Investors are starting to think of Meta Platforms (META 2.98%) as a value stock, and there are reasons that analysis makes some sense. After falling more than 50% from its high, Meta stock trades for value-like price-to-earnings and price-to-free cash flow multiples.
But under the surface, there are some real challenges facing Meta. Apple (AAPL 0.64%) has fundamentally changed Meta's advertising business, competitors are stronger than ever, and the metaverse is anything but a sure bet for the company. These three challenges make this a more risky stock than it seems on the surface. Let's take a closer look at these three challenges to Meta Platform's future performance.
FB data by YCharts
1. Apple broke Facebook's advertising stranglehold
The core of Facebook's business model is what's called targeted and direct response advertising. This is where a company targets a very specific group of customers and wants them to take direct action, like buying an item or installing an app. The better the targeting, and the better an ad performs, the more advertisers will pay Facebook or Instagram. And for advertisers like niche brands and apps, Facebook and Instagram opened up possibilities that aren't available on platforms that focus on wider audiences, like television, where you don't know exactly who is watching.
Put another way, Facebook would rather generate $100 apiece in ad revenue from 1 million small advertisers than $5 million apiece from 10 big advertisers. The big checks might be nice, but Facebook's advertising pie is bigger because it serves more small businesses.
To make this kind of advertising work, it takes a lot of information. Meta needs to know a lot about users, which is why it installs tracking tools into thousands of apps. It also needs to know who sees an ad -- including information about that viewer like age, sex, location, and interests -- and then what actions they take. If an ad can be directly linked to a sale, it's extremely valuable to advertisers.
When Apple released app tracking transparency changes to its operating system, it effectively broke the tie Meta had to an ad and its conversion. This made it more difficult to calculate the effectiveness of a given ad, and will generally have the effect of bringing down the value advertisers will pay per click, because each ad is incrementally less effective. For Meta, that means less revenue per ad -- and since ads are very high-margin, any lost revenue translates almost directly to lost profit and free cash flow.
Image source: Getty Images.
2. Competitors are taking attention (and dollars)
At the same time, Facebook and Instagram ads are getting less effective at advertising, we are seeing competitors improve their ad offerings. Snap's (SNAP 2.24%) advertising business is booming, Spotify (SPOT 11.41%) is gaining attention with audio advertisers, and of course, Alphabet (GOOG 1.25%) (GOOGL 1.27%) is the giant in the room. Add in an attention competitor like TikTok, and Meta is losing both attention and dollars to the competition.
While the advertising business could be improved over time as Meta finds better ways to tie ads to actions, the attention challenge is more difficult to solve. Younger users are using platforms like TikTok, and both Facebook and Instagram seem to have lost their luster in recent years.
Social networking has historically been very fluid as users adopt new platforms every few years. Facebook has adapted by acquiring competitors when they are young (see Instagram and WhatsApp). But given Facebook's size and regulatory pressure, acquisitions seem off the table, allowing competitors to bloom in ways they haven't since Facebook rose to prominence.
3. The metaverse is an uphill climb
As the core business faces challenges, Mark Zuckerberg is betting Meta's future on the metaverse. Oculus VR headsets seem to be a core piece of that vision. Augmented reality, virtual meetings, social hangouts, and, of course, virtual ads are seen as a big part of the company's future.
I think this is an uphill climb for Meta. For perspective, four years after Facebook was founded in a Harvard dorm room, it had 100 million users. Eight years after it acquired Oculus, there are somewhere around 10 million Oculus headsets in existence and likely significantly fewer active users.
The metaverse clearly doesn't have the same consumer or business pull as social media, search, or smartphones, and I don't think we should assume Meta will be the default winner. Oculus may make a great headset, but the value in the metaverse may come from Microsoft (MSFT 1.65%) Teams, or an Apple headset, or dozens of NFT projects being built today.
Meta may have a metaverse, but I don't think there will be one metaverse to rule them all -- and the amount the company is spending may never be earned back as a result.
Meta Platforms is riskier than it seems
It's easy to see based on backward-looking numbers how Meta's stock looks cheap. But I don't think the future is as rosy as investors think. Advertising is under pressure, competition is better than ever, and the metaverse is a big swing that may miss. If you're jumping into Meta stock today assuming it's cheap, at least know the risks in case the market has this one right after all.
