One of the buzziest terms this earnings season has been "the metaverse". But what exactly does it mean and how can investors get ahead of this trend?
August 16, 2021
One of the buzziest terms this earnings season has been “the metaverse.” On Facebook‘s (NASDAQ: FB) conference call, metaverse was mentioned 20 times. Microsoft (NASDAQ: MSFT) CEO Satya Nadella said, “As the digital and physical worlds converge, we are leading in a new layer of the infrastructure stack, the enterprise metaverse.” There is now even an ETF devoted to the theme, with Roundhill Investments recently launching the Metaverse ETF (NYSE: META).
While it’s hard to find a definitive description of what precisely the metaverse is, we can get close by calling it an immersive virtual environment complete with social activities, games, work functions, and even a functioning economy. When Mark Zuckerberg was asked this same question, he answered:
So what is the metaverse? It’s a virtual environment where you can be present with people in digital spaces. You can kind of think about this as an embodied internet that you’re inside of rather than just looking at. We believe that this is going to be the successor to the mobile internet. You’re going to be able to access the metaverse from all different devices in different levels of fidelity — from apps on phones and PCs to immersive virtual and augmented reality devices. Within the metaverse, you’re going to be able to hang out, play games with friends, work, create, and more.
It might seem easy to dismiss the metaverse as child’s play, fit for a few games and niche industrial uses. But the metaverse has far more potential than just a new gaming platform. Morgan Housel has noted, “Just like the Wright Brothers, most important innovations are only obvious in hindsight. There is a long history of world-changing technologies being written off as irrelevant toys even years after they were developed.”
For investors interested in looking for opportunities in this space (with the caveat that this is still a nascent platform far from maturity), these three companies will probably help shape the future of the metaverse and share in its profits: Facebook, Tencent Holdings ADR (OTC: TCEHY), and Unity Software (NYSE: U).
It’s impossible to talk about the metaverse without mentioning Facebook. Facebook Reality Labs is the company’s division of developers, engineers, and researchers that work on the future of virtual and augmented reality (VR/AR). The social media giant has poured resources into Reality Labs. In 2017, Facebook had about 1,000 engineers and developers working on VR/AR. Its Reality Labs division now employs closer to 10,000 employees — a tenfold increase in just four years — demonstrating just how much Facebook has ramped up its VR/AR efforts.
To date, these efforts have proven effective as Facebook’s Oculus sales have taken off, a recent speedbump notwithstanding. Facebook’s Other Revenue, where Oculus revenue is accounted for, has exploded in recent quarters. Through the first six months of 2021, Other Revenue has grown to $1.23 billion, an 85% increase over the 2020’s first half. Facebook recently offered a voluntary recall of its Oculus Quest 2 headset, as a small number of users reported skin irritation from its facial foam interface. But this is a relatively minor setback that should matter little over the long term.
After butting heads with Apple (NASDAQ: AAPL) over new privacy policies it enacted for iPhones, the importance of owning the next computing platform has never been more apparent for Facebook. Zuckerberg has even said that the metaverse represents the “next chapter” for Facebook as a company. He believes that people will see Facebook as primarily a metaverse company, not a social media company, in the coming years. In the company’s 2021 second-quarter conference call, he continued:
I see our focus here as a continuation of our work to build technology that brings people together. In many ways, the metaverse is the ultimate expression of social technology. Some of the experiences I’ve dreamed of building since well before I started Facebook are only starting to become possible now. If you look at the investments we’ve made over the years, you can see this vision gradually starting to come into focus, and you can see why we’re so excited about it.
Tencent is a Chinese internet giant with investments and businesses across a wide range of services, including mobile payments, social messaging, cloud services, and, of course, games. Indeed, Tencent is the world’s largest gaming firm, raking in $21 billion in revenue and $7.4 billion in profits from its gaming divisions in 2021’s first quarter.
Tencent is also the leading global investor in game studios, with a 40% stake in Epic Games, the maker of popular video game Fortnite; 5% of Activision Blizzard (NASDAQ: ATVI), owner of the Call of Duty franchise; and 5% of Ubisoft Entertainment (OTC: UBSFY). Its messaging platform QQ allows users to message across games, enabling them to integrate social and content consumption experiences better.
In the company’s first-quarter conference call, Chief Strategy Officer James Mitchell said the metaverse is a wide-open opportunity and explained why Tencent was well-positioned to take advantage of it:
Now I wouldn’t say that Metaverse is a genre. Metaverse is more of an overarching opportunity in which different kinds of games are played within a single sort of social graph and software suite … And that’s a wide open field at the moment. No one has realized that vision yet, although some people are closer than others. And we certainly believe that we’re in a good position to be one of the companies that realizes that vision given our expertise at creating and operating games, given our history of facilitating social interactions and also given our cloud infrastructure at the back end because the Metaverse will be very infrastructure intensive.
Unity’s software platform enables creators to make real-time 2D and 3D interactive content for mobile devices, PCs, consoles, and AR/VR glasses. In the company’s 2021 second quarter, revenue rose to $273 million, a 48% increase year over year, marking the 11th consecutive quarter of greater than 30% growth. No matter which AR/VR platforms win over consumers or which future gaming titles become hits, there’s a good chance Unity will create the content.
In the company’s conference call following its earnings announcement, CEO John Riccitello stated:
As I’ve said before, we believe in the emergence of the metaverse and that Unity will be a major player in defining and help lead its creation and operation. We believe the adoption of real-time 3D will change the way people interact with digital content and entertainment … Unity’s mission and world view centers on a belief that the world is a better place with more creators. At Unity, we intend to support and shape the metaverse. We will emphasize content creation, cross-platform access and narrowing the distance and reducing the friction between creators and consumers.
The metaverse is still more an abstract concept than a reality at this early stage, but there’s a lot of smart people in the room who seem to believe it represents our digital future. These three companies offer investors a way to be exposed to this trend without risking a lot of capital if the metaverse never fully materializes as expected. All three of these businesses are currently capitalizing on real opportunities in other sectors, such as social media, digital payments, and gaming.
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