Meta Platforms (NASDAQ: META) has fallen substantially this year with shares down 67% year to date.
Despite the stock’s decline, the company still boasts 3.7 billion monthly users, US$41.8 billion in cash and marketable securities, and substantial scale.
Given the decline, it now sports a forward price to earnings (P/E) ratio of around 14.
For a company with Meta Platforms’ quality, this valuation seems rather low.
Could the stock qualify as a bargain?
Meta Platforms’ metaverse spending
Although advertising market weakness and slowing user growth are acting as headwinds, Meta Platforms’ metaverse spending is arguably the biggest reason for the stock’s poor performance.
The metaverse is a virtual reality world that optimists hope will be the next version of the internet.
The company has already spent US$15 billion on the metaverse since the beginning of 2021 and the company is planning on spending even more for a sustained period of time.
While other companies invest a modest amount of capital to bring a promising product to market when there is sufficient demand, it is spending a substantial amount of capital without any sign of consumer demand at all.
The huge metaverse spending hasn’t shown any results so far.
The company’s Horizon Worlds metaverse product has less than 200,000 monthly active users, below the company’s initial goal of 500,000 monthly active users.
Many of Horizon Worlds’ users don’t stick around for very long as they don’t return after the first month.
It also said it expects Reality Labs’ operating losses in 2023 to be significantly larger than this year’s.
Reality Labs is Meta Platforms’ division that makes its metaverse virtual reality and artificial reality hardware and software products.
The key worry is that Meta Platforms will not focus enough on its core social media business due to its metaverse investments, thus causing its earnings per share to further decline.
While Meta Platforms’ net profit has been badly hit this year, the following are potential ways the business could improve in the long term.
#1: A realistic and compelling metaverse
First, Meta Platforms’ metaverse product could improve enough such that the market eventually buys into it.
Although the existing iteration of Meta Platform’s metaverse, Horizon Worlds, doesn’t have good graphics, the future product still has a lot of potential because there are video games that are pretty realistic already.
There are also many people who want to spend time in a virtual world given the popularity of Massive Multiplayer Online Role-Playing Games (MMORPG).
If it keeps up its spending, it may be a matter of time before the company creates something compelling for both users and investors.
#2: Other platforms succeed
Secondly, CEO Mark Zuckerberg has reiterated that other than the metaverse, the company will spend money on three other major platforms – a virtual reality consumer product, augmented reality, and neural interfaces.
There is the potential for any of these to succeed and generate high market demand even if the metaverse does not.
#3: Meta Platforms spends less on the metaverse
Another potential way for Meta Platforms to improve its earnings is if it doesn’t spend as much on the metaverse.
Meta Platforms’ core business generates substantial free cash flow.
For 2021, the company generated free cash flow of US$39.1 billion even though Meta Platforms already invested billions of dollars into the metaverse that year.
If Zuckerberg focuses on the company’s core business and decides to not invest in the metaverse, I believe the company could achieve a free cash flow of US$25 billion to US$40 billion as it has in terms of recent history.
If it traded at 15 times free cash flow of US$25 billion, the stock would have an enterprise value of US$375 billion, versus the company’s current enterprise value of US$281.2 billion.
This simple back of the envelope calculation suggests that there is still some upside to Meta Platforms’ share price should the company reduce its metaverse spending.
#4 Reels bringing in more revenue
A fourth way for Meta Platforms to engineer a turnaround is if its Reels product improves and the company keeps its user base and strong engagement in the long term.
Meta Platforms’ Reels saw a US$3 billion revenue run rate across Meta Platforms’ family of apps.
Given the company hasn’t monetized Reels that well yet, the product is considered in its infancy.
In the next 18 months, however, Reels could gain momentum and achieve a higher revenue run-rate, eventually adding value to overall group revenue.
While competitor TikTok has grown, Meta Platforms’ user numbers show that the company is still doing well despite competition.
For its third quarter, the company’s total number of monthly active users increased by 4% year on year to 3.7 billion.
If the company maintains its user base, carries on with its strong engagement and increases Reels’ monetisation, Meta Platforms’ earnings could grow in the long term.
#5 Meta Platforms’ artificial intelligence unit
Meta Platforms could benefit from the successful utilisation of artificial intelligence (AI).
In the third quarter of this year, much of the increase in the company’s capital spending was due to the company building out its AI infrastructure.
With better AI, the company could potentially display better, targeted advertisements and that will help its Reels product to monetise better in the future.
Conclusion
Meta Platforms stock is down substantially this year due to its substantial metaverse spending that isn’t currently showing much potential.
Nevertheless, the company has multiple ways to increase earnings and its stock price in the long term.
Investors will, however, need to be patient as these methods will take time to show results.
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Disclosure: Jay Yao does not own any shares of Meta Platforms.
