Meta Platforms (formerly Facebook) is a multinational technology giant headquartered in California, USA, with Facebook, Instagram, WhatsApp and other products and services. Meta is one of the most valuable companies in the world and one of the top 10 publicly traded companies in the United States. Meta has a profound influence and innovation in the field of artificial intelligence (AI), and its open source strategy, talent introduction, global innovation and economies of scale have put it at the forefront of AI. AI has had a positive effect on Meta's user experience and revenue growth, as can be seen in its financial report for the first quarter of 2023. Meta's financial position also demonstrates the resilience of its business model, maintaining steady revenue growth and shareholder value despite the challenges.
Meta's AI journey
Meta has been in the AI field since 2013, with Yann LeCun leading its AI research lab. Since then, it has made significant progress. One of the important contributions was the development of PyTorch, a leading AI programming language.
PyTorch's impact on the AI industry is profound. It has been widely adopted by AI researchers and developers worldwide because of its flexible and intuitive design, which accelerates the AI model development process and promotes AI innovation and advancement.
To support community development, Meta has also publicly shared more than 30 AI models and frameworks, including the recently developed Large Language Model (LLaMA) and computer vision models. This open source strategy makes advanced AI tools accessible to the masses and drives progress throughout the AI community.
AI has become a force for change within Meta, shifting the user experience from being social graph-oriented to being driven by an intelligent recommendation engine. In addition, we recognize the potential of Meta's growing AI-driven advertising tools. These tools are expected to offset the impact of Apple's App Tracking Transparency (ATT) policy and facilitate a recovery in revenue growth.
Yann LeCun, as head of the Basic AI Research Lab, is focusing more on the academic aspects of Meta's AI project. Meanwhile, on the product side, we're seeing Ahmad Al-Dahle leading the way. Al-Dahle, a veteran of Apple, reports to product director Chris Cox, who returned to the company in 2020 and reports directly to CEO Mark Zuckerberg.
Meta's stance on open source AI
In our analysis, Meta's continued dedication to the open source community clearly positions it as a leader in the field. The company not only demonstrates its commitment to transparency by open-sourcing its AI models, but accelerates the entire AI community by allowing researchers and developers to use, improve, and innovate based on their work.
The recently released LLaMA LLM model and groundbreaking visual models such as Segment Anything, DINOv2 and Animated Drawings are testament to Meta's drive for community development. These models not only expand the possibilities of AI, but also make them available to the public, sparking innovation that could lead to unexpected breakthroughs that benefit the entire tech ecosystem.
Meta's open source strategy is markedly different from other tech giants such as Alphabet (Google), Microsoft (MSFT), and Amazon (AMZN). Instead of privatizing its software infrastructure, Meta creates industry standards through its open-source tools. Essentially, Meta is nurturing an ecosystem of shared progress in which everyone benefits — in stark contrast to the more closed, competitive strategies of other companies.
One of the most notable examples of this strategy is the development and open-source PyTorch, which is now one of the industry-standard tools. By making this tool available to the broader developer community, Meta has established a foundation on which any improvements or innovations made by external developers can be easily integrated into their own systems, creating a mutually beneficial relationship that improves the efficiency and effectiveness of the entire AI development ecosystem.
However, it should be clarified that not all of Meta's work is or will be open source. The company recognized the need to create unique value in its own products. They seem to have found a good balance between contributing to the open source community and keeping their products apart from the know-how.
In our view, Meta's commitment to open source is not only a contribution to the tech community, but also a shrewd move that brings numerous strategic benefits. Meta's open source strategy is a powerful magnet for attracting top talent. Engineers and researchers prefer to use tools and platforms they are familiar with. By open-sourcing its AI models and tools, Meta actually provides a playground for potential employees where they can learn and innovate using Meta's technology. It's an ingenious way to nurture the next generation of AI professionals who have adapted to Meta's ecosystem.
Furthermore, it's clear that Meta's open source strategy isn't just about promoting friendliness or establishing industry standards — it's a smart way to stay on the cutting edge of AI innovation. By opening up its technology to the world, Meta effectively harnesses the collective wisdom of researchers and developers around the world. Every innovation made in this community using Meta's models and tools is a potential addition to the company's technology arsenal, turning the global open source community into a de facto R&D department that is constantly operating and driven by passion rather than profit.
Another significant advantage of this approach is the efficiency of scale. By encouraging widespread use of its tools, Meta can spread the costs associated with development, updates, and troubleshooting across a larger user base. This not only reduces Meta's own spend, but also lowers costs for all users, which increases the accessibility and attractiveness of the tool, which in turn drives further expansion of the user base.
The first quarter 2023 earnings report reveals a treasure trove of AI capabilities
Meta's Q1 2023 earnings report clearly demonstrates the central role of AI in the company's strategic vision. Notably, two parallel waves of technology underpin Meta's growth roadmap – the current and dominant AI wave and the expected metaverse wave. These insights provide shareholders with a clear view of Meta's strategic path and, in our view, reassure the company's solid foundation.
The company's vast recommendation and ranking infrastructure is one of the twin pillars of its AI strategy, affecting all product lines. The benefits are already beginning to show. In fact, it was revealed on the conference call that AI now recommends more than 20% of Facebook and Instagram feeds from non-following sources, and a staggering 40% on Instagram overall, demonstrating the effective integration of AI on the Meta platform. However, we believe that Meta should pay close attention to ensuring that this AI-curated content remains relevant and non-intrusive to avoid possible opposition from users who value its curated social feed.
What really shines through Meta's AI investments in user engagement and revenue growth is its impact. With the launch of Reels, AI recommendations drove a significant 24% increase in time spent on Instagram, a significant win for Meta. Monetization efficiency is equally impressive, growing more than 30% in the last quarter on Instagram and more than 40% on Facebook. Advantage+ shopping activity daily revenue grew sevenfold in six months, a clear sign that Meta's AI investments not only improved the user experience, but also drove strong revenue growth. In our view, these are tangible results that should give investors some confidence in Meta's AI strategy.
Meta's work on generative basic models is the second focus area of AI and has great potential. We're curious about how these models can transform apps and services, potentially opening up new avenues for user engagement and revenue growth. However, implementing these models on different platforms, such as WhatsApp and Messenger, will require careful execution to ensure a seamless user experience.
We see the integration of AI agents into business messaging and customer support as an exciting development with great prospects. As these tools evolve, we expect them to extend to Meta's metaverse work to enhance the interactive experience of virtual space.
Finance & Valuation
Note: All historical data in this section is from Company 10-K files, and all consensus data is from FactSet.
Meta's fiscal 2023 first-quarter earnings report gave investors a fresh breath, with shares soaring 13.9% after the announcement. The company managed to beat consensus revenue expectations by 3.5%, reporting a year-over-year increase of 2.6% to $28.6 billion. Meta is commendable for exceeding revenue expectations in such a challenging market environment, demonstrating the resilience of its business model.
However, Meta's operating margin was 25.2%, down from 30.5% in the year-ago quarter, indicating higher operating costs. In our view, this is an area worth watching closely because lower margins could hurt long-term profitability. Despite this, Meta still delivered earnings of $2.20 per share, down 19% year-over-year but still beating the consensus of 8.9%. This exceeded expectations and showed that the company was able to create shareholder value with margins under pressure.
Considering financial trends, Meta's revenue growth was driven by an 18.2% CAGR over the past three fiscal years, underscoring the company's ability to consistently scale its revenue. While seller consensus forecasts growth to slow to 8.0 percent this year and 10.8 percent next year, that's a realistic expectation, given the company's size and market saturation. Nonetheless, we remain optimistic about Meta's ability to maintain steady revenue growth.
Worryingly, the company's earnings before interest and taxes (EBIT) margin has contracted by 9.1 percentage points over the past three fiscal years. Happily, consensus expects Meta's EBIT margin to expand by 540 basis points this year and a further 262 basis points next year. If realized, it would be a positive sign for Meta's profitability.
Interestingly, over the past three years, Meta has spent 8.6% of its revenue on stock-based compensation. This was offset by the company's robust share repurchase program, which saw an 8.7% decrease in the number of diluted common shares over the same period. However, EPS growth of 10.1% over the past three fiscal years has lagged revenue growth, hinting at potential efficiency issues. Future EPS growth is expected to be 37.8% (this year) and 23.7% (next year), which will be an important metric to watch closely.
Meta's free cash flow (FCF) forecast for the current fiscal year is $23,453 million, equivalent to an FCF margin of 18.6%, down from 28.8% four years ago. However, considering the company's historical average FCF margin of 27.5%, we consider Meta's current FCF margin to be an outlier and expect it to return to near average. We also note that Meta's capital expenditure is 21.4% of revenue, indicating that it is relatively capital-intensive, suggesting significant investments in infrastructure and business expansion.
With a 16.0% ROI and $33.681 billion in net cash, Meta is well positioned for future growth investments. We are also encouraged by the company's impressive stock performance over the past year, which has outperformed the S&P 500 by 35 percentage points.
Meta's current valuation is mixed. At an enterprise value/sales (EV/Sales) multiple of 4.6x, an enterprise value/EBIT multiple of 14.1x, a price-to-earnings (P/E) multiple of 18.1x, and a free cash flow (FCF) multiple of 24.3x, Meta is at a premium on some metrics and at a discount on others.