In the fourth quarter of 2021, Facebook changed its name to “Meta” to signify its huge business change to leave its old social media businesses, beholden to Apple (AAPL, Financial) and Android app store rules, behind and forge a new path for itself in the Metaverse, a 3D version of the internet.
No one's sure yet what the Metaverse will look like exactly, but many envision it as an alternate virtual world created through a mixture of virtual reality, augmented reality and graphics. As the old saying goes, the best way to predict the future is to create it, and that is exactly what Meta is aiming to do.
According to a report by Global Data, the global Metaverse market was valued at $22.8 billion in 2021 and is forecasted to grow at a rapid 39.8% compounded annual growth rate (CAGR) to reach just under $1 trillion in value by 2030, though there's no guarantee that Meta will succeed in becoming the top dog. Thus, in this article, I'm going to do a dive deep into Meta’s Metaverse strategy before touching on the financial situation of its core business and valuation; let's dive in.
A new direction needed
To understand the company's change in direction, note that founder and CEO Mark Zuckerberg owns approximately 11% of all outstanding shares of Meta. However, he has ~56% of all voting rights on the board of directors, as he owns a special class of founder shares. This means Zuckerberg can steer the company or reinvent the business in any way he sees fit.
In this case, he has put a “stake in the ground” with the Metaverse and is investing between $10 billion and $15 billion in the technology. Critics say that it is very different from the core business and still an unproven technology. However, Zuckerberg doesn't see any better route because Meta’s core Facebook and Instagram platforms have reported slowing user growth in recent quarters and have also suffered ad revenue hits due to Apple and Android privacy rules. By changing the organization's name to Meta and giving it a new direction, Zuckerberg is effectively trying to distance the company from its own bad press and declining legacy businesses.
Enter the Metaverse
The good news is Meta has made strong progress with the Metaverse so far and does seem to be catching up with competitors fast to become an innovator in the industry. Meta bought Oculus a while back, the company which sells the most popular VR headset in the world.
According to a report by Meta, Oculus has 66% market share of VR headsets as of the second quarter of 2022. This is followed by DPVR headsets at 9% and Pico (by Chinese tech giant Bytedance) at 11%. Other providers such as the Microsoft (MSFT, Financial) Hololens and the Playstation VR have a 13% market share. Rumors are that Apple could be launching a VR headset that could disrupt the market and vastly impact Meta’s market share. If Apple has another "iPhone moment” with a VR headset that could be a game-changer for the industry.
At the Meta Connect event in October 2022, Zuckerberg announced a range of new products and prototypes. These included the new Meta Quest Pro headset. This includes state-of-the-art “pancake lenses” which fold over multiple times in order to reduce the headset size while still showing sharp visuals. Its high-resolution outward-facing cameras capture four times as many pixels as the Meta Quest 2 and Meta Quest Pro. The product is also rebalanced with a curved battery at the back to improve ergonomics and comfort.
The new headset also is the first to include built-in facial expression sensors. This includes eye tracking and enables natural facial expressions to be tracked from smiling to even raising an eyebrow.
This latest headset has a focus on both play and work, as the company scored a new partnership with Microsoft to integrate the device with Microsoft Windows 365 and Microsoft Teams. This enables a participant to join a Teams meeting right from Meta Horizon Workrooms.
From a branding perspective, I feel Meta should stick more to the social side of the platform and leave the work side to a company such as Microsoft. As for me personally, the words “Facebook, Instagram and productivity" don’t really gel together.
A major challenge in the adoption of the Metaverse is getting people to purchase and use VR headsets. Meta’s Quest 2 headset costs ~$500 while its Quest Pro VR headset has a hefty price tag of ~$1,600. Given we are in a recessionary environment, encouraging users to buy these headsets and use them in expensive applications is indeed a tall task. Sure, an iPhone 14 costs ~$1,100, but most people use a smartphone every single day and it is often seen as an essential device for entertainment and work. A VR headset is really a discretionary item and would likely be used much less often - after all, you can't make use of a VR headset when doing anything out in the real world like you can with a smartphone, as it confines users to the virtual world. Therefore Meta still has a challenge in driving down the costs for its headsets.
Meta’s smart glasses announced a partnership with Ray Ban that could be a nice middle ground into the Metaverse. The glasses tick the box in terms of fashion and style. However, currently, these only offer the ability to take photos and videos via the glasses. The next iteration is expected to include advanced AR features.
In the meantime, Meta has announced plans to launch its Horizon worlds platform on the web, so a user can join friends in VR direct from their mobile device or laptop.
In the world of Avatars, Zuckerberg announced legs for its Workrooms characters, which has been historically very difficult to do as this effectively requires cameras that point down from the Quest headset and track legs.
The company also announced a photo-realistic avatar that showcased an eerie-looking replica of Mark Zuckerberg.
Zuckerberg also showcased an Augmented Reality (AR) wristband which can be used to control smart glasses. This is still a prototype but has alot of potential for the future.
Mixed financials
Despite the excitement surrounding the Metaverse, Meta still makes the majority of its revenue from its core social media platforms Facebook and Instagram. These platforms generate revenue through advertising, in which business customers effectively pay for users' attention and the data that the apps collect on them.
For the third quarter of 2022, revenue was $27.7 billion, which declined by 4% year over year, but still surpassed analyst estimates by $314 million. This decline was mainly driven by unfavorable foreign exchange headwinds from a strong U.S. dollar; on a constant currency basis revenue would have increased by 2% year over year, which isn’t exactly breathtaking.
The company is experiencing challenges monetizing its Reels video format as it aims to compete with TikTok, which has over 1 billion monthly active users. The good news is its Reels format has achieved a 50% increase in the number of views of the past two quarters, with 140 billion views each day.
Another positive for Facebook and Instagram is that a member of the Federal Communications Commission, Brendan Carr, has recently voiced strong opinions on banning TikTok (whose parent company is Chinese tech giant Bytedance) because of the way the company handles U.S. data. U.S. social media stocks such as Meta and Snap (SNAP, Financial) showed an uptick on this news, despite no bans being formerly announced yet. While there's nothing of particular note in Bytedance's handling of foreign users' data, there has been increasing deblogalization sentiment among governments due to how much data tech companies tend to collect. This is the same reason why U.S. social media companies like Facebook may soon find themselves banned form the European Union due to not having compliance with EU data privacy laws built into their business models.
Profitability is a major issue for Meta as its earnings have been sliced in half by close to 50% year over year. Earnings per share was $3.22 in the third quarter of 2021 and declined to $1.64 by the third quarter of 2022. This was been driven by the aforementioned issues monetizing reels, in addition to reduced advertising spend due to the recessionary environment. The company has also experienced a 19% increase in operating expenses, which was driven by product investments in the Metaverse and Metaverse employee headcount.
During 2020 and into 2021, tech companies hired aggressively in order to meet the surging demand. However, as we enter a lower demand environment, tech companies are looking for ways to cut costs and many employees are being fired. Even Meta is forecasted to announce a major round of layoffs in mid-November 2022, which could help allay investor fears about the high amount of Metaverse spending.
Valuation
I have plugged the latest financial details for Meta as well as my forecasts for the company into my advanced valuation model, which calculates the intrinsic value using the discounted cash flow method.
I have forecasted revenue to decline by 10% next year, as management expects a strong 7% headwind driven by foreign exchange rates. After that, I have forecasted the business to increase its revenue by 10% per year over the next five years as cyclical advertising revenue rebounds.
I have also forecasted the company’s operating margin to recover, as it benefits from improved monetization of Reels and benefits from product investments.
Given these calculations, I get a fair value estimate of $228 per share. The stock is trading at $92 per share at the time of writing and thus is ~58% undervalued - without even taking the Metaverse potential into account.
The GF Value chart indicates a fair value of $386 per share, making the stock “signficantly undervalued” at the time of writing.
Final thoughts
Meta is a social media giant which still has a large market share and the attention of 3.7 billion monthly active users across its platforms. Zuckerberg’s push toward the Metaverse is bold, but he has made solid progress so far, and one might argue it's needed for the long-term since the legacy business has entered stagnation and decline. There is still a long way to go, but if the Metaverse moves from the early adopters to the mainstream, then Meta could become much more valuable.
