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Digital advertising has been transforming the world for decades and this will continue as machine learning keeps making ads more efficient. Back in 2004, Alphabet (GOOG) (GOOGL) had revenue of $3,189 million. A decade of high growth followed such that Alphabet’s revenue had gone up nearly 21 times in 10 years to $66,001 million by 2014. Similar to Alphabet’s 2004 level of revenue, Meta (NASDAQ:FB) had revenue of $3,711 million 10 years ago in 2011. 10 years later in 2021, Meta’s revenue had grown nearly 32 times to $117,929 million which means it doubled up nearly 5 times as it grew revenue even faster than the iconic Google. Many challenges were faced along the way as Meta’s revenue grew prodigiously and lessons were learned with each challenge. The mobile shift of early 2012, the General Data Protection Regulation (“GDPR”) implementation of May 2018 and the Stories shift of late 2018 couldn’t stop Meta’s long term revenue growth:
Meta Revenue (Author’s spreadsheet)
My thesis is that Meta is applying what they have learned from past challenges to navigate through Apple’s (AAPL) privacy changes and the shifts from Feed to Stories to Reels. In the past, Meta increased revenue through the combination of increasing the number of users and making ad innovations. Moving forward, revenue growth won’t be as high because the number of users is largely fixed now. However, the power of ad innovations is tremendous, and Meta will increase revenue more than many other companies in the coming years.
When consumers switched from laptops to smart phones, Meta learned that they could no longer do things the old way. CEO Mark Zuckerberg led by example, writing a shareholder letter of more than 2,000 words on his phone. Navigating through the changing landscape from desktop to mobile helped give Meta a blueprint for future changes like the shifts from Feed to Stories to Reels. A 2019 Vox article explains the challenges faced as Meta shifted to mobile in early 2012. CEO Zuckerberg redirected the company to have a mobile-first focus:
He all but abandoned his laptop and started working primarily from a mobile device. Product managers disabled their own desktop versions of Facebook, forcing themselves to use the mobile version instead. In meetings, Zuckerberg expected employees to present the mobile version of new products first. If they didn’t, the meeting was over. Facebook hired new iOS and Android engineers, held week-long bootcamps to get their existing employees up to speed, and embedded mobile engineers onto every product team at the company.
GDPR taught Meta how to work with regulators and get more things done with less third-party data. It pushed Meta to make better use of the first-party data collected in their apps per a June 2019 WSJ article. GDPR went into effect in Europe on May 25, 2018. Meta’s stock was at $194.32 around that time on June 1, 2018, but there were negative GDPR headlines throughout the year and the stock fell to $131.09 by December 1st. Given all the improvements Meta has made the last few years, it’s crazy that the stock is back down to the June 2018 level. The quarterly average revenue per user (“ARPU”) for Europe was $8.12 back in 1Q18 before GDPR went into effect. This has climbed over the years up to $15.35 for 1Q22. This makes me optimistic that Meta can still increase revenue even after Apple’s privacy restrictions went into place in late 2021.
At a February 2019 Morgan Stanley conference, COO Sheryl Sandberg talked about working with regulators around the world to come up with solutions that are pro-innovation. She mentioned that Meta’s size gives them an advantage over smaller companies in terms of putting things in place that adhere to privacy restrictions. Much of this advantage applies whether the privacy restrictions come from regulators in the case of GDPR or Apple in the case of late 2021:
And so we’re in the process right now of working with other people in our industry and regulators around the world about what is the right kind of regulation. Regulation that’s effective, regulation that can prevent harm while still allowing people to have free expression. And I think, importantly, regulation that’s pro-innovation, because the truth is it’s actually easier for big companies like Facebook, or other big competitors, to put in place things that adhere to regulation than it is for start-ups. If I think back to Facebook 10 years ago, GDPR would have been much harder for us then than it was now. And so regulation, in its core, has to be pro-innovation so that the next Facebook can happen as well.
Per COO Sheryl Sandberg in the 1Q22 call, half of time spent on Facebook is video. Lessons from Stories videos are being applied to Reels videos:
We’ve accelerated our efforts to improve the Reels ads format. Our experience monetizing Stories is directly applicable here. We’re leveraging what we learned with Stories ads to create ads for Reels that have a native format, perform well, and are easy for advertisers to create.
COO Sandberg talked about the 3 main areas of Meta’s advertising strategy in the 1Q22 call. Meta is focused on video monetization, AI investments and the evolution of the ad system to do more with less data. The lessons outlined above from the past have helped shape all 3 of these main areas. At a March Morgan Stanley conference, CFO Wehner broke out broke out the ad strategy for the near term, the medium term and the longer term:
So look, in the near term, we’re using AEM, that’s Aggregated Events Measurement, to help aggregate and [anonymize] data, and that’s going to be important. It’s rolled out, getting better at that, as the year progresses, and is an important effort. In the medium term, we’re moving clients more towards first-party ads and on-site conversion. So that’s click-to-messaging, it’s Shops, lead gen. Longer term, we’re building our ad stack around AI and ML, to throw some acronyms out, using less data.
One way Meta can do more with less data is to make it easier to measure conversions. Privacy restrictions make it hard to track sales on external websites. Another form of conversion is making contact with potential customers and this can be done with messaging apps inside of Meta’s ecosystem as discussed by COO Sandberg in the 1Q22 call:
We’re also helping businesses connect directly with customers and grow more onsite data conversions through products like Click-to-Message ads. This is where you click on an ad in your Facebook or Instagram feed and it opens a chat with the business in Messenger, Instagram Direct or WhatsApp. It’s already a multi-billion dollar business, with healthy double digit year-over-year growth in Q1.
Meta made a May 4th announcement about new ads and messaging tools for small businesses. They noted that nearly 71% of people want to communicate with businesses in the same way they message friends and family:
Many businesses are finding Facebook and Instagram ads that open to a WhatsApp chat the best way to get discovered by new customers and have a conversation. To make it easier to create these ads, starting soon we’ll make it possible to create the full ad directly from the WhatsApp Business app. This will make it faster for small businesses looking to find new customers and grow.
In some ways, the May 4th announcement makes it sound like message marketing will be a partial replacement for email marketing:
We’re testing a new capability that will allow businesses to send promotional message campaigns via Messenger to customers who opt in. For example, a customer may opt in to receiving notifications about upcoming sales, allowing businesses to keep customers in the loop about future sales.
We’ve all been on slow and inefficient customer support calls where frustration sets in as it can be difficult to get a human being on the line. Messaging can help in this regard; it is easier for a customer support person to help 3 or 4 people at a time while messaging as opposed to talking. Here is what Meta says about their upcoming Conversation event on May 19th:
Today, more than 1 billion users connect with a business account across Meta’s messaging services every week, yet many businesses are still stuck relying on phone and email which are not cost-effective, efficient or preferred by their customers. As people’s expectations with how they communicate with businesses shifts, Meta is investing in solutions to support developers, partners, and businesses reimagine how they connect with customers.
Large merchants tend to have in-house development teams to integrate Conversions API (“CAPI”), a pixel alternative that is a direct, reliable and privacy-safe connection between a merchant’s marketing data and Meta. Small and midsize (“SMB”) businesses need help with these types of integrations, so Meta introduced CAPI Gateway, a self‐service configuration option for CAPI where less technical know-how is required. Finance VP Susan Li talked about tools like CAPI Gateway in the 1Q22 follow up call.
I mean, we are – we’re building a variety of tools that I think we are helping advertisers understand how they work, how they work in terms of the aggregation and anonymization and time delay processes and why the tools sort of are the most effective – most effective ways for us to help them measure ad performance in the current ‐‐ in the current ATT environment.
A November 2021 eMarketer report shows that the growth of worldwide ad spending is slowing but we can assuage ourselves by noting that there are still good years ahead:
Digital Ad Spending (eMarketer)
Meta revenue increased 37% from $85,965 million in 2020 to $117,929 in 2021. Per the 1Q22 release, 1Q22 revenue was $27,908 million, 7% higher than the $26,171 million from 1Q21. 2Q22 revenue is expected to be about $29 billion which would be growth of about 1.5% from $28,580 million in 2Q21. The 3Q22 and 4Q22 comps should be easier as we start lapping periods that were impacted by Apple’s privacy change. If full year 2022 revenue is 5 to 10% higher than 2021 then it should be $124 billion to $130 billion. Rather than thinking about revenue growth as 37% one year and 5 or 10% the next, I think about it as being 23% one year and 17 to 23% the next.
There are other valuation concerns besides Apple’s privacy change and the monetization of Stories. A May 5th eMarketer note reveals that Meta’s e-commerce initiative has lost at least 5 executives in 6 months. We know that e-commerce is Meta’s biggest channel and in a perfect world, Meta would be more successful helping merchants sell products directly on IG where measurement and privacy factors aren’t prohibitive. Despite frustrations in this area, Finance VP Li noted in the 1Q22 follow up call that Click to Messaging ads are helpful in the e-commerce space. The 2022 hiring freeze will have a broader impact than just the e-commerce space; a May 6th eMarketer note says it will impact almost every team at Meta.
Trailing-twelve-month (“TTM”) net income is $37.4 billion [$7.5 billion + $39.4 billion – $9.5 billion]. I think much of the capex is made up of growth investments such that adjusted free cash flow (“FCF”) is close to this net income figure. Interest rates matter and Meta will no longer trade at high multiples if interest rates keep getting higher and remain elevated. Given future growth prospects, I think the valuation range is 18 to 22 times TTM net income or $673 billion to $823 billion.
The 1Q22 10-Q filing shows 2,706,323,387 shares outstanding as of April 22nd composed of 2,293,518,778 class A plus 412,804,609 class B. Multiplying this by the May 11th share price of $188.74 gives us a market cap of $511 billion. Given the $14.9 billion in cash and the $29 billion in marketable securities on the balance sheet, the enterprise value is lower than the market cap. The market cap and the enterprise value are below my valuation range, so I think the stock is underpriced.
Investors should keep tabs on the upcoming Conversation event on May 19th to confirm that Meta is continuing to implement the right changes with respect to the new landscape.
Disclaimer: Any material in this article should not be relied on as a formal investment recommendation. Never buy a stock without doing your own thorough research.
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Disclosure: I/we have a beneficial long position in the shares of FB, AAPL, GOOG, GOOGL, VOO 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.