater Long-Term Growth
Nonetheless, the company remains focused on ramping up its transition to Reels to ensure adequate monetization of growing engagement on short-form video platforms. The company also remains committed to the build-out of the metaverse and other AI opportunities with increased investments in data centers, servers, network infrastructure and talent to ensure capitalization on related opportunities ahead. While FB may suffer from some near-term headwinds as it embarks onto a transition period, the company is expected to emerge with sustainable growth over the longer-term after achieving alignment with key trends that underpin global digitization in coming years.
1. Rising Above Competition
The rising threat of competition is starting to show itself in FB’s financial performance. As user communication preferences continue to evolve from text and images to short-form videos, FB is losing its edge against rival TikTok in particular, which currently dominates in the space of video-format interactions. While monetization on Reels – FB’s TikTok equivalent – has been slow compared to the company’s other advertising outlets, it currently represents the biggest contributor to engagement growth across both Facebook and Instagram.
The fact that Reels is being well-adopted by the Facebook and Instagram community already makes up half of the equation in ramping up its transition from traditional digital advertising surfaces like News Feed to short-form videos. The second half will depend on FB’s ability to adequately monetize the feature and scale related opportunities in the long-run. And the prospects of success here is promising considering FB’s ability to leverage past experiences gained from its transition to mobile Feed and Stories, which overtook Snap’s leadership in timed video/image interactions at the time. Looking ahead, FB’s continued commitment to introducing more content creation and monetization tools for creators and influencers on Reels is expected to narrow the feature’s distance from TikTok within the realm of short-form videos, underpinning sustainable engagement growth over the longer term.
Although increasing competition will inadvertently become a diluting factor to FB’s leading market share across its core digital ads business over time, the company’s unparalleled expertise and traction within the sector remain robust. This is demonstrated through continued penetration into newer peripheral markets like APAC and the rest of the world, which saw strength in user growth, while also maintaining engagement in North America in the face of rising competition. The results reflect the effectiveness of FB’s ongoing commitment to innovating its products, like the introduction of Reels, to facilitate greater interactions between creators and users on its platforms.
FB is also in progress of improving its near-term fixes to its severed pipeline of user data used to ensure greater effectiveness of targeted ads on its platforms. This includes the introduction of its proprietary “aggregated events measurement” tool, which allows the measurement of web activities from iOS users to better pinpoint the delivery of ads to the appropriate audience, while reducing reliance on user-data-driven targeting. And in the longer term, FB will continue to invest in the ongoing development of “privacy-enhancing technology,” including the use of AI, to reduce reliance on personal information, and instead utilize more “anonymized data” to deliver effective personalized ads. While the transition in FB’s approach on targeted ads will likely be a multi-year ordeal, related near- and longer-term efforts paired with its ongoing commitment to innovating its products will accordingly drive better capitalization on growing digital advertising opportunities ahead.
Our forecast projects FB’s advertising revenues to expand at a compounded annual growth rate of 12.3% from $126.8 billion by the end of this year towards $226.8 billion by mid-decade. The growth assumption applied considers FB’s most recent revenue guidance, as well as historical performance in preceding quarters. The projection compares to current market forecasts on global digital advertising demand, which is expected to grow at a CAGR of more than 13% over the next five years toward an $800 billion market led by web-based search advertising. The slight discount in the growth rate applied to FB’s advertising revenues compared to market projections reflects the near-term headwinds related to its ongoing efforts in scaling monetization opportunities on Reels, as well as recent user data collection changes introduced by Apple, which is expected to ameliorate over the longer-term.
2. Metaverse Adoption Will Become Stickier
FB’s recent shift in corporate strategy towards metaverse opportunities is also expected to compensate for some of the impacts from moderating growth across its core advertising business. Specifically, the company’s continued build-out of metaverse offerings is expected to create new opportunities ahead and bolster its long-term growth outlook.
Since FB’s announcement of the strategy in the third quarter, immersive virtual experiences have rapidly transitioned from a concept into a reality with a wide variety of use cases ranging from leisure and socializing to working and learning. FB’s metaverse strategy has also encouraged other industry peers like Nvidia (Nasdaq: NVDA), Microsoft (Nasdaq: MSFT), Roblox (NYSE: RBLX) and Take-Two (Nasdaq: TTWO) to adopt the trend, which further bolsters growth in related opportunities in coming years.
The metaverse is expected to grow into an $800 billion opportunity over the next five years. software and service sales related to the metaverse are expected to drive more than 70% of the emerging segment’s addressable market, while the remainder will likely be driven by related hardware sales. And FB is already well-prepared to capitalize on said opportunities considering its early-mover advantage within the metaverse market:
- Leading Oculus Quest headset: FB’s Oculus Quest 2 is currently the market’s best-selling VR headset. The device commands more than 35% of global market share, leading competitor products like the Valve Index and HTC’s Vive by wide margins. The complementing Oculus App, which allows users to buy, sell and manage their Oculus Quest headsets and related apps, has also facilitated more than $1 billion in content-related transactions. Adoption of the leading VR headset has also taken off this past holiday season, with the Oculus app ranking first on the Apple App Store for the first time on Christmas Day in the U.S. To complement the level of traction acquired to date, the company is also slated for the release of a high-end VR headset later this year.
- Project Nazare: FB has recently announced the development of its first augmented reality glasses to accompany its portfolio of supporting hardware for the metaverse. While the product’s debut timeline has not yet been disclosed, the addition is expected to further bolster FB’s leadership in metaverse opportunities in the long run.
- Horizon Worlds: Horizon is a virtual world that is currently available to Oculus Quest users in the U.S. and Canada. Horizon plays a critical role to FB’s metaverse vision, as it creates a comprehensive “world-building experience” where users can “explore, play and create in extraordinary ways.” FB plans to expand Horizon access on mobile later this year to extend metaverse experiences beyond VR, which will encourage further adoption of the nascent trend in coming years.
- Meta Avatars SDK: The software development kit (“SDK”) was introduced in December to all Unity developers on Quest, Rift and Windows-based VR platforms. The new tool enables developers to create virtual “Meta Avatars” that reflect their own unique VR experiences. Meta Avatars SDK has also engaged in collaborations with reputable partners like the NFL to roll-out digital clothing for Meta Avatars, indicating the increasing comprehensiveness of products and services within FB’s virtual world. The unique Meta Avatars can also be used across FB’s platforms beyond Quest, including Facebook, Instagram and Messenger, bridging 3D immersive VR experiences to 2D social apps to increase assimilation and adoption in the long-run.
As a pioneer of virtual reality experiences and a market leader on related hardware and software, FB’s metaverse strategy is expected to pay large dividends in the long-run. Our forecast projects Reality Labs revenues to expand at a CAGR of 17.1% from $2.7 billion by the end of the current year towards more than $6.0 billion by 2026. The growth assumption, which exceeds the anticipated market growth CAGR of about 13%, reflects FB’s leadership in pioneering both hardware- and software-related metaverse opportunities as demonstrated through its recent achievements discussed above.
3. Balance Sheet Strength
Despite the near-term slowdown in user growth as FB engages into a transition period across both its core advertising business approach and broader corporate strategy, the company still boasts a robust balance sheet that remains debt-free and cash-abundant. For the year-ended December 31, 2021, FB had more than $16.6 billion in cash on hand, while having generated more than $57.6 billion in cash inflows from daily operations alone.
Despite greater investments deployed towards the build-out of new strategies, temporary increases to legal costs stemming from regulatory headwinds, and higher costs in navigating through advertising platform changes in the near-term, FB’s operating margins also remain generous at north of 30% thanks to the cost-light nature of its core digital ads business. And the company’s financial strength comes handy, as it defies rising investors’ angst over potential erosion of value on future cash flows and slowing growth due to higher costs of capital when the Federal Reserve further tightens monetary policies with rate hikes beginning March. The company’s current financial strength paired with its sustainable long-term growth outlook discussed in the foregoing analysis is expected to make the FB stock more resilient against the longer-term macro-economic challenges.
Based on the foregoing analysis on FB’s long-term growth outlook, which will continue to be led by its core advertising business and bolstered by emerging metaverse opportunities in coming years, our base case forecast projects total revenues of $130.3 billion by the end of the current year with further growth towards $233.8 billion by 2026.
Meanwhile, FB’s cost structure is expected to see some near-term pressures related to greater spending towards the build-out of new strategies, complying with regulatory changes, and adapting to advertising operation changes as discussed in the foregoing analysis. However, margins are expected to moderate towards historical trends, with further expansion approaching mid-decade to reflect the company’s anticipated strength in scaling new opportunities ahead.
Coupled with other nominal non-operational income and expenses, our forecast projects net income of $37.0 billion for the current year with further growth towards $82.2 billion by 2026.
i. Base Case Financial Forecast:
Drawing on the above analysis on FB’s five-year growth trajectory, our 12-month price target for the stock is $369.46. This represents upside potential of more than 50% in the near-term based on the stock’s last traded price of $243.57 at the time of writing (Feb. 3).
The 12-month price target is derived from a discounted cash flow (“DCF”) analysis over a five-year discrete period in conjunction with the financial projections for FB as discussed in earlier sections. A WACC of 10.2% is applied to discount FB’s projected free cash flows in our valuation analysis. The valuation assumption applied is consistent with the company’s current risk profile, which takes into consideration its debt-free capital structure and robust liquidity. The valuation analysis also assumes an exit multiple of 10.4x, which is reflective of current market expectations based on FB’s growth prospects, and takes into consideration the multiple range identified across its industry peers.
i. Base Case Valuation Analysis:
Acknowledging that the FB stock has lost close to a quarter of its market value overnight after reporting a weaker-than-expected near-term performance outlook on Wednesday evening, we have also performed a sensitivity analysis on key assumptions applied in our valuation analysis to validate the bullish thesis on FB. Based on our findings, the stock’s current share price at the $245-level reflects revenue growth of only 1.3% per year over the next four years across all operating segments, while holding all other key valuation assumptions (i.e. exit multiple, WACC, cost structure) constant. While the company expects slower growth in the near-term as it enters into a transitional period on operational strategies, the likelihood of annual revenue growth over the next four years declining to 1.3% is remote. Such a growth rate would be even less than projected GDP expansion in the long-run, which does not reflect the critical role that leading tech companies, like FB, play in ensuring adequate economic expansion.
i. Sensitized Revenue Valuation Analysis:
We have also used a multiple-based valuation approach to validate our thesis that the recent FB stock sell-off is an overblown response to the company’s weaker-than-expected performance and forecast reported Wednesday. Recall that FB’s megacap peer, Netflix (Nasdaq: NFLX), had also reported disappointing earnings that showed signs of slowing user growth about two weeks ago, which led to comparable intraday stock price declines of about 25%. The Netflix stock’s price-to-sales multiple (NTM) dropped 30% immediately from 6.8x to 4.8x in response to the disappointing results reported on January 20th, but quickly pared declines to about 16% over the following two weeks. Taking Netflix’s recent performance as a proxy to gauge the extent of FB’s latest rout, the stock is expected to rebound from its current price-to-sales ratio (NTM) of about 5.6x to about 6.8x within the next few weeks. This would represent an anticipated rebound to about $312, which reflects upsides of about 30% based on the stock’s current price level at the $245-range.
ii. Multiple-Based Near-Term Price Projection:
The recent sell-off on the FB stock appears to be an overblown response to the company’s disappointing outlook for the current period reported on Wednesday evening. While FB has warned of temporary operational headwinds that could lead to a slowdown in near-term user growth, the extent of the stock’s 25% decline overnight is likely fueled by growing investors’ angst over uncertainties pertaining to the current macroeconomic environment instead.
Yet, based on our foregoing analysis, FB’s near-term growth slowdown is only a reflection of temporary adjustments to its business strategy. The company is expected to emerge with robust and sustainable growth over the longer-term as it continues to penetrate new, high-growth opportunities in nascent technologies like the metaverse. Meanwhile, it’s also expected to further bolster its strength in digital ads with reduced reliance on personal data over time to ensure the segment’s performance is independent of third-party decisions and changes. Based on these considerations, we believe the FB stock makes a reasonable investment pick, especially at current price-levels which is non-reflective of even its most conservative growth outlook.