Meta platforms set to double down on Reality Labs (NASDAQ:META)

Thesis

Since Facebook first presented its vision for the metaverse and became Meta Platforms, Inc. (NASDAQ: META), the stock fell lower and lower, eliminating a previous “bottom” almost every week. Investors are clearly concerned about the future prospects of the social media empire, as competition with TikTok intensifies. Additionally, investors don’t like Meta’s aggressive investments in R&D to support Reality Labs and the company’s metaverse strategy.

But I do not agree. I think CEO Mark Zuckerberg’s push into the metaverse is the right strategic move. In my opinion, as the penetration of social media around the world matures, there are only two potential outcomes for Meta: either gradually losing market share and profitability in fierce competition with advertising companies online such as TikTok, YouTube, and now also Netflix; or innovate to lead the race to the $13 trillion metaverse economy.

In my opinion, being on the offensive with creative innovation in a new market always trumps competition in a mature market. And personally, I am convinced that Mark Zuckerberg can achieve his ambitious goals. So far, the market disagrees. Meta Platforms stock is down about 65% from all-time highs. But I remain a confident maverick – the lower META stocks go, the more I buy.

Financial discipline through lower R&D?

On September 29, new surfaced that Meta Platforms was pushing to implement a hiring freeze and corporate restructuring. ApparentlyZuckerberg told employees that the company will need “plan somewhat cautiously“, because the company will probably have”fewer resources to work with than expected.”

Following Zuckerberg’s communication, investors are hoping Meta will significantly reduce R&D investment in Reality Labs, as analysts have frequently pointed out how this segment puts pressure on the company’s margins and free cash flow: for the last twelve months, the segment recorded a net loss of almost 12 USD. billion on revenues less than $2.5 billion.

Although as an investor I always encourage more financial discipline, I am strongly to disagree with the prevailing market sentiment that Meta Platforms should cut funding for Reality Labs. In my opinion, cutting back on investment to make an already very profitable business slightly more profitable in the short term will likely hurt the business significantly in the long run.

Meta’s need for innovation

Before we can discuss why Zuckerberg’s Reality Labs ambitions make sense, it’s worth considering why the move might be necessary.

With Facebook, Instagram and WhatsApp, Meta Platforms has arguably the most popular digital communication infrastructure in the world, especially for text and phone. But in the recent past, communication – and entertainment on social media – has gradually shifted to video.

According to data provided by investment boutique Piper Sandler, only 22% of American teens say Instagram is their favorite social media platform, up from 29% in 2015. The same indicator for Facebook fell to 3%, from 12 % in 2015.

Mark Zuckerberg describes it as follows: (emphasis added):

When I started in 2004, the primary means of sharing online was text. Then we had phones… with cameras and it became mostly photos, now it’s the video…

That said, compared to other platforms – notably TikTok and YouTube – Meta Platforms is somewhat behind in adopting video as a primary communication and engagement tool. And so, the argument goes, meta-platforms will gradually lose their competitive edge.

But Zuckerberg added that the evolution of communication will inevitably continue (emphasis ours):

But that’s not the end of the line. There is something after text, photo and video. Communication is becoming more and more immersive.

And immersive communication is exactly what Meta hopes to achieve through its metaverse ambition.

The Metaverse: A $13 Trillion Opportunity

Metaverse is nothing but a generic term for immersive experiences. As the adoption and sophistication of VR technology advances, as it undoubtedly will, the technology will fundamentally change the way people communicate, play, work and learn online, with respective disruptions to the social media landscape, the gaming industry, the education industry, as well as the arts and entertainment sector.

McKinsey estimated that the market potential for the metaverse economy could reach $5 trillion in 2030, as the leading strategy consultancy noted strong excitement “surveying 3,400 consumers and executives about metaverse adoption, its potential, and how it can change behaviors.”

Citigroup (C) analysts are even more bullish on the metaverse and its economic potential. The US investment bank has estimated that the economic value of VR/AR-related applications could reach $13 trillion by 2030.

Personally, I agree with McKinsey and Citigroup regarding the huge potential of the metaverse opportunity. And it’s exciting to know that Zuckerberg still agrees. On the Q2 analyst call, Meta’s CEO commented (emphasis ours):

I am even more convinced now that the development of these platforms will unlock hundreds of billions of dollars, if not billionsover time.

The market currently does not see the potential of the metaverse as strong. But is this lack of enthusiasm a function of correct anticipation of failure, or is it a function of extreme risk aversion caused by depressed economic growth sentiment? I believe the latter is the case. Consider that adoption of VR/AR devices could top 100 million users by 2025, according to Counterpoint estimates.

In a previous article, I argued that market sentiment towards Zuckerberg’s metaverse strategy may turn more positive with the launch of the company’s new VR console – Project Cambria – which is slated for release in the coming weeks.

Conclusion

Zuckerberg’s metaverse bet is brave. But is its ambition for social connection via VR/AR unreasonable? I do not think so. In my opinion, VR/AR is the next frontier of innovation. And I believe that the market potential of the metaverse could rival the value creation materialized by the Internet revolution.

As an investor, I’m happy to know that despite leading a multi-billion dollar empire, Zuckerberg still thinks like an innovator and entrepreneur. And investors should never doubt the power of entrepreneurship. Here are some “expert opinions” on the greatest innovations in history.

1878, Sir William Preece on the telephone:

…we don’t need (a phone)…we have a lot of couriers.

1927, HM Warner on voice television:

Who the hell wants to hear the actors talk?

1977, leader of IBM on the PC:

There is no reason for an individual to have a computer at home.

2007, Steve Ballmer on iPhone:

(the Iphone) …is the most expensive phone in the world. And it doesn’t appeal to business customers because it doesn’t have a keyboard. What makes it a very bad e-mail machine…

In my opinion, Zuckerberg should move forward with his vision. He shouldn’t cut funding to Reality Labs. He should add more.

“Editor’s Note: This article was submitted as part of Seeking Alpha’s Best Contrarian Investing Competition which runs until October 10. With cash prizes and a chance to chat with the CEO , this contest – open to all contributors – is not the one you want to miss. Click here to find out more and submit your article today!”