Meta Platforms: Significantly Undervalued With Strong Fundamentals

May 17, 2022 11:11 AM ETMeta Platforms, Inc. (META)GOOG14 Comments6 Likes
Okky Rijanto profile picture
Okky Rijanto
74 Followers

Summary

  • At the prevailing stock price, the market is only pricing approx. 0.5% revenue growth rate for the next 5 years despite revenue growth at the past 5-year CAGR of 33.7%.
  • Meta is a deep value stock that can weather through the rate hikes and quantitative tightening due to its growing FCF, user activity, and cost-savings measures (i.e. hiring freeze).
  • Despite spending $19 Billion capex in FYE '21 for the Metaverse bet, it has been growing Free Cash Flow at a CAGR of 32.49% over the past 5 years.
  • Meta has the lowest prevailing P/E at 14.8x among Big Tech with the highest EBITDA margin at 38.3% (Q1 2022).
  • Meta has a wide moat in Social and the Metaverse economy to provide high growth potential in the long term.

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Making Sense Of Valuation In The Current Macroeconomic Climate

The market has been seeing strong headwinds from the Federal Reserve's intention to bring inflation down by increasing 50bps rates multiple times. Valuation mathematic indicates that the rate increase will decrease equity values, and the discounting effect is far greater for companies with cash flow that will occur in the far future. Therefore, in these times, I am seeking companies with strong cash flow today, but with valuation that is being penalized. Meta Platforms (FB) is one such company.

Investment Thesis

Interest rate hikes are creating volatility for the blue-chip company with a wide moat and strong free cash flow generation. Currently being priced at almost no growth, it is growing at double digits. With the prevailing stock price at $198, the market is pricing approximately 0.5% revenue growth for the next 5 years with each year discounted at its cost of capital at 8.8%. However, Meta Platforms has been growing its revenue at a CAGR of 33.7% for the past 5 years. The graph below illustrates Meta Platforms’ growing revenue trend.

Meta Platforms’ growing revenue trend.

Meta Platforms’ growing revenue trend. (Refinitiv)

This represents a very attractive buying opportunity since it appears to be a mispricing due to the current macroeconomic climate. I expect revenue to still be growing from the stickiness of the product and having a wide moat in the social media space. There is also a catalyst for high growth in the coming years, which is the ecosystem surrounding the Metaverse platform, devices, and economy. By having its own platform, the social media giant will be free from Apple's privacy restrictions. The independent platform will also bolster ads revenues growth beyond third-party platforms.

As well, with the recent focus on improving user experience and ad targeting using AI and Machine Learning, Meta Platforms is a longstanding tech company with high growth opportunities in the long term. Accumulating in the consolidation range of $180 to $197.08 (VWAP) might be a compelling trade with a price target of $261.12 to $305.60.

The strong Free Cash Flow growth and the new cost-saving initiatives such as the hiring freeze and scaling back Metaverse capex will enable Meta Platforms to weather through the quantitative tightening as the company is already generating strong free cash flow today and for the foreseeable future.

Meta Platform’s Fundamental Strength

In terms of the growth rate per year, 2020 growth was the slowest at 21.6% which was due to most advertisers’ budget cuts. The subsequent year 2021 saw a return to high growth at 37.2%, which was a very impressive growth unmatched by any other large software companies.

Meta Platforms' Revenue Trend Over The Years

Revenue Trend (Refinitiv)

Revenue Growth Rate Trend

Revenue Growth Rate Trend (Refinitiv)

Comparing Meta Platforms’ 37.2% growth rate to other tech companies in 2021, it is second only to Tesla (TSLA), which was growing at 50.4%.

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Meta Platforms' Growth Rate Is 2nd Only To Tesla In 2021 (Refinitiv)

Speaking of margins, Meta Platforms commands a hefty 43.50% EBITDA margins (FYE '21), the largest in the peer group and amongst Big Tech. In Q1 2022, EBITDA Margin was 38.3%.

EBITDA Margin

FYE 2021 EBITA Margin Peer Comparison (Author's Analysis)

If Meta Platforms is still growing, then why does it not have higher multiples? Compared to peers in the digital advertisement space, Meta Platforms is priced the cheapest at 14.8x P/E.

P/E Ratio Peer Comparison

P/E Ratio Peer Comparison (Author's Analysis)

Spending Money For Innovation Is Not Necessarily A Bad Thing

The market has been penalizing Meta Platforms for spending money on building infrastructure for its Metaverse ambitions. The capital expenditures started in 2018 with over $15 Billions of spending and now in 2021 with over $19 Billions of spending. However, I believe this should be viewed as a positive factor since Mark Zuckerberg knew that to grow more, the company needs to spend money on innovation.

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Meta Platforms' Capex Spending Trend (Refinitiv)

Free Cashflow Is Still Growing Despite Large Capex Spending

Despite the jump in CAPEX spending, Meta Platforms has been growing its Unlevered Free Cashflow at a CAGR of 32.49% over the past 5 years and over the last 12 months, it has hit a record of $30.5 Billion. Free cash flow is still substantial despite spending on innovation.

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Meta Platforms' Free Cash Flow Trend (Refinitiv)

Stickiness Of Product And Wide Moat

Meta Platforms' current social media apps are still proven to be sticky, despite competition from TikTok, Snapchat (SNAP), and Google's (GOOGL) YouTube. Mark Zuckerberg has shown that he is willing to copy features from rivals to make its platforms sticky. The current family of apps such as Facebook, WhatsApp and Instagram have a wide moat from its network effect and tighter integration. If the competitors' features are made available in the Meta Platforms ecosystem, then users most likely will stay in the ecosystem due to the network effect. From Meta Platforms' investors deck, users are not going anywhere. The family of apps showed improving user activity growth. According to Q1 Company Filings, Daily Active People reached 2.87 billion in Q1 2022. As well, users are spending 20% more time on Instagram’s Reels and 50% more time on Facebook Videos.

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Meta Platforms' Daily Active People (In Billions) (Company Filings)

Metaverse: Spending For A Moonshot

The Metaverse thesis so far has been a double sword for investors. For one, investors are wary of the large CAPEX spending required to build the virtual world and the devices required to access them. The segment has also been losing money since its inception.

Graphical user interface, application Description automatically generated

Meta Platforms' Segmented Revenues (Company Filings)

However, as explored earlier, capex investments are necessary to build the next growth engine for the social media company.

Mark Zuckerberg’s vision for the Metaverse is perhaps acting as a hedge against Apple’s ads tracking restriction. To be able to monetize more money per user, Meta Platforms needs to learn from its users’ behaviors. However, the ad tracking restriction on Apple devices has dampened this growth. To build phones and computers that rival Apple would probably require much larger capital spending (and it failed to build a Facebook phone before). Therefore, I believe the vision for the Metaverse is the economy that it will bring.

The current realization of this vision is Project Cambria and Horizon. In replicating the real world, the vision is that users will be “living” in the Metaverse. If users are making economic transactions in the Metaverse, it could learn from the user’s behavior, such as working, shopping, and other social interactions. The utility for Metaverse could allow users to work, learn, shop, and play in the virtual world. The data generated from these activities could be highly valuable. Free from Apple's privacy restrictions, advertisers will be able to buy targeted ads based on user data in the Metaverse and make higher conversions.

If The Moonshot Fails

Behind the Metaverse are large infrastructure projects to build out new data centers and AI capabilities. If the Metaverse vision is not working out, Meta Platforms could pivot and use these new infrastructures for other projects, especially the AI capabilities which it could pivot to AI products and services. The AI capabilities such as discovery and recommendation engines could also be used to bolster user experience in its existing family of apps, especially for Instagram’s Reels as users’ engagement is growing at a high rate there. At the same time, advanced AI capabilities could be used to improve better ads tracking and conversion result for advertisers.

A Blue-Chip Value Stock

Whether the Metaverse vision will be realized, I will make reasonable and conservative assumptions in valuing Meta Platforms.

Meta Platform’s revenue growth in F’21A was 37.2%. However, with the pandemic restrictions lifted, I assume revenue growth will decline to 5.0% in F’22E due to less user activity compared to the prior year. Then, revenue will increase to 10% growth in F’23E, 15% growth in F’24E, 10% growth in F’25E and finally going back down to 5% growth in F’26E as I will be assuming a normal growth rate going forward. The terminal growth rate will be 3%, aligning with the long-term growth rate expectations of the economy.

Revenue Growth Rate For The Next 5 Years Of Forecast Horizon

Revenue Growth Rate For The Next 5 Years Of Forecast Horizon (Author's Analysis)

In calculating Unlevered Free Cashflow, I assume $28-29 Billion in capital expenditure for the next 5 years as Meta is building its infrastructures for the Metaverse. I project Unlevered Free Cash Flow to decline by 30% in F’22E due to the steep decline in revenue to $19B and will recover in the subsequent years as per the revenue forecast assumptions above. Meta Platforms' hiring freeze should save some expenses and improve Free Cash Flow. The 10% revenue growth assumption in F’23E will increase Unlevered Free Cash Flow by 41% due to the operating leverage the company has with an average of 81% gross margins in the past 5 years. I project that with the revenue growth assumptions above, Unlevered Free Cashflow will double by F’26E to $48 Billion.

Projected Unlevered Cash Flow For The Next 5 Years Of Forecast Horizon

Projected Unlevered Cash Flow For The Next 5 Years Of Forecast Horizon (Author's Analysis)

The market currently valued the social media company at $537.53 Billion and as mentioned earlier this implies that the market is only expecting approximately 0.5% revenue growth for the next 5 years at a WACC of 8.8%.

My DCF model incorporated the revenue growth assumption of 8.9% 5YR-CAGR, EBITDA at 9.9% 5YR-CAGR, and Unlevered Free Cash Flow at 11.4% 5YR-CAGR for the next 5 years of the forecast horizon. The EBITDA Margin will be at an average of 46.6% and the Free Cashflow Margin at an average of 22.4% for the 5 years forecast period.

For the Base Case, I assume WACC at 8.8% and Perpetuity Growth Rate at 3.0% for the Terminal value, and I calculated the Implied Equity Value at $707 Billion or $261.12 price per share. For the Bull Case, the Implied price per share is $305.60.

Base Case, Bull Case, and Market Historical Case

Base Case, Bull Case, and Market Historical Case (Author's Analysis)

Meta Platforms Is At Its Lowest Valuation Since IPO

The social media company is prevailing at only 14.8 P/E and is at its lowest valuation ever, with the average for the past 5 years being 27.9x.

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Meta Platform's P/E Ratio Trend Since IPO (Refinitiv)

Key Risks

Some of Meta Platforms' key risks are the slowing engagement in the younger demographics as they are enticed by trendy apps such as TikTok, Snapchat, and YouTube. Slowing advertisers’ growth and competition from these other apps may lower revenue growth in the future. Capex spending could compress margins. Regulatory changes could restrict Meta Platform’s privacy tools and policies. The large CAPEX spending on Metaverse devices and virtual worlds may fail to generate meaningful EBITDA margins or even losses.

There is also a price risk as the stock price may declines even further until the Fed completes its rate hike and quantitative tightening cycle to bring inflation under control. The further interest rate hikes and increasing market risk premium may increase the WACC and therefore lower the equity value.

Final Thoughts

Meta Platforms' wide moat in social media and its focus on improving user experience and the advertisers’ conversion rate should position itself to become a longstanding blue chip company for the long term. Cash flow generated from the Family of Apps should offset losses from the Reality Labs and creates strong and growing Consolidated Free Cash Flow going forward for the next 5 years. Should the Metaverse become a reality and contribute to a meaningful EBITDA, it may become the growth engine to propel the social media company to new heights in the long term.

This article was written by

Okky Rijanto profile picture
74 Followers
I am a Credit Analyst and hold a Masters in Finance degree. I do research to seek capital appreciation in value stocks with high growth opportunities in the long term.
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Disclosure: I/we have a beneficial long position in the shares of FB, GOOG 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.

Additional disclosure: This article contains forward-looking statements and are not guarantee of future performance and undue reliance should not be placed on them. Forward-looking statements involve known and unknown risks and uncertainties which may cause actual performance and financial results in future periods to differ materially. This article is for educational purposes only. Not Financial Advice.

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