- META's growth stays challenging as advertising budgets shrink amidst a slowing economy.
- Lower monetization of Reels to weigh on the company's profitability in the near term.
- The company's paid features could become significant revenue contributors in the long term.
- Apple's advertising platform's competition poses a high risk to META's ad revenues.
- META at current levels offers a fair margin of safety which will prove fruitful over the next 1-2 years.
Investment Thesis
Meta Platforms, Inc.$Meta Platforms, Inc.(META)$ has been going through a brutal sell-off since the start of the year, and the never-ending challenges will likely move the stock sideways for the foreseeable future. Undoubtedly, the cyclical nature of the advertising business will weigh on the company's financials in the next quarters, too.
From time to time, META has always been a stock in trouble, as it often faces challenges due to scandals, lawsuits, and negative publicity, which is not surprising to me considering its power and enormous size. In today's environment, META needs to shrink before it grows, and the headwinds might last for a year or two, but I am not invested in META for a quick buck. Today's analysis explores some of the company's current challenges and why the attractive valuation justifies the buy rating.
Meta's Growth To Stay Challenged
Meta's near-term growth may remain under pressure during a period of multiple transitions, including management changes, cannibalization of Stories/Feed ad revenue due to a push on Reels engagement, and continued efforts to recover relevant signals for advertisers. I believe Meta's expectation for a 2-10% revenue decline for Q3 2022, including a 6% currency headwind, reflects greater IDFA headwinds and structural weakness, with the company likely more exposed to a pullback in ad spending. However, we have previously analyzed how Meta will go around Apple's (AAPL) Privacy Changes while meeting the requirements through Conversions API Gateway. Still, due to the cyclical nature of the advertising business, it is reasonable to expect contracting quarters.
Meta's topline decline of 1% and operating margin compression of about 14 percentage points compared to last year during Q2 2022 reflects the company's challenges after Apple's IDFA changes. Though Meta has already warned its workforce in July that it will lay off workers and curtail hiring this year, I don't think it will be enough to offset the margin drag in the near to medium term. In addition, although scaling back the level of investment in Reality Labs seems to have improved sentiment, Meta may see structurally lower operating margins in coming years, given the heavy capital spending required to build the Metaverse.
Meta Is Exploring Paid Features
Meta is setting up a New Monetization Experiences group, led by Pratiti Raychoudhury, Meta's head of research, to explore paid features for Facebook, Instagram, and WhatsApp.
Even though Meta's app now has several paid features, such offerings have not been a priority until now. However, some other players in the industry have already rolled out subscription services or payment features for benefits such as exclusive content; for example, Twitter$Twitter(TWTR)$ 's monthly subscription Super Follows rolled out in 2021; YouTube's channel memberships launched in 2018; and Snapchat$Snap Inc(SNAP)$ 's (SNAP) recently launched Snapchat+.
While the revenue for Twitter from subscription services remained meager, amounting to $100 million in Q2 2022, YouTube takes a 30% share of profits from creators. On the contrary, Meta announced on June 21 that it will hold off taking a slice of the revenue earned by creators on Instagram and Facebook until 2024.
In an interview, John Hegeman, Meta's VP of monetization, noted that this revenue line is not likely to become a meaningful contributor in the short term but can become a significant revenue source on a five-year time horizon.
Meta Aims To Unlock The Marketplace
Meta Platforms' partnership with DoorDash$DoorDash, Inc.(DASH)$ suggests that the company is seeking to unlock e-commerce on Instagram and potentially WhatsApp with the help of DoorDash's last-mile delivery. In addition, the integration of ads with payments and delivery could help bolster engagement and expand its Marketplace business, which has about 1.1 billion monthly active visitors, to compete with Amazon.com$Amazon.com(AMZN)$ , Shopify $Shopify(SHOP)$, and Etsy$Etsy(ETSY)$. Thus, the new collaboration will elevate Facebook's marketplace and increase user engagement and satisfaction.
Competition From Apple Poses A Threat
Apple Inc.$Apple Hospitality(APLE)$ is seemingly entering the ad business via a demand-side platform which is bad news for META. There have been several recent reports which indicate that Apple is currently in the process of building an AdTech platform that would allow the company to place mobile ads into its iOS ecosystem apps in a privacy-first way. Based on job postings, it can be inferred that Apple is in the early stages of building a new mobile advertising platform. This new ad platform would put the company into direct competition with Meta's network advertising businesses.
A key reason Apple is pursuing the advertising revenue stream is that mobile advertising has a large and rapidly growing global TAM expected to grow to $621 billion+ by 2029. In addition, Apple has stated that it has 1 billion unique users and 1.8 billion active devices globally. Therefore, if Apple successfully builds a demand-side platform, its data will be best in class and negatively impact META's revenue growth rate.
Lower Monetization Of Reels
According to Meta, Reels generate lower monetization than Instagram and Facebook news feeds and Stories. In the near term, Meta has stated that it is focused on driving higher user engagement. Meta has stated that there are "relatively few ads in Reels" and that "monetization will take time" (i.e., several quarters). Inevitably, by pushing consumers toward Reels and away from ad-heavy News Feed and Stories formats, Meta is intentionally slowing its near-term revenue growth.
Though Meta may be able to match creator rewards on Reels to compete with competitors like YouTube and TikTok. Thus, the company needs to be careful not to cannibalize Meta's high-margin Stories and conventional Feeds ad inventory through Reels. As a result, this might put pressure on the company's gross margins, assuming that Meta would likely have to split at least 40-50% of Reels ad-driven revenues with artists to promote original content creation. Nevertheless, the Meta team has proved its capability to capitalize on new trends such as short-form videos, and the successful monetization of Reels remains a catalyst for the stock to move to new highs.
Advertising Businesses Are Affected By IDFA
Meta's overall ad-pricing growth may remain constricted until 2023. Near-term macroeconomic pressures and reduced ad spending due to Apple's privacy changes affect advertisers' willingness to pay for social media ad inventory. However, Meta faces several near-term headwinds, including competition from TikTok and lower ad efficacy.
Undoubtedly, Instagram remains a valuable business, with average revenue per user remaining higher than other social media platforms, including TikTok, Snap, Twitter, and Pinterest. Moreover, a continued shift in ad budgets away from traditional TV also remains a long-term tailwind for digital-ad pricing and social-media platforms, which may partly help offset the effects of slower user growth.
Meta's launch of payments features on Instagram chat signals a deeper push to drive e-commerce on its messaging apps, where META has an advantage over rivals, including TikTok. In addition, payment data across Meta's family of apps ('FoA') could help enhance its first-party data, which is key to offsetting lost signals for its ad targeting from Apple's privacy changes on iOS.META Offers A Fair Margin Of Safety
Historically, META has reported high revenue growth and user growth, making analysts value the company as a growth stock. However, the company is now approaching a maturity stage, which could be treated as a value or GARP stock warranting a valuation on a P/E basis or future cashflow basis. In the below analysis, I summarize each case's scenario to arrive at META's target price:
Bullish Case Assumptions (Weight 30%): META over-delivers revenue growth, margins, and regulatory pressures on the company ease resulting in a year-end EPS of $12.5 and YoY growth of 15%.
Base Case Assumptions (Weight 40%): Meta faces competition from rival apps like TikTok and Alphabet, while Apple venturing into the ad space also poses a risk to topline growth. Finally, enormous investments in the Metaverse are growing costs despite negative revenue growth in the near term, with an uncertain long-term payoff. For the base case, I assume an EPS base of $11.0 and growth of YoY 11%.
Bear Case Assumptions (Weight 30%): The bear case assumptions include Meta's user losses in the US and EU, the company's highest ARPU areas, competition from OTT viewing, video games, TikTok, YouTube, etc., and deteriorating brand value, driven by scandals and negative press headlines. I assume a bear case EPS of $9.5 and growth of YoY 8%.
Using the assigned weights (normally distributed) and accounting for the suggested DCF prices based on earnings, the model suggests a target price of around $183, implying an upside of 32% from current levels and a fair margin of safety of 24%. The risk and uncertainty in the stock have been factored into the stock price, with a notable additional decline being remote. Nevertheless, I believe that the downside risks at the current levels are priced into a large extent, and the stock provides a fair margin of safety.
Concluding Thoughts
Meta's rebranding hasn't helped raise engagement across its apps. As a result, it will be challenging for Meta to restore topline growth in the near term, with ad-pricing challenges and Reality Labs remaining a minor contributor to overall revenues. However, I believe Meta's venture into payments and e-commerce is vital for the platform to drive future revenue growth from its messaging apps.
Amid regulatory scrutiny in North America and Europe, emerging markets will lead the way in monetization efforts. For example, the recent launch of an in-app purchasing experience with JioMart in India provides the basis for other e-commerce to be enabled on WhatsApp, which might stimulate demand for its services.
Moreover, Meta's development of a payments function in Instagram chat indicates a greater push to increase e-commerce on its messaging applications, where the firm has a competitive advantage over competitors like Alphabet (GOOGL) (GOOG) and TikTok. Payments data across Meta's FoA might enhance its first-party data, which is crucial for compensating for lost ad targeting signals due to Apple's iOS privacy changes.
Despite the tough times ahead, META is well-positioned to weather the storm and come out of this crisis stronger. The recent drop in the stock is an excellent opportunity for the long-term holders to Dollar-Cost-Average their positions that will prove fruitful in a 1-2 year timeframe.
https://seekingalpha.com/article/4544586-meta-the-negative-outlook-and-why-i-stay-long
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