The world’s largest social media platform enjoys immense network effect as it gains tighter hold over users and advertisers alike
SINGAPORE (Jan 23): Facebook is a runaway success story. However, the downside is that tech giants like Facebook are viewed as exerting undue influence on culture, the economy and people’s daily lives. None other than Bill Gates, co-founder of Microsoft and one of the world’s richest men, said in June last year at The Economic Club forum in Washington DC that it’s time for government to step in and regulate big tech companies.
Moreover, in the past few years, Facebook has been rocked by a series of privacy scandals, and regulators are mulling over whether to take action on the spread of fake news through Facebook. “There will be more regulation of the tech sector. For example, regulation that relates to privacy. The way people consume media has brought it into a realm where we should shape it so that the benefits outweigh the negatives,” Gates said.
Last year, the United Kingdom proposed a “duty of care” standard for companies such as Facebook to ensure they filter potentially harmful content. The government of Canada declared that Facebook had broken the law by failing to protect users’ data from flowing to the political consulting firm, Cambridge Analytica. Irish regulators started investigating Facebook for failing to protect users’ passwords. The government of Sri Lanka temporarily shut down Facebook and WhatsApp which is owned by Facebook, after a terrorist attack on Christians killed more than 250 people. Facebook itself told its investors that it expects the US government to issue a fine of up to US$5 billion ($6.7 billion).
A future for Facebook?
Where does that leave Facebook? For the time being, Facebook’s financials are in top notch form. For its most recent 3QFY2019, revenue and operating income was up 28.6% and 24.3% respectively y-o-y. Daily and monthly active users also improved by 9% and 8% respectively for the same period, despite the negative press the company receives.
The active user figures are a key performance metric measure for Facebook, because trends in the number of users influence the number of ads it is able to show, which affect the value of its ads to marketers, which then ultimately affect its revenue and financial results. Facebook has a seen a strong growth in active users over the quarters, as shown in the chart. (see chart 1)
Valuations-wise, Facebook’s fundamentals have been stellar both over a 3 year and 5 year span. The weighted value growth (represented by 10% revenue, 20% net profits, 30% operating cash flow and 40% free cash flow) exceeds the share price growth for both the 3 year and 5 year period. The 5 year weighted value CAGR was 44.0% against a share price CAGR of 22.6%; the 3 year weighted value CAGR was 26.5% against a share price CAGR of 18.9%. Facebook’s balance sheet is healthy, given its strong liquidity and solvency indicators. Facebook currently has a current ratio and quick ratio of 7.2 times and 6.9 times, well above the 1.0 times benchmark. Facebook also has almost no debt on its balance sheet and is net cash.
Facebook’s current margins are also very strong, at 83.2% and 44.6% for it gross margins and operating margins, which reflect the strong profitability of the company. Compared to its global peers, Facebook trades at a 21% for its P/E, and is at the industry average for EV/ EBITDA, which on an overall basis makes it a marginally attractive company within the industry. Further, Facebook’s OCF and FCF margin, which is currently at 52.5% and 29.4%, is well above the industry average of 12.8% and 14.9% respectively. Facebook’s yields are also attractive compared to the benchmark US risk-free-rate. (see chart 2)
Facebook’s Instagram Checkout, introduced in March 2019, allows users to buy items on the app. This is expected to contribute to Facebook’s top line moving forward, through its current 800 million buyers on the platform. Facebook’s ecommerce platforms – Messenger, Instagram Checkout, Facebook Shop and Marketplace – has also potential for over 800 million users over the next 3 years according to market research, which should provide further earnings visibility for the company over the medium term. Also, Facebook’s Libra cryptocurrency venture is focused on the strategy of establishing an easy and single transaction place for B2B and e-commerce transactions; which would go well with Instagram Checkout.
Analysts are optimistic of Facebook’s growth, even after factoring the billions of dollars that could be given out in damages for the Cambridge Analytica privacy suit. We share the same view, given that Facebook’s earnings and cash flow and cash flow reserves are more than enough to cover this potential risk. With strong fundamentals, a growing population, and Facebook’s venture into e-commerce and cryptocurrency, we believe Facebook’s potential upside from its current share price of US$219.06 is upwards of 15% over the next 12 months. The analyst consensus target price is US$239.02, a 9.1% upside potential, with a resounding 86% buy call from 57 analysts, according to Bloomberg. This is a stock suitable for investors looking for growth with a medium risk tolerance profile.
So why the undervaluation? Probably the known unknown of government regulation globally. How many US$5 billions can Facebook afford to pay when global regulators start imposing fines? Even then, Facebook is a household name, the 21st century’s Coca Cola, and it may weather the regulatory storm. Worth the risk? You decide.
