We are raising our fair value estimate for wide-moat Meta (META) to $560 from $450 after taking a fresh look at the firm’s overall business and incorporating a more optimistic outlook on the firm’s investments in artificial intelligence, especially as they relate to Meta’s ability to improve its ad-targeting business.
• Fair Value Estimate: $560
• Morningstar Rating: 3 stars
• Economic Moat Rating: Wide
• Uncertainty Rating: High
While the firm’s investments in AI could potentially improve its core business, we remain pessimistic on the long-term value created by Meta’s investments in its Reality Labs division and are reducing our Morningstar Capital Allocation Rating to Standard from Exemplary.
We view Meta as the clear leader in social media. The firm’s application lineup, which includes Facebook, Instagram, WhatsApp, and Messenger, has close to 4 billion monthly active users, giving Meta unmatched scale in the space.
The firm’s strategy is two-pronged. On the user side, Meta has leveraged its scale and social media savvy to improve its product lineup, adding features such as Stories, Reels, and even new products such as Threads. Such enhancements and additions not only improve user engagement, but also allow Meta to grow revenue by layering ads onto them.
Shift to Digital Advertising
On the ad side, Meta allows advertisers of all shapes and sizes to place ads in front of engaged users. The company has benefited greatly from a general shift toward digital advertising within the broader advertising market, with social media advertising gaining substantial share, especially since the covid-19 pandemic. To bolster its ad business, Meta has invested heavily in improving its ad-targeting algorithms, allowing it to improve advertisers’ returns on ad spending and increasing its average revenue per user over time.
We forecast Meta’s sales growing at a 12% compound annual growth rate for the next five years, spearheaded primarily by an increase in average revenue per user with user growth also chipping in. We believe Meta has a strong opportunity ahead in Asia and the rest of the world.
While we expect advertising sales from North America and Europe to also grow steadily, we believe increasingly affluent and growing middle classes in Asia, Africa, and the Middle East will give Meta an opportunity to improve its ad monetization in those regions.
While we expect Reality Labs’ sales to grow at a double-digit rate over the next five years, we believe that Meta’s advertising juggernaut will remain the primary driver of its business and intrinsic value over our explicit forecast.
On the profitability side, we remain impressed by Meta’s ability to drive efficiency across its operational footprint, with the firm’s 2024 GAAP operating margins expected to be close to 40%, up from the 2022 nadir of 25%.
Looking Beyond Advertising
Looking ahead, we believe that the firm’s profitability will remain at current levels over our explicit five-year forecast as increased efficiency is offset by expanding investments in areas such as AI and Reality Labs.
While the firm’s core business remains advertising, Meta has shown a proclivity to expand beyond its ad-based revenue model by investing heavily in hardware, via Reality Labs, and in AI, by investing in its own Llama large language model. While the firm’s investments in Reality Labs have been demonstrably unprofitable, we are more optimistic about Meta’s investments in AI. We view Meta’s AI investments, especially those aimed at improving the firm’s ad-targeting algorithms, as value-accretive.
Beyond ad targeting, Meta is also investing in consumer-facing AI, via its Llama chatbot, which is accessible to users across its applications. While a monetization strategy for this chatbot remains elusive in the near term, we believe the firm could drive increasing user engagement/time spent by allowing its users access to a chatbot assistant within Meta’s applications.