META - METV ETF: Looking Behind The Metaverse Facade

2023-08-21 07:23:22 ET

Summary

• The Roundhill Ball Metaverse ETF has experienced losses in the past year, while the Invesco QQQ Trust has seen gains due to interest in artificial intelligence.
• Interest in the metaverse theme has declined, with companies like Facebook and Disney scaling back their metaverse plans.
• METV has remained relatively resilient due to its exposure to both the metaverse and AI industry, with holdings in companies like Apple, Nvidia, and Roblox.
• Its exposure to Chinese big tech has been detrimental to its performance.

The Roundhill Ball Metaverse ETF ( METV ) has delivered losses of 2.26% in the last year which does not make it appealing at the current juncture especially when the tech-heavy Invesco QQQ Trust ( QQQ ) has delivered gains of 8.76% mainly due to the buzz around artificial intelligence. This makes you wonder whether there has not been a shift in investors' interest away from the metaverse theme to AI.

It is precisely the aim of this thesis to uncover whether the metaverse theme is now obsolete and what it implies for the Roundhill Ball ETF.

Lack of interest in the Metaverse

Looking in the rear mirror, enthusiasm about the metaverse started to grapple the market in October 2021 as Facebook, the social media company rebranded to Meta Platforms ( META ). At that time, its CEO Mark Zuckerberg's ambition was to create a new generation of internet, where users would circulate in the form of avatars, or their virtual representations and play games, exercise, meet friends, or even work. He wanted Meta to be seen as a metaverse company, but barely 200,000 people connected to its virtual rooms each month as of October 2022. Subsequently, the company abandoned its plans and fired about 10,000 employees in March this year.

A few weeks later, Disney ( DIS ) closed down its metaverse development division, amid a global lack of interest in the theme, but, one event which appears to have sealed its fate is the banking turmoil. Hence, after the bankruptcy of Silicon Valley Bank ((SVB)) which was a creditor to about 50% of all U.S. venture-backed technology startups and was also ready to accept higher credit risks, the virtual reality market in the United States appears to have lost its shine in terms of attracting new capital. This is in sharp contrast to Generative AI, the technology which drives ChatGPT and which is drawing billions of dollars of venture capitalists' funds.

Furthermore, events in the blockchain-led metaverse no longer create the same buzz with one example of a struggling platform being Decentraland , a major virtual world where users trade virtual real estate in the form of non-fungible tokens (NFTs). The platform was once popular but is currently in trouble , with low interest in owning virtual land with the price of real estate dropping by as much as 80% in March. This gloom also seems to be pricing in the impact of the cryptocurrency crisis with the value of Bitcoin now being less than two third of its 2021 peak.

There was some more bad news, this time for stock market investors in May when there was an announcement that one of the ETFs focused on the metaverse called the Subversive Metaverse ETF ( PUNK ) would be closed down. The issuer Subversive Capital Advisor called the sector " misguided " and decided to shift its energy toward AI.

PUNK has gone defunct since May 31, but, far from facing an erosion of investor confidence, METV lost only 9.25% of its value since that time as illustrated below. Also, with assets under management of over $400 million, a level that it crossed in the second half of 2021, the ETF has been relatively resilient.

METV's relative Resiliency due to AI

This resiliency is due to its holdings (as pictured below), which, in addition to providing exposure to the metaverse also play leading roles in the AI industry. First, there is Apple ( AAPL ) with its iPhone, iPad, and MacBook devices which can be envisioned as the gateways for people to access AI applications, whether these are developed on Microsoft's ( MSFT ) Azure, Alphabet's ( GOOG ) GCP, or Amazon's ( AMZN ) AWS cloud infrastructures.

All of these stocks form part of METV's holdings and have been largely responsible for its 32% YTD upside, built the one which has outperformed them all is Nvidia (NVDA). This semiconductor company produces the chips which have enabled OpenAI's ChatGPT to be so prolific in generating reports on any subject you may query it. Also, it proceeds at a rapid pace by digesting the vast amount of data available on the internet, with the rendering done in such a way that it seems like an actual human being has contributed to the work.

As for Roblox ( RBLX ), in addition to being an online game platform, it also enables developers to create games and has recently added Generative AI tools for creators to develop more engaging experiences. Thus, its gaming universe could considerably benefit. Next, there is also Meta which I mentioned earlier, and, which has also opted for AI.

Now, together, the above-mentioned seven stocks form around 36% of the Ball Metaverse Index which is tracked by METV.

AI Strength but Weakness due to Chinese Tech

As for the other holdings, as I have shown in a recent publication , most of them have an AI strategy that is not necessarily about ChatGPT-style chatbots but more traditional flavors of AI like Analytics and Conversational, but, which are also getting traction following the success of ChatGPT.

For this purpose, artificial intelligence can enable additional productivity gains according to researchers from McKinsey, but this also depends on the pace of adoption. In this respect, most of the big tech companies held by METV have already chosen AI to optimize business operations and cut down on costs as illustrated by the more than 150K job cuts they have collectively announced.

Looking ahead, this should translate into better earnings for tech companies in 2024 since the job cuts mostly take effect this year and should also reverberate positively on METV. However, its exposure to Chinese big tech has been particularly detrimental to its value as of May this year when it became evident that the post-Covid economic recovery in that country was turning out to be uneven . For illustration purposes, the chart below shows how the stocks of Tencent ( TCEHY ), Baidu ( BIDU ), and Alibaba ( BABA ) have been weighing on METV's share price relative to QQQ which has much less international exposure .

Therefore, behind the metaverse facade, the Roundhill ETF provides exposure to a cocktail of tech stocks that are not only reinforcing their product offering through the use of AI but also using the technology to streamline their own internal business processes. On the other hand, METV's approximately 9% exposure to Chinese stocks should continue to weigh on its performance in case the country's economic problems is worsening according to more recent data.

In these circumstances, unless there is an asset reallocation away from China or there are stimulus measures by the country's leadership, I have a sell position. Moreover, considering valuations from Morningstar, METV's lower price-to-earnings of 24.95x compared to QQQ's 26.16x are justified and metaverse ETF's share price could further dip to the $9 support level, down from the current share price of $9.5.

However, for those wanting to position themselves for the longer term, it is unlikely for the Roundhill ETF to suffer from a value erosion, which I justify through a comparison with peers.

METV is not a Buy Currently

This comparison shows that METV has a much higher AUM of above $100 million, with more than 300K shares traded daily on average. It has also enabled better gains, either on a YTD or one-year basis, and has been around for more than three years implying that it is less likely for the issuer Roundhill to shut it down.

Substantiating my position further, I look at Roundhill's selection criteria which is pictured in blue below.

In this case, while the ETF is designed to track the performance of the metaverse, it equally invests in companies supplying computing power, network connectivity, and hardware. Coincidentally, these are the very ingredients also necessary to drive AI applications as exemplified by Nvidia whose GPU cards are not only well-suited for better gaming experiences but also to power computers hosting large language models needed by ChatGPT.

There are other criteria as well such as platforms and content, but these services are also being provided by the tech companies which are using AI to create more engaging experiences.

In conclusion, behind METV's metaverse theme which is now becoming obsolete, there are holdings that are leveraging AI. However, after a 32% gain since the start of 2023, it would be prudent to adopt caution and wait for the Federal Reserve's next meeting in one month's time when a key decision about interest rates is awaited. In this respect, the U.S. economy continues to demonstrate resiliency , and inflation has come down, but, hawkishness by the U.S. Central Bank could spell volatility to equities in general. Equally important, there is also the earnings season with Nvidia expected to announce results on August 23 . Finally, as an actively managed ETF, the fund managers can also reduce the fund's exposure to more volatile China-based holdings, and an update on this matter would be most welcome.

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