is a cow!
Facebook is a simple story.
Everyone knows about it, everyone uses at least one of its platforms, the company is growing and it’s highly likely that it will continue to grow in the future.
I’ve written about Facebook 4 times already.
But what about the current crisis? Exactly. The current situation will definitely take its toll on Facebook. Although Mark Zuckerberg has come out to say that the company was seeing record amounts of engagement, there have also been accounts of advertisers spending less dollars on digital marketing. Twitter has recently issued a press-release withdrawing its guidance not only for Q1 but for the rest of the year as well.
Advertising on these platforms works as an auction. The higher the number of bidders, the higher the cost-per-click. Right now, the number of bidders has decreased dramatically (my assumption), but the number of impressions or inventory has increased in the same proportion. There’s a lot more people online these days, so there are more places where you can show an advert.
With the current situation as it is, I would say that this will likely go on for some time. How long? Who knows?
Just so we can get the whole picture, here’s the stock-price chart. The stock is currently trading at $165,9.
And here’s the evolution of the Revenue and Operating Income. In 2019 the revenue grew by 27%.
By now, you should’ve noticed that in a situation like the one we’re living in, I put a lot of emphasis on the likelihood of a company to go bust. With close to $55B in cash and no debt, we can safely say that Facebook will be ok.
Free Cash Flow has lagged Net Income for the past years because the company is still investing heavily in Property, Plant and Equipment. In time, we should be seeing these level out as the Capital Investments (CAPEX) flow to the Income Statement as Depreciation (if you don’t know what i’m talking about, please let me know- I’ll be happy to explain).
Although the company will still spend cash on upgrading these new data centers in the future, the amounts will be much lower than the amounts needed to ramp them up.
Given the high operating leverage, we will probably be seeing profits come down more than revenue in 2020, but I expect that to be a temporary issue.
Valuation:
In a “normalized” scenario, we could say that the company has generated around $20B of FCF in 2019. At a $165,9 share price, the whole company is worth today $473B. If we take out the $55B in cash, we get to an Enterprise Value of $418B which in turn would mean a EV/FCF= 20. Is this cheap? It depends on what you compare it to. If you compare it to Facebook’s previous years, it’s at its lowest since the IPO. Not even in the short-but-deep-drop at the end of 2018 was Facebook so cheap.
Bear in mind that this is no ordinary company. Facebook has had truly astonishing Return-on-Invested-Capital in recent years, probably the best gauge for the quality of a business.
But what about the future? Will Facebook be able to grow as it has in the past? Will it be able to get such high returns on capital?
I think I’m not alone in thinking that it won’t grow as in the past (27% in 2019), but the company – or should I say Mark Zuckerberg – is making the right moves. Bringing payments to Whatsapp, betting on Instagram Check-out, Facebook Pay, etc…
I don’t think people realize the impact this will have in our lives.
I was reading the Q4 Conference Call transcript and Mark is no dummy. The huge investment in data centers is the stepping stone to go after Shopify, Amazon, Uber and the likes. Everyone will be buying from Instagram, Whatsapp and Facebook in the future. You will be able to pay your rent through Whatsapp or order food from Instagram. These guys are slowly building a super platform (like Wechat in China).
Recently, news came out that the company rewrote the entire code for Facebook Messenger to make it 84% faster and lighter. At first I was like, “Ok. So what?“, but now I start to get it. Messenger (and the rest) will have to support so many features in the future that this was fundamental. These guys are thinking about where they’ll be 10 years from now and they’re taking the steps needed to reach that place right now.
Just look at the data center they are building in Singapore, the biggest in the world (some say).
And this isn’t the only one. They’re building dozens of these around the world. This isn’t just to house messages or photos. These will be crucial for everything Facebook will build in the next 20 years. And they’re building them right now. Talk about long-term view.
Here are some quotes from the latest conference call that illustrate what I’m saying (emphasis added by me):
Mark Zuckerberg on transfering money across borders:
“That is a proposal to make it so that some of the payment infrastructure around the world can be more efficient, especially for things like transferring money across borders, and there aren’t that many folks who have an incentive to make this work well across different places around the world, so that’s someplace where we thought that we could add.“
Still on payments and money transferring:
“this is an important feature to be able to move your money around, pay friends and individuals as well as small businesses. From a small business perspective, being able to close the loop on ads and transactions we think is just going to make it so that it’s more valuable to have a presence on our services, and buying ads is going to be more valuable.
The payments can be free or really as cheap as possible, because we think that, from a business perspective, we will get some of the value just by having the services be more valuable for businesses and the ad prices that they’ll bid in the auction.“
Mark Zuckerberg on the future of the apps and the investments needed to get there:
“we’re trying to build out our private messaging apps into richer, private social platforms… But our texting apps today are primarily still testing.
So a lot of what we’ve been trying to do is make it so that we build out the infrastructure so that way WhatsApp and Messenger and Instagram Direct can evolve someway rather than being just places where you message folks. They can be places where you can hang out and feel more present with people, where you can connect to different groups in different ways, interact with businesses and do payments and commerce…when we kicked off this big initiative, a lot of the stuff was long-term infrastructure that we need to get started building. So we’ve now been – we’re now a year or so into – starting to build out a lot of that.“
Some conclusions I take from these words:
The moment we can transfer money via WhatsApp, the app will become even more stickier and will attract kids as their parents will send them money through the app.
Facebook says that this will be free or very cheap. They may even charge some small amount for this.
Facebook is going after TransferWise, Western Union, Moneygram and the likes.
Facebook is going after Shopify by letting people set up their own shop on Instagram.
A lot more must be planned to justify all this massive infrastructure around the world. I’m thinking gaming, Virtual Reality, Augmented Reality, wearables, etc, etc.
I can’t wait for the payments to come to Whatsapp. There is an app/service in Portugal called MBway. It’s a way to quickly transfer money to other people. It will be obliterated the moment payments come to WhatsApp. I wish I could short MBway.
Valuation:
I update my Facebook valuation model every once in a while. Although this will surely be wrong in more than one way, it serves me to lay down my assumptions and track the company’s performance over time. Let’s assume a really dark scenario going forward:
- Revenue growth of 10% going forward (remember that in 2019 alone, revenue grew 27%)
- Operating margin of 40%
- Tax Rate of 21% (effective tax rate is much lower)
- Constant number of shares (the company is buying back shares, but let’s stay on the conservative side)
- Net cash is added to the stock price (assuming debt=0, cash will be piling up in the bank)
- Conservative multiples
With these very pessimist assumptions, I see at least a 12% CAGR (Compounded Annual Growth Rate) for the next 5 years.
On my first analysis, I’ve laid out far better assumptions and the “expected returns” were similar to what I get with these new assumptions.
How can I be wrong?
This is an exercise I like doing to ensure my reasoning is sound.
1) I would say that with the recent emergence of Tik Tok, Discord, HouseParty, Zoom and whatnot, the switching costs for Facebook might not be that high (yet). I know that these apps are no substitute for Whatsapp or Instagram, but the prudent investor must always be alert to what the competition is doing.
2) This is the first time Facebook is dealing with a massive economic downturn. Virtually all of its revenue comes from advertising. With millions of businesses closing shop around the world, Facebook will surely take a huge hit.
Having said this, I trust that Mark Zuckerberg is right now developing new features that will be winners not only in the future as well as in the present. I’ve recently read that he and his team have put to second place several of Facebook’s initiatives (like “Events”) to focus on Live Streaming.
I’ve also heard accounts of people tipping musicians while they’re performing live. I’m still not familiarized with this feature that originated from the gaming industry, but this is a HUGE market in China. It might become another revenue stream for Facebook as well.
All of this to say that we might not be fully aware of how strong and ubiquitous these super-apps will become in the future, but I think Mark knows it. And as you might be aware by now, one of the most important things I look for in my companies is a founder who still owns a good share of the business and who is still at the helm of the company.
Behavioural check-list
This is another useful technique I’ve learned from my mentor Gary Mishuris from Silver Ring Value Partners that I use to assess how my behaviour might be influencing my decisions:
1) Have the most recent developments changed the analysis of the company’s prospects disproportionately to their long-term significance?
I don’t think so.
2) If the markets closed tomorrow and I couldn’t sell this security for 5 years, would I be comfortable owning it?
Definitely.
3) Do I have emotions – positive or negative – towards this investment?
I will always have emotions, but I’m truly convinced that my reasoning is sound.
Facebook is the second addition to the All in Stocks Portfolio. There is no price target. I hope to own Facebook shares for many years as long as the investment thesis remains intact.
In the meantime, with the probable decrease in revenue for 2020, it’s likely that shares go even lower. I’ll be a buyer when that happens.
As explained on my last email, I’m going to build a $5.000 position in tranches over the coming 5 weeks. €1000 each monday starting tomorrow (01/04/2020).
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