Facebook,
A fundamental analysis!
January 31, 2019
SHARE PRICE: $166.99
MARKET CAP: $343B
1. INTRODUCTION
With more than 2,2 Billion users on its major platform, 1,5 Billion users on WhatsApp and 1 Billion on Instagram, Facebook is the undisputed world champion of social media. So what makes it different from all other social media that allows it to become this big for so long? Let’s take a better look.
2. BUSINESS OVERVIEW
2.1. BUSINESS DESCRIPTION
Facebook’s business model is a simple one to understand: You sign up to one of their platforms, they collect data like your age, gender, location or interests and then they sell ad space to companies, brands and services. But they don’t sell just any space. With all that data collected, they allow marketers to laser-focus their advertising to their potential customers like no other traditional advertising platform.
Their products are: Facebook; Instagram, Whatsapp, Messenger and Oculus.
2.2. LARGEST SHAREHOLDERS
Mark Zuckerberg is not only the CEO but the largest shareholder as well. One of the things I look for when searching for good companies to invest in, is founder ownership.
Mark Zuckerberg has created a peculiar dual-class stock structure that allows him to have 57% of voting rights while owning about 18% of the company.
That means, among other things, that if you want to take him out of there, you won’t be able unless he wants to. (This kind of share structure is increasingly more common in tech stocks these days)
2.3. MANAGEMENT TEAM
As I was saying, Mark Zuckerberg the famous founder and CEO is the largest shareholder. Among others, we can see that Peter Thiel, the famous Venture Capitalist that co-founded Paypal is still in the company.
3. HISTORICAL CONTEXT
3.1. LONG TERM CHART
Since it went public, the company has gone up 3,5x. The stock price is now $166,99.
3.2. MARKET CAP AND SHARES OUTSTANDING
Given Facebook’s young age there is some dilution for shareholders but not a lot. Facebook has in place two separate share-based employee compensation plans and what we see is the result of that. Meanwhile, in 2018 alone, they bought back $12,9 Billion of their own stock!!!
The recent Market-Cap fall is due to privacy scandals and fears of increased regulation in the near future.
3.3. SALES - OPERATING INCOME - OPERATING MARGIN
As expected sales are on the rise since the IPO as well as the operating income. 44% operating margin is just phenomenal! Let’s compare it to other tech giants so you can better understand Facebook’s humongous earning power.
Alphabet: 26%; Microsoft: 31%; Netflix: 7%.
Operating margin decreased to 44,6% in 2018 and will keep on decreasing in 2019 due to higher expenditures.
They are spending heavily in safety and security (the number of employees increased 45% in 2018 alone) but also in facilities to support growth. Yes, although they are in the middle of the hurricane right now, they are still growing.
Although growth is decelerating, revenue grew 30% in 2018 compared to a year ago. 30%!!!
3.4. KEY FACEBOOK METRICS
Lets take a look at their latest Earnings Presentation. What a clear and amazing presentation they’ve put together.
From the chart below we can see that most of the revenue comes from the US & Canada.
When talking about social media platforms one of the most important metrics to assess its potential to make money is its active users. Usually Facebook talks about Monthly Active Users (MAU’s) and Daily Active Users (DAU’s).
Let’s take a look at its Monthly Active Users:
One really important piece of information we can take from analyzing these two charts together is that half of Facebook’s revenue comes from the geographical area where it has just 11% of its users: US & Canada.
This mismatch between number of users and revenue can be seen in two ways. The first is a negative one: The user base that brings in more money is leveling off.
The other one, and the one I like best is that the runway is really long, that these other geographies, although they represent the bigger chunk of users, are not yet so fully developed in what relates to online advertising as North America is. And that is a good thing.
3.5. REVENUE PER USER
Another very important metric derived from the previous charts is the average revenue per user. Clearly revenue per user is rising. A lot!
Average revenue per user in the US is $34,8 while in Asia-Pacific it is 12x lower at $2,96.
3.6. USERS BY PRODUCT
It’s amazing that they only earn money from Facebook and Instagram platforms. Just imagine what they will earn once they monetize WhatsApp.
Note: The numbers on this chart may be somewhat out of date.
3.7. NET INCOME, NET MARGIN
Net Income has been rising since the IPO and it hit $22B in 2018. Net margin will suffer this year because of all the expenses Facebook is having with security and regulation. Analysts estimate a lower net income for 2019 when compared to 2018, but I’m not convinced of this. In fact, I’m estimating something like $24B.
Let’s take a look at FCF as well.
Because of all the capital expenditures they are incurring in this year, FCF went down to $16,2B. Again, analysts are estimating $16,8B for 2019, and I’m estimating around $18B.
3.8. CAPITAL EXPENDITURES
From 2017 to 2018 Capex more than doubled to $14B. Facebook has been investing heavily in data centers and infrastructure in order to tackle the privacy issues it has been facing.
3.9. SEASONALITY
As an advertising company, the best performing quarter is obviously the 4th quarter.
3.10. DIVIDENDS
Fortunately Facebook doesn’t pay dividends. They are more worried about growing their business than returning cash to the shareholders at this stage.
3.11. PROFITABILITY RATIOS
Facebook is slowly getting to the high ROE’s I like to see while employing little or no debt. It is a low capital intensive business and its becoming more and more profitable. I like to see ROE above 20% and Facebook is definitely on the right track to hit a much higher number.
3.12. FINANCIAL RATIOS
This is one of the healthiest companies I have ever seen.
It has zero debt and its current ratio (which measures it´s ability to pay short-term obligations) is just amazing. This means it has 7 times more current assets than current liabilities.
The debt to equity ratio is ……. well, it’s zero because the company has no debt whatsoever, which is something I love. I think it was Charlie Munger who once said that it’s very hard for a company with no debt to go bankrupt, so we can take that one out of our minds.
In fact, Facebook has $41B in cash, even after spending loads of money in infrastructure, and in share buybacks.
3.13. PRICE TO FCF RATIO
Let’s take a look at the Price to Free Cash Flow.
This ratio is at its lowest since the IPO, suggesting the stock is undervalued compared to historical values.
3.14. RISKS AND COMPETITION
The risks section on their Annual Report is 22 pages long!!! It´s like a 1-0-1 manual on how to kill Facebook. I know this is not a common metric to use but Google’s risks section is 13 pages long, Apple’s is 8 pages long, Netflix’s is 10 pages long and Amazon’s is 8 pages long:
1. Economic panorama.
2. Regulation
3. Reputation as related to security of personal data
4. Reliance on a single form of income
3.15. TYPE OF PLAY
No doubt Facebook is a growth stock.
5. OVERVIEW AND CONCLUSION
5.1. OVERVIEW
I must confess I had to think and dig in for some time before reaching any conclusion on what exactly are Facebook’s competitive advantages. Yes, I know that it has Network Effects: The more people use Facebook, the more valuable it is for its users and advertisers alike. But that alone didn’t stop other tech companies or products from disappearing. Do you remember Yahoo (I know it still exists), sms, mms, IRC, ICQ, Napster, the list is long.
And this is where I take my hat off to Mr. Zuckerberg. Not only did he develop the world’s largest online community, he bought and developed the third and the fourth largest social media platforms in the world. Facebook is at a level where it can just copy or buy its competitors.
With US and Canada making up for 50% of its total revenue while representing just 11% of its active users, the runway for improvement here is huge.
May I remind you that Facebook has 947 Billion users in the Asia Pacific region and only 242 in North America? And that North America accounts for half of its revenues?
If we think that other geographies will converge to similar “Revenue per User” rates, and I am perfectly aware that a lot of them won’t even come close, we are talking about huge numbers without even having the need to add one more user.
So the main growth catalysts are:
1. The increasing revenue per user in other geographies;
2. Stories and WhatsApp being monetized with features like Tencent is doing with WeChat in China like professional profiles, the introduction of ads and digital payments, giving people the ability to go for dinner and split the bill with no hassles, the ability to pay for tickets and other things directly through the app;
3. The number of Instagram users still growing.
4. Artificial Intelligence.
Note: If you’re not aware of what WeChat is, I advise you to google it. It might be the future model of whatsapp.
Being very conservative, let’s assume the following scenario for the next 5 years:
- Revenue growth of 20% (it has grown 30% in 2018)
- Operating margin of 45% in 2018 going to 38% in 5 years time
- Tax Rate of 21% (effective tax rate is much lower)
- Constant number of shares (the company is buying back huge amounts, but let’s stay on the conservative side)
- Net Cash is added to the stock price (assuming debt=0 going forward, cash is piling up in the bank)
- Really low multiples.
I’ve painted what I think is a very dark picture for Facebook and even in this doomsday scenario, I think we could see the share price at $312 in five years time, representing a CAGR of 13%.
In the meantime, do I think shares can come crumbling down? There is a strong possibility, specially if and when they get fined, but we are here for the long run.
5.2. CONCLUSION
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