Meta Faces Uphill Battle Against TikTok, Analyst Points to Margin Headwinds and Valuation Pressure

Needham analyst Laura Martin reiterated Meta Platforms Inc META with an Underperform rating. The analyst valued Reels based on a deep dive into its consumer reach, time spent, and ad revenue trends.

META must try to regain creators, users, and advertisers from TikTok. 

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Still, as she sees it, either META loses, which is the worst case for shareholders because META's core business has no terminal value without creators and users, or META wins but its ROICs and EBITDA margins will fall structurally because TikTok's normalized margins at maturity are 30%-50% below META's historical EBITDA margins of 30%-40%, she estimates. 

A portion of TikTok's ROIC is not financial but data instead, so for META to beat TikTok, its financial ROICs must fall. META must compete with TikTok for creators and users, creating a structural margin headwind for META.

Reportedly, ByteDance lost $7 billion on $80 billion of total revenue in 2022, implying a negative profit margin of 9%. In 2022, TikTok's global ad revenue was $9.9 billion (i.e., 11% of total ByteDance revenue), up 155% Y/Y, of which $5 billion came from the U.S., according to eMarketer. 

Owing to its nascence, Martin estimates TikTok's profit margin at negative 25%, well below the negative 9% average for ByteDance. 

Data collection represents a core value to TikTok's owners and that they will settle for a lower financial ROIC hurdle rate than META has accomplished in the past. To win, META must lower its ROICs to below TikTok's, which is value destructive to META shareholders when compared to META's historical ROICs (i.e., FCF/investment). 

Between 2019 and 2022, META generally traded at 6-7x forward-year revenue, by Martin's calculations. Today, META is valued at 3.4x FY24 revenue (the forward year), owing to its Metaverse aspirations and market share losses to TikTok. 

Even assuming that TikTok demands a positive ROIC (i.e., FCF/investment) of 15% annually, this is well below META's historical margins of 30%-40%. 

Price Action: META shares traded lower by 2.62% at $314.26 on the last check Wednesday.