Home Latest Meta Platforms Stock: Intrinsically Cheap, Time To Buy? (NASDAQ:FB) – Seeking Alpha

Meta Platforms Stock: Intrinsically Cheap, Time To Buy? (NASDAQ:FB) – Seeking Alpha

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Fritz Jorgensen/iStock Editorial via Getty Images

Fritz Jorgensen/iStock Editorial via Getty Images
Meta Platforms’ (NASDAQ:FB) ecosystem consists of 4 key applications – Facebook, Instagram, Messenger and WhatsApp. The company has also developed an augmented and virtual reality business selling both hardware and software applications in a division now called Reality Labs.
At the time of writing this report, Meta Platforms had a market capitalization of $542 B which makes it the 7th largest publicly listed company in the US.
The bulk of the company’s revenues come from the selling of advertising placements. The company currently reports 2 operating segments – Facebook Family of Apps (which comprises the advertising business and the other revenues collected from the social network business) and the virtual reality business called Reality Labs.
The most recent annual report showed the following revenue breakdown:

Meta Platforms Sales

Author’s compilation

Author’s compilation
Source: Author’s compilation using Meta Platforms 2021 10-K filing.
It is estimated that 45% of advertising revenues come from North America and 25% from Europe.
It is noted that the Facebook Family of Apps division’s most recent operating margins were 49% whilst the Reality Labs division is operating at a loss (it has yet to report a divisional operating profit).
Global Advertising Market Size
According to eMarketer, who specialize in media investment and market intelligence, they believe that in 2021 the global advertising market had the following dimensions:

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Global Advertising Market Size

eMarketer

eMarketer
Source: Author’s summary of eMarketer’s data.
Global advertising markets had a remarkably strong 2021 where it is believed that advertising spend increased by 15%. In 2020, the initial year of the global COVID-19 pandemic, it was thought that the global advertising market contracted by almost 2%.
It is also important to note the relative size of the advertising market by country:

Global Advertising by country

Statista

Statista
Source: Statista
This chart highlights the significance of the US market within the global market. Interestingly, China is the 2 nd largest market, but this market is essentially closed to foreign companies.
The reactions of governments around the world to the COVID-19 pandemic has dramatically distorted the long run historical trends in many sectors. Advertising is no different. Prior to the pandemic, the global markets were characterized by slowing growing mature markets amongst the developed economies and the faster growing markets in the developing economies of China and other parts of Asia (including India).
As a result of the community lockdowns in many countries we witnessed a shrinking of the global advertising market in 2020 followed by a massive rebound in 2021.
The one underlying macro trend which has not changed is the growth in digital advertising relative to traditional advertising. This can be seen in the following chart from eMarketer:

Historical & forecast size of digital advertising market.

eMarketer

eMarketer
Source: eMarketer, April 19, 2021
Many industry observers are forecasting that the long-term sector trends of declining growth in traditional advertising and a growing market share for digital will continue but the rate of digital growth is starting to decline as the market approaches a new “normal” share split between the two forms of advertising.
This is reflected in the following chart:

Historical & forecast changes in components of the global advertising market.

Axios

Axios
Source: Axios Media Trends, 8 Dec. 2021.
The total underlying market is relatively mature with a typical growth rate of around 3% to 4%. The on-going shift in the advertising mix appears to be heading for a split around 70% digital and 30% traditional forms of advertising
Global Digital Advertising Market
The digital market is dominated by a small number of companies but particularly by Meta Platforms and Google (GOOG) (GOOGL). Fortunately, the major market participants are listed companies. I have used their annual regulatory filings to put together this snapshot of their reported digital advertising revenues:

Revenues of major digital advertising companies.

Author’s compilation.

Author’s compilation.
Source: Author’s compilation using data sourced from each company’s 10-K filings.
There are several gaps in the historical data:
From the table, I estimate that Google and Meta have increased their combined market share from 53% to of 71% over the last 5 years.
I think that potentially Meta is at most risk here particularly if Google implements its own version of privacy changes for Android devices. The competition from the likes of TikTok and others is also becoming ferocious.
There is a significant risk that these operating system software developments under the guise of privacy enhancements may prompt regulatory intervention if the market shares of Google, Apple and to a lesser extent Facebook continues to increase.
Virtual & Augmented Reality Market
The virtual reality (VR) and augmented reality (AR) market comprises hardware, device controlling software and content. There are wide discrepancies about the current size of the VR / AR market.
If 2020 is used as the base year, I have seen market size estimates ranging from as low as US $4.4B to as high as US $21.8B. Most commentators are at the lower end. For my analysis I have settled on the Globe Newswire estimate of $4.4 B.
It is interesting that there is more agreement on what the size of the market might be by the end of 2030. It is generally agreed that the market size will be around $80 B. This implies a compound annual growth rate (CAGR) of around 35%.
Meta Platforms now shows its VR division (called Reality Labs) as a separate reportable segment. Mark Zuckerberg, Meta Platforms’ CEO / Chairman, has stated that VR may be the next generation in computing platforms and therefore Meta wants to be involved in the shaping of the new platform.
Meta acquired its core VR investment in 2014 when its purchased Oculus for $2 B. This investment has been supported with additional acquisitions of VR software companies. It is believed that up to 20% of Meta’s headcount now work in the Reality Labs division.
Meta fundamentally generates income by selling digital advertising on its various platforms. To be attractive to advertisers, Meta must continue to grow its user base and increase the time that users spend on Facebook applications. To encourage users to spend more time on the network, Meta must continue to innovate and offer more services to users. The whole Facebook app ecosystem then acts as a virtuous circle.
Meta has a compelling value proposition for the 3 main stakeholders to its business model – Users, Content developers, and Advertisers.
The customer (user) value proposition as originally conceived was about the ease of use and how it enabled users to communicate with their social groups. Over time this has been extended to include aspects of creating a place where users go to be entertained and gain information. The information gathering can be about general news, interests, products, and services.
In a generic strategy sense the customer value proposition is about product leadership. A Facebook app is the place where you go to stay in touch with your community, to keep up with what is going on and to find out about stuff that you might be interested in buying.
The generic strategy for content developers and advertisers is different to that of platform users. It is about low cost. A Facebook app is pitched as the most efficient way to grow their business.
For content developers, the value proposition is reasonably straightforward. Facebook is a great platform for them to showcase their products which will enable the developers to grow their business and make more income.
Finally, for advertisers, the Facebook platform provides a very high return on investment for their advertising campaigns by being able to run targeted advertisements to generally receptive consumers.
How well is Meta executing its strategy?
According to Statista, Meta has the largest social media user base in the world. Here is a chart of the estimated number of monthly users per application as of January 2022 (the number are in millions):

Leading social media platform user numbers.

Statista

Statista
Source: Statista
The Meta Platform user number becomes even more impressive when you add in the users from all the Facebook apps.
We can measure Meta’s performance against its strategy by looking at its key performance measures:

Historical Facebook user numbers.

Author’s compilation.

Author’s compilation.
Source: Author’s compilation using data from Meta Platforms’ 10-K filings.
The chart indicates that prior to the COVID-19 pandemic, The Facebook’s user growth had started to slow and was trending towards maturity. The onset of the pandemic saw a “kick-up” in user growth but one year later we can see that the growth rate has returned to the pre-pandemic trajectory.
Clearly the Facebook app has almost reached maturity but interestingly the revenues being generated per user are continuing to increase:

Historical Facebook revenue per user.

Author’s compilation.

Author’s compilation.
Source: Author’s compilation using data from Meta Platforms’ 10-K filings.
It should be noted that the above charts are only for users of The Facebook application and does not include the other Facebook apps. Meta currently only provides 3 years of historical data for the total Facebook Family, so it is difficult to draw any meaningful conclusions from the data regarding future trends.
I think that we have reached an interesting point in Meta’s evolution. The company is facing several challenges as a result of the Apple iOS change which is limiting Meta’s ability to provide important data to its advertisers.
Meta needs to protect its existing platform base and advertising revenues whilst developing what management believes will be the future platform for social media. In order to fix the iOS induced gaps in its value proposition, Meta is making investments in Artificial Intelligence (AI) whilst at the same time continuing to heavily invest in Reality Labs.
Currently, I am a believer in Meta’s management being capable of successfully steering a course through these troubled waters.
Meta’s historical revenues and adjusted operating margins are shown in the chart below:

Meta Platforms' historical revenues & operating margins.

Author’s compilation

Author’s compilation
Source: Author’s compilation using data from Meta Platforms’ 10-K filings.
The reported operating margins have been adjusted for the impact of:
The chart indicates that although Meta’s operating margins are very healthy there is evidence that margins may have peaked and are now showing a downward trajectory. This trend started before COVID and has continued.
I suspect that much of the margin tightness has been caused by political, regulatory and competitive pressures which are likely to increase over time.
My moat assessment for Meta Platforms is shown in the following table:

Meta Platforms' moat assessment.

Author’s compilation.

Author’s compilation.
Source: Author’s assessment.
The major sources of moat strength for Meta are multi-faceted. The Facebook brand is generally well regarded but the real strengths of the moat have been held within the intellectual property associated with the data collected from users of the various Facebook apps and the network effects associated within the apps.
We are now seeing evidence that aspects of Meta’s ability to provide high quality data to advertisers is being challenged as a result of Apple’s iOS changes. Time will tell whether Meta can repair this element of its value proposition through their investments in AI.
The size of Facebook’s user base coupled to its ability to data-mine what its users are up to provides for a very powerful competitive advantage. When this is linked to the network effect that is created it becomes very clear just how powerful the Meta business model really is.
The strength of Meta Platforms’ moat can be measured by its return on invested capital which is shown in the chart below:

Meta Platform's historical return on invested capital.

Author’s compilation.

Author’s compilation.
Source: Author’s compilation using data from Meta Platforms’ 10-K filings.
Note that I have adjusted the published financial data for:
Meta Platforms’ returns on invested capital is high and very stable which leads me to conclude that its moat has been historically strong and deep.
The question remains will the Apple iOS issue impact the strength of the moat over the longer term, and will Meta be able to develop a technical solution to compensate for the loss of data quality? If the answer to these questions is no, then Meta’s ROIC will decline.
I have no concerns about Meta’s capital structure. The following chart demonstrates how lightly geared the company is (measured by total debt plus operating leases divided by the market value of equity):

Meta Platforms' historical capital structure.

Author’s compilation.

Author’s compilation.
Source: Author’s compilation using data from Meta Platforms’ 10-K filings.
The chart indicates that Meta is extremely conservatively geared with no traditional long-term debt. There is no doubt that as the company matures it will take on more debt and release more of the value embedded in its balance sheet back to shareholders.
The following table summarizes Meta’s cash flows over the last 10 years:

Meta Platforms' historical cash flows.

Author’s compilation.

Author’s compilation.
Source: Author’s compilation using data from Meta Platforms’ 10-K filings.
There is good alignment between Meta’s reported Net Income and the Net Operating cash-flow. This gives me confidence that there is probably very little management manipulation of the financial statements.
Over the last 10 years Meta has generated 30% of free cash flow to capital from its sales revenues. This is an extraordinary figure – significantly higher than companies such as Apple and Google – and places the company in the elite category with the likes of Booking Holdings (BKNG) and Mastercard (MA).
Meta only returns cash to shareholders via share buybacks which until last year had been relatively modest. As I expected, last year the company bought back $44,537 M in stock. Although the level of buybacks in the future will be much lower than last year’s figure, I expect that it will be higher than the company’s historical average as the power of its Balance Sheet is exploited for the benefit of shareholders.

Meta Platforms price action for last 12 months.

Yahoo Finance

Yahoo Finance
Source: Yahoo Finance
The chart indicates that Meta essentially traded sideways for almost 8 months until the quarterly earnings announcement in February. Investors didn’t like what they heard from the company and as a result the stock price has fallen by 40%. So far there has only been a relatively weak relief rally from the 12-month low.

Meta Platforms' historical return to shareholders.

Author’s compilation.

Author’s compilation.
Source: Author’s compilation using data from Yahoo Finance.
This table indicates that as a result of the recent price fall, an investor who has held Meta shares for the last 5 years has significantly under-performed the broader market. Long term investors (greater than 5 years) nevertheless are more than satisfied with their investment in Meta.
The biggest threats to Meta’s business are driven by regulation and technology.
The issues that governments are concerned about include:
The remaining key threat to Meta comes from its competitors. Will Google develop similar operating system changes for Android devices that will impact Meta’s ability to data mine? Will competitors develop a better product which causes Meta to lose its current market position?
The world, for the most part, is now returning to a post-COVID way of life notwithstanding the current lockdowns in China, the Russian / Ukraine war and the economic dark clouds which are looming over much of the western world.
The advertising sector (both digital and traditional) has experienced a mini boom during COVID. It is my expectation that the advertising market post-COVID will resume its historical growth patterns (around 4% per year).
My scenario for Meta contains the following key assumptions for the global advertising market:
Just like the digital advertising market, Meta has also hit peak growth and I expect that its advertising revenues will grow at 8% per year for the next 3 years before slowly declining to 3% per year by year 10.
I think that Google will continue to dominate the digital advertising market and the combined Google and Meta market share will peak in the next 2 to 3 years before slowly declining due to rising competition from existing and emerging competitors.
Although Meta reports that its Advertising operating margins are currently rising I expect that the trend will reverse over the longer term as a result of both competitive forces and the impact of increasing government regulation.
Similarly, I expect that the market participants will be forced to slowly increase their investments in product development just to maintain their technology superiority. Meta already reinvests at a much higher rate than typical companies in the sector and this will continue.
Meta also has revenue exposure to the virtual reality and augmented reality markets through the sale of hardware and ancillary services. I think that the potential for this market is quite significant. I estimate that Meta may currently have almost a 40% share of this market. I don’t believe that this is sustainable, but Meta can grow its Reality Labs revenues by 20% to 30% per year for the next 10 years.
The operating margin for Meta’s Reality Labs division is currently negative. I expect that within 3 years the division will be profitable but if the Consumer Electronics sector is a guide, then the expected long-term operating margin for this division is probably around 10% to 15% (reflecting low hardware margins relative to software).
Due to anti-trust pressure, I have assumed that there will be no substantial acquisitions over the forecast period. I have not factored in any attempts by the US government to break up Meta Platforms.
The output from my DCF model is:

Meta Platforms' DCF model.

Author’s compilation.

FB stock intrinsic value.

Author’s compilation.

Author’s compilation.
Author’s compilation.
Source: Author’s model
I also developed a Monte Carlo simulation for the valuation based on the range of inputs for the valuation. The output of the simulation is developed after 100,000 iterations.

Meta Platforms intrinsic value distribution.

Author’s compilation.

Author’s compilation.
Source: Author’s model.
The Monte Carlo simulation is very useful in helping to understand the major sources of sensitivity in the valuation:
The simulation is indicating that the revenue growth and operating margin forecasts are the greatest source of risk to the valuation.
From the simulation, the valuation for Meta Platforms at a discount rate between 7.75% to 8.25%, is between $244 and $371 per share with a typical value around $302.
I think that based on my scenario Meta Platforms is currently priced significantly below fair value.
What assumptions about revenue growth and operating margin are baked into the current share price?
I developed the following table which shows Meta’s intrinsic value for a range of revenue growth rates and operating margins:

Meta Platforms' valuation sensitivity analysis.

Author’s compilation.

Author’s compilation.
Source: Author’s compilation.
The table indicates that the current share price equates to fair value for the stock when revenue growth is expected to be less than 6% per year for the next 5 years and the operating margin declines by almost a 50% decline from the current levels.
I think that the assumptions baked into the current share price are extremely conservative which provides me with some comfort that Meta could today be confidently purchased on any price weakness.
Meta Platforms is a global social media brand and arguably one of the leaders in its sector. Its value proposition has been exceedingly strong which has resulted in high returns on invested capital. The sustainability of the company’s market position is being challenged as a result of a competitive technology shift.
The digital advertising market has experienced remarkable growth, and this is expected to moderate although remaining at an enviable level for many years.
Based on management’s track record I expect that Meta can meet the technology challenge from Apple’s iOS changes and restore its value proposition to advertisers.
Is Meta Platforms a Tier 1 investment?
For each company I value I also assess what role this company could potentially play in my portfolio. The cornerstone of my portfolio is what I term “Tier 1” companies. These are the companies that I hold for the long term and where I invest most of my cash.
My high-level assessment for Meta is:

Meta Platforms' Tier1 assessment.

Author’s compilation.

Author’s compilation.
Source: Author’s assessment.
My assessment is that Meta is a very high-quality Tier 1 company and I confirm that I am an existing shareholder.
Is Meta Platforms today a buy, hold or sell?
If I was answering this question without any regard to the current macro investing environment, I think that there is little doubt that Meta is a strong BUY.
I feel uncomfortable recommending to BUY the stock whilst the equity market is charting unstable waters. The market appears to have entered a corrective phase as a result of the challenging global macro-economic environment. Although Meta is cheap, I suspect that the price could fall further if the entire market were to fall.
My investing plan for Meta currently involves a combination of long equity holdings and long dated at the money bull call spread options (purchased when the underlying price dipped to $180). I am also taking the opportunity to generate income by selling calls against my long equity holding.
Best wishes.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of FB, GOOGL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Nitika is a MCA graduate and works as all-round news writer at The Hoops News. In free time, she works on Photoshop and plays GTA V on her Xbox. A tech-enthusiast at heart, she explores ways that businesses can leverage the Internet and move their businesses to the next level. You can contact her at nitika@thehoopsnews.com.