- Based on 2022 expectations, META stock looks cheap, but perhaps not cheap enough
- Investors with a long-term focus might see this as a ‘reset year’ and META as a buying opportunity
- Meta has challenges looking forward that even bulls need to keep in mind
Despite the steep decline this year, Meta Platforms (NASDAQ:META) stock doesn’t look all that cheap. Even backing out $15 per share in cash and marketable securities on the balance sheet, the company formerly known as Facebook trades at about 15x this year’s consensus earnings estimate.
Indeed, that multiple is lower than that assigned to what was then FB stock in past years. However, this company version doesn’t look quite like the old one either.
Meta’s growth has stalled out; revenue declined year-over-year in the second quarter. For the full year, earnings per share are expected to decrease by 28%.
To be sure, short-term considerations are at play here. But that doesn’t mean Meta stock is a long-term play. Those short-term considerations look precisely like the long-term risks.
1. Is Recession The Problem?
Facebook management blamed the economic environment on the second quarter earnings call for the weak revenue results. Chief executive officer Mark Zuckerberg said in his prepared remarks that: "we seem to have entered an economic downturn." Chief financial officer Dave Wehner attributed guidance for another decline in the third quarter to "broader macroeconomic uncertainty."
To be sure, advertising demand has receded. Other social media platforms like Twitter (NYSE:TWTR) and Snap (NYSE:SNAP), too, are struggling. But it’s worth emphasizing that demand has receded from last year—not necessarily from a long-term standpoint.
And last year was not a typical year. Consumers worldwide were flush and happy to spend. Advertisers thus were doing the same.
In the second quarter of 2019, Facebook generated ARPU (average revenue per user) of $7.05. The figure in Q2 2022 was $9.82. That’s an increase of 39%—nearly 12% annualized.
Meta management construes that ARPU declined 3% year-over-year last quarter—and no doubt will decline again in Q3—as a sign of a recession. But the broader picture looks much more like a reversion to the mean. Advertiser demand is far higher than it was three years ago—during a pretty solid worldwide economy. That, in turn, undercuts the argument that 2022 revenue is taking a hit because of external issues.
Meta’s own history suggests that’s not the entire story. That raises the question of what happens when and if the economy turns further south.
2. The Metaverse
Of course, Facebook changed its name to highlight its efforts in the so-called ‘metaverse.’ Those efforts aren’t cheap.
In 2021, Meta’s Reality Labs segment, which includes the metaverse business, posted an operating loss of $10.2 billion. In the first half of this year, the loss expanded by another $1.5 billion; metaverse investments will probably cost the company $12 billion this year.
Those losses are depressing overall profitability and obscuring the valuation assigned to the core social media business. At Meta’s first-half effective tax rate of 18%, Reality Labs is taking $3.66 per share off this year’s net profit. Excluding cash on the balance sheet and those losses, META is trading at 11x earnings.
As far as the fundamentals go, the core of the bull case for META stock is that it is one of the world’s biggest businesses; nearly half the world’s adult population uses a Meta property daily.
But, again, if advertising demand is normalizing, not weakening, that kind of outlook isn’t necessarily a buying opportunity. That aside, the investments in the metaverse are not going to slow.
Zuckerberg clearly is a believer: he said on the Q2 call that the initiative could unlock "trillions" of dollars in value over time.
For shareholders’ sake, Zuckerberg had better be right.
3. The Shift To Video
Bulls might argue that even if Zuckerberg is wrong and the metaverse effort flops, META stock remains cheap enough. At some point, the company will cut its losses, allowing the earnings power of the core business to shine through.
But that leads to the third risk: the core business is not what it used to be. Competition from TikTok remains intense, to the point that Meta is copying that platform with its "Reels" offering on both the Facebook and Instagram platforms.
The issue isn’t necessarily that TikTok takes viewing time and engagement away from Meta’s platforms. Short-form video ads are not nearly as profitable even if Instagram and Facebook hold up. CFO Wehner noted on the Q2 call that the shift to time spent on Reels is indeed a headwind to revenue.
Meta believes that will change over time. Advertisers will adapt. But the shift to video is part of the longest-running risk here: that Facebook’s dominance will erode.
Similar fears have existed literally since Meta went public a decade ago. After a lackluster first day of trading, the stock nearly halved in its first few months amid fears that the company wouldn’t be able to monetize mobile usage to the extent it did on the desktop.
That fear proved unfounded: FB/META was a 20x from bottom to its peak in September last year. Bulls need to be aware that fears around the shift to video are similarly unfounded.
Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned.