Advertising, AI and Hardware Will Push Revenues and Earnings Higher

Key Takeaways

• Meta can maintain social media dominance via new products, AI and continued advertising trends. 
• Its LlaMA models are more adaptable and customizable, which will drive developer adoption.
• Strong balance sheet will help fuel AR/VR innovations, like AR glasses.
• Meta may not dominate AR/VR, but should lead with cost advantages.

Catalysts

Portfolio Diversification

Going forward, I believe Meta will reduce its dependency on Family of Apps (FoA) segments by significantly growing its Reality Labs revenues. Fuelled by the fast market development and new products, I expect Reality Labs to become profitable by the second half of 2026 when revenues outpace significant CAPEX investments that would lay a path for Zuckerberg's target of 1 billion people in the metaverse.

However, I expect further diversification within the FoA segment, as I believe its Thread app, which is a direct Twitter competitor, can achieve a successful launch through synergies with its other app to siphon away at least 20% of Twitter’s market share, worth at least $600m per year.

AI Driving ARPU Growth

Meta is making significant changes to its advertisement business. I expect its advertising revenues to exceed $210 billion by 2028, driven by an open-source approach to language models. This translates into an average 13.2% CAGR growth per year for the next five years.

I believe that advanced AI systems like Meta Lattice will deliver ARPU growth through better user targeting. Leveraging AI offers an opportunity to reach audiences beyond advertisers’ manual selection and generate more leads for their budgets.

I expect global ARPU to grow to $15 globally (up from $9.62 in Q1 of 2023), driven by the US/Canada region, while I expect Asia to remain a laggard.

Continuous Domination in the AR/VR Segment

I believe Meta will be able to capture a broader user base in the VR industry as its incoming Meta Quest 3 is 7 times cheaper than Apple’s Vision Pro. The user base will eventually serve as a launching platform for the first pair of full-fledged AR glasses in 2027.

For Meta to thrive, Metaverse, as they envision it, has to become the next big thing. The Metaverse will become the next evolutionary step in global social media design, connecting 1 billion people by 2030.

Meta will monetize the Metaverse by selling virtual goods and next-generation immersible advertisements that connect users and brands like never before (likely within the Reality Labs revenue). By continuing to leverage AI and Meta’s large datasets, its cost-efficient targeted advertising will continue to get better.

Meta’s efficiency will reduce costs

Meta has already shed about 21,000 employees, incurring short-term severance costs but saving billions in the long-run. Alongside promoting from within and reducing employee acquisition costs, this “Year of Efficiency” will strive to make the organization flatter. 

Zuckerberg plans to remove multiple layers of management, claiming that a leaner organization will be more fun, fulfilling and become an even greater magnet for the most talented people. Additionally, they plan to use AI to speed up engineering processes by as much as 50%, reducing engineers idle time and increasing the output.

Assumptions

Metaverse hardware & services revenue will grow

Although I don’t expect Meta to keep a dominant presence in the AR/VR market (due to competition from Apple and others), I believe it can keep a market share of over 50%. Global AR/VR headset shipments are expected to grow from 22 million units in 2023 to 60 million units in 2028, which I assume Meta will be responsible for 30m of.

A more modest estimation of 40% would estimate sales of 24 million units in 2028, where Meta would sell 11 million units. 

Considering a competitive average price cost of $799 per unit, this would result in hardware sales between $8.8bn and $23.9bn. Given the wide range of possibilities, I’ll go somewhere in the middle and assume $15bn in revenue from this segment.

I assume that users will have at least one paid app per device at an average cost of $20/month, contributing to Meta’s software revenues. I assume they’ll use a 30% revenue share model (even though there’s been discussions about 50% splits), Meta will keep $72/year per new user (30% revenue share x $240 annual subscription).

This implies an additional software revenue of minimum $800m in 2028 alone, excluding cumulative sales which could be significantly higher. But to be conservative, I won’t attribute any of this in my valuation.

Meta’s profit margins will grow to 25% as cost-cutting takes effect 

Meta’s operating expenses exploded in recent years as the company was spending for growth, and expanding into the Metaverse. The company’s operating expenses rose from $16bn in 2018 to $59bn in 2023, a 29% annual increase compared to revenues which only grew 20% annually.

Thus, it is unsurprising that Zuckerberg announced 2023 as “the year of efficiency.”  Former Executive VR Consultant John Carmack resigned, claiming that the organization operates at half the effectiveness.

Therefore, Meta will reduce the hiring pace and promote from within and through internships.

According to levels.fyi, Meta’s employee benefits were attributed to $38b in expenses in 2022, bringing the unallocated OPEX (operating expenses) to $16.6b. This includes all other costs like travel expenses, software bills, gadgets, furniture, etc. In total it comes to $210,000 per remaining employee – plenty of space to trim the expenses.

Pivoting isn’t cheap and expenses heavily weighted on Meta in recent quarters, suppressing its net profit margin. However, if the company continues focusing on cost-cutting, I expect its net profit margins to revert toward a longer-term average of approx. 25% by 2028.

Stock buybacks will outpace stock based compensation

Meta started buying back stock in 2017, but its stock-based compensation (SBC) has accelerated recently, exceeding $10b in 2022. However, in that same year the company repurchased $27.9b of its shares.

In February, it announced a $40b share repurchase program. Thus, I expect buybacks to comfortably outpace SBC, eventually resulting in a steady decline of shares issued (1.2% per year) by around 6% by the year 2028.

Risks

Regulatory Challenges

Meta along with most of the mega tech sector face intensifying regulatory scrutiny globally, particularly around data privacy, antitrust issues, and content moderation. Any new regulations or fines could impact Meta's business model, particularly its ad targeting abilities. The discussions around changes in digital advertising rules and potential antitrust regulations, like the EU's Digital Markets Act, could pose significant threats to Meta's current operating model.

Dependence on Ad Revenue

Despite efforts at diversification, a substantial portion of Meta's revenue still comes from advertising. Any changes in the digital advertising landscape, such as ad-blocker usage, changes to third-party cookie policies, or increasing privacy consciousness among users could negatively impact this revenue stream.

Execution Risk in AR/VR and Metaverse Initiatives

The successful implementation of Meta's ambitious AR/VR and metaverse plans hinges on numerous uncertain factors. These include technological advancements, consumer acceptance of this new form of interaction, and the willingness of developers and businesses to build within the metaverse. To put it simply, for the metaverse to succeed, the market needs to want it. No amount of product positioning or investment in the metaverse will be fruitful from Meta’s behalf unless they get the supoprt of consumers and developers.

Cybersecurity and Data Breaches

As a company dealing with billions of users' data, Meta is constantly at risk of significant cybersecurity threats and potential data breaches. Any successful cyber-attack or data leak could harm Meta's reputation, result in substantial financial penalties, and lose users' trust, impacting its user base and, consequently, its revenue.

Global Economic Conditions

We’ve already seen tougher economic conditions impacting advertising revenue. The equation is quite simple really. Tougher economic conditions mean consumers are less likely to have and want to spend excess cash and so advertising initiatives are less successful. The ongoing effects of a global cost-of-living crises off the back astronomical inflation and rising interest rates could mean that Meta’s advertising revenue will be impacted more severely for longer.