Meta faces the most important period in its history as a public company (NASDAQ:META)

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Currently Meta Platforms (NASDAQ: META) is one of the underappreciated large-cap tech stocks on the market. With its earnings multiple at an all-time low and its core ad business recovering, I think the company’s recent liquidation offers contrarian investors. an interesting buying opportunity. Let me explain why.

Market sentiment for Meta Platforms is at an all time low following the release of its third quarter earnings in late October. Deciphering Meta’s results and the accompanying comments from founder/CEO Mark Zuckerberg, it’s clear that Meta is no longer just an online advertising and social media company. As its core ad business matures, Meta is increasingly focusing its resources on its virtual and augmented reality division, “Reality Labs.” Mark Zuckerberg is fully committed to his vision of the metaverse, and so far Meta appears to have a commanding advantage over competing VR/AR headset makers. However, the question remains: will AR/VR prevail? Or is the metaverse just another overhyped Silicon Valley tech fad? While the future of the metaverse is undoubtedly filled with uncertainty, the opportunity for virtual reality applications is huge, with Meta Platforms the company best placed in the space to capitalize on this secular trend in the years to come.

Third Quarter Earnings Highlights

For Meta’s main family of applications (FOA) division, the company reported strong user engagement across Facebook, Instagram, and WhatsApp. Year-over-year daily active users grew 5.7% to 3.71 billion, while ad impressions increased 17%. This, however, was offset by an 18% drop in price per ad due to the growth of Reels, which the company monetizes at a lower rate than traditional Facebook and Instagram news feeds.

Investors, however, were spooked by rising costs and operating expenses targeting Meta’s Reality Labs division. The company’s research and development spending grew 45% year-on-year, while capital spending soared to a record US$9bn for the quarter. To deal with the sharp increase in costs, Zuckerberg stressed that the company will focus on reducing its total expenses in the coming quarters, including reducing the hiring rate.

Meta’s high costs and expenses won’t rise forever

While Meta’s future capital needs will undoubtedly be greater than ever, I believe its total costs and expenses will normalize as Reality Labs achieves significant scale.

Meta spending towards the metaverse has definitely grown faster than investors, including myself, anticipated. Currently, these costs are incredibly high. However, Zuckerberg clearly has a plan for how Meta will allocate future cash flows generated by his core ad business. While in the short term, the company’s spending will likely be destructive to its earnings and free cash flow, in the long term, such investments have the potential to create significant shareholder value.

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Today, VR/AR technology is still incredibly in its infancy. Subsequently, a large initial investment is needed to iterate and develop a first-class product suitable for mass market adoption. With such a heavy focus on their investment in the metaverse, it’s hard to deny that Meta is building a strong competitive advantage over rival AR and VR hardware developers that will be hard to stop. However, the question on everyone’s mind is whether such a large investment is justified.

If you can’t beat them join them

Meta’s recent partnership with rival tech conglomerate Microsoft highlights Oculus’ strong positioning in the virtual and augmented reality space. Recently, Microsoft, the popular Xbox gaming device maker, announced that it would be partnering with Meta to integrate its suite of office and business collaboration software (Microsoft Teams) with Meta’s Oculus hardware devices. This collaborative approach is significant. As one of the largest and most profitable technology companies in the world, Microsoft could easily have decided to defy Meta and develop its own virtual reality headset. Instead, they have chosen to work collaboratively, perhaps indicating that Oculus is way ahead of its peers in developing a highly sophisticated, cutting-edge VR headset. While Microsoft has its own VR headset, it hasn’t released a new device since 2019.

Additionally, Microsoft had the option to partner with a handful of other VR hardware device manufacturers, including Sony and Apple. Alternatively, they might not have taken any action. By extending its software applications into virtual reality, Microsoft clearly sees value in the metaverse and may indicate where the tech giant sees the metaverse going in the future. Traditionally, gaming and social engagement have been the two experiences most associated with the metaverse. Microsoft and Meta’s focus on enterprise collaboration and productivity tools for VR highlight the metaverse’s broad use case outside of Web 3.0, gaming, and social media.

Reality Labs is winning the virtual reality race

As of June of this year, Meta Platforms had sold approximately 15 million of its Oculus headsets. Additionally, Meta’s Oculus Quest 2 sales have already surpassed Microsoft’s Xbox ‘Series X’ lifetime total sales and are quickly catching up with PlayStation 5’s total sales. This makes the Oculus Quest 2 the go-to VR headset most used on the market. While competitors such as HTC, Sony, and Apple have or are in the process of developing rival devices, they have yet to come close to Oculus in terms of total units sold, demonstrating the quality of Oculus’ product relative to its peers. As Meta increases its investment in VR headsets, we believe it will become increasingly difficult for competitors to compete with Oculus’ superior technological capabilities, user experience, and selection of third-party apps. Going forward, only time will tell if the investment in the Meta metaverse pays off – looking at Zuckerberg’s track record and the leadership Oculus has in the VR/AR space, we think it will.

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So where does Meta go from here?

There is no doubt that there is great uncertainty about the future of Meta Platforms. If there was one thing I learned from Meta’s Q3 earnings call, it was that Zuckerberg’s future capital allocation strategy will be geared toward building the Metaverse. With Reality Labs expected to burn through a significant amount of cash for at least the next 2-3 years, Meta’s other businesses will have to do much of the heavy lifting in terms of generating cash flow. Although they have struggled for the past 12 months, I think recovery is closer than many expect.

For the Meta App Family Division, I remain optimistic. Looking at Q3 results, engagement on FB, Instagram, and WhatsApp is stable, if not growing. Additionally, the release of Reels appears to be gaining considerable traction. Reels are currently played 140 billion times a day on FB and Instagram – a 50% increase from six months ago. While it’s still early days, it looks like Reels is stealing market share from TikTok. Meta’s integration of AI discovery engines to drive its Reels recommendations has been a critical factor in the recent success of Reels across all of its platforms. As Meta puts more time and energy into AI technology for its discovery engine, Reels should continue to grow in popularity. While engagement going forward looks positive, the key metric to watch will be Reels monetization. As Reels grows, it will continue to act as a drag on revenue given its lower monetization rate; if and when Meta fixes this, their FOA division revenues should normalize.

As for messaging, Meta click message business for WhatsApp and Messenger is another promising development. However, both remain irrelevant to the company’s top and bottom results. Since acquiring WhatsApp in 2014, Meta has yet to monetize its massive global user base, which has grown to more than 2 billion people. Meta’s new click-to-message business is changing this and is the company’s fastest-growing product. Furthermore, the click to WhatsApp recently surpassed the US$1.5 billion run rate and is growing over 80% year over year. While starting from a low base, the opportunity to generate significant revenue from WhatsApp and Messager is huge, given that the platforms have such a huge user base. Additionally, WhatsApp’s strategic partnership with Salesforce, which enables all customers to use WhatsApp as the primary messaging service to answer customer questions and sell directly in chat, is an exciting development that could significantly increase growth. WhatsApp revenue.

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Meta’s Reality Labs is without a doubt the division facing the most uncertainty. As I mentioned before, Oculus is way ahead of its peers in the VR space in terms of technology and functionality. The two questions on my mind are 1.) Is the amount of capital currently allocated to Oculus justified? 2.) Will VR and the metaverse become mainstream? Meta is currently pulling out the kitchen sink at Reality Labs; however, this expense is highly discretionary and can be reduced if necessary. Based on recent growth rates from Reality Lab, current spending looks unsustainable for more than 12-18 months. If Reality Labs begins to gain significant adoption over the next 6-12 months, investors are likely to become more accepting of Meta’s high CapEx and OpEx budgets. Market response to the new Meta Quest Pro and 3 headsets will be a good indication of such adoption and I’ll be watching for user feedback in the coming months.

Valuation

Below is a summary of my operating income growth assumptions for Meta Platforms through the end of fiscal 2027.

Operating Income

Operating Income (OJRB Investment Research)

Valuation Summary

Valuation Summary (OJRB Investment Research)

Based on my conservative growth assumptions, I expect Meta Platforms to grow its net operating profit after taxes (NOPAT) to approximately $48 billion by 2027. $725 billion capitalization IN FY2027. For investors buying the stock today, this would generate an annualized return of about 19%. as such, I think Target is a buy below $100 per share.

conclusion

The next 12-18 months will definitely be a challenging period for Meta Platforms, contrary to what many have said, however, I believe the company will successfully navigate this period. In my opinion, Mark Zuckerberg is a very smart allocator of capital who is intent on maximizing long-term shareholder value. While there is a big question mark over the future of Reality Labs, Meta’s core advertising business is in a good position and should continue to generate strong cash flows that will support the development of Meta’s Oculus products.

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