Meta’s Network Effect Is Sound, and We Expect Higher Monetization in 2H; Shares Undervalued
While Meta posted mixed first-quarter results, what stood out was the increase in both monthly and daily active users, which demonstrates that the firm’s strong network effect remains intact. We are pleased that while Meta continues to focus on metaverse opportunities in the long run, it is also increasing its efforts and investments in its very profitable advertising business to overcome obstacles created by Apple and position itself to benefit from the growing short-form video trend. With lower-than-expected first-quarter revenue and Meta’s revenue guidance for the current quarter, we have reduced our projections a bit, which lowered our fair value estimate only 4% to $384. We view this wide-moat name attractive as it is trading at less than half our fair value estimate.
Meta’s ongoing strategy to monetize Reels, which currently has lower ad prices, was partially responsible for the revenue miss, as it drove its user monetization down slightly from last year. However, we remain confident that over time Meta will increase Reels monetization by attracting more advertisers with its large user base that is spending more time consuming content on Reels. While we expect Meta to keep facing pressure from policy changes at Apple, competition from the likes of TikTok, and current geopolitical and economic factors, we foresee the successful monetization of Reels and the firm’s investments in ad effectiveness and measurement enhancements will return it to double-digit top-line growth in the second half of 2022 and beyond.
On the user front, the family monthly active people count increased to 3.64 billion from 3.59 billion in the previous quarter and 3.45 billion last year. Daily user count was 2.87 billion, up from 2.72 billion and 2.82 billion in last year’s fourth and first quarters, respectively. Facebook specific daily and monthly user counts increased sequentially and from last year; however, the number of European users declined as Russia has blocked Facebook users.
Fair Value and Profit Drivers
Our fair value estimate is $384 per share, representing a 2022 enterprise value/adjusted EBITDA multiple of 14.5 times our adjusted EBITDA projection. We have modeled 15% average annual growth over the next five years. As the firm plans to further invest in research and development and content creation and virtual reality and augmented reality offerings, in addition to data security, we see average operating margin coming in around 37% over the next five years, comparable with the previous three years.
Meta’s revenue growth will be driven primarily by online advertising and increasing allocation of online ad dollars toward mobile, video, and social network ads. We expect a 10% increase in 2022 ad revenue followed by nearly 19% growth in 2023, assuming a continuing global economic rebound. We expect a 6% five-year CAGR in Meta’s monthly active users, mainly due to strong growth in Asia. We also assume deceleration in overall advertising ARPU growth to 9% per year over the next five years, from the average annual 21% growth the firm displayed over the past five years.
We look for higher growth in operating expenses in 2022 as the economic recovery will allow the firm to more aggressively increase its R&D, especially in metaverse. Such growth will lower margins. We have assumed a 32% operating margin for 2022, lower than 40% in 2021. In 2023, we expect operating margin to widen to 35%. A portion of those investments is in content and data monitoring, which requires a higher headcount. In addition, given the pressure the firm faces from users and lawmakers, legal fees could continue to affect margins.
We expect the operating margin will expand in 2023-2026 to 39%, as lower growth in operating expenses (driven by more automation of content, data, and user monitoring), coupled with revenue growth, creates operating leverage. Our fair value uncertainty rating for Meta is high, based on uncertainty over future advertising growth rates and additional regulations restricting Meta’s access to and use of data, both of which drive growth in the firm’s source of revenue.