Facebook a Buy? The Social Media Juggernaut
You know you are doing well as a company when people claim it to be a monopoly in a space that has plenty of competition. Let the haters hate and post their disgust on Instagram/Facebook to friends and family 🙂
I want to dive into why Facebook is still attractive even with a market cap around $750 billion.
First let’s take a look at the most recent earnings report as it gives insights into current financials with coivd-19 impact as well as forward looking statements.
Earnings look great vs. prior year Q2! With an EPS of $1.80 that is a whopping 98% increase! Everything is up!
But this is why it is important to look at the financial statements and read all the footnotes, as Facebook did have large legal one-time expenses related to a settlement with the FTC in Q1/Q2 of 2019. So in actuality outside of the revenue growth, the operating margins were slightly down. Still impressive numbers, but it looks like they have increased for Q2 there operational expenses which may make sense on a temporary timeline due to COVID. Unfortunately they don’t specify in that level of details why the operating margin was slightly deflated.
Essentially you had user growth spike due to people being at home, so DAUs (Daily Active Users)/MAUs (Monthly Active Users) did go up. But Facebook believes that growth rates will either be flat or slightly down in Q3 of 2020.
This was mentioned on Revenues:
“In the first three weeks of July, our year-over-year ad revenue growth rate was approximately in-line with our second quarter 2020 year-over-year ad revenue growth rate of 10%. We expect our full quarter year-over-year ad revenue growth rate for the third quarter of 2020 will be roughly similar to this July performance.”
So they expect similar growth vs. Q3 2019 as well. Honestly this is impressive with total ad spending going down due to COVID.
Regardless of temporary fall, spending in social media advertising is projected to continued growth and Facebook has a dominant market share allowing it to capture more revenue growth.
Future areas of growth will be in AR/VR for their oculus division. I see this area as a huge opportunity to disrupt education and workplace environments.
Another area that I feel Facebook is unlocking is more e-commerce and payment processing as it allows creators to sell directly from their platforms and they can take a piece of the transaction. The relatively recent announcement of Shops is part of this strategy. They even have the development of the Libra cryptocurrency coin that could be designed to be a native payment currency for their platforms which would reduce overall cost/fee structure from the current system.
Fortress Balance Sheet
Facebook has a great balance sheet with $58 billion end of Q2 (which would be $52 Billion after the Jio Platforms Limited investment that was finalized in July).
They have a debt/equity 0.104%, meaning they have very little debt. Honestly I would be okay with them using more debt to fuel further growth if there was opportunity to do so. Nonetheless, the ability to have the current growth while still maintaining a rock solid balance sheet will help really help Facebook down the road.
Current P/E ratio for Facebook sits around 32.34 (TTM) and FY projection of 2020 expects to land around a similar P/E. While that sounds high, I like to use the PEG Ratio to factor in growth. Facebook is still a growth play, so the premium will be higher.
With a consensus of expected growth around 20% in EPS for the next 5 years, that puts the PEG ratio at 1.62 which in my books is in an alright range. Under 1 is undervalued, Under 2 for me is priced fairly. It really depends on what growth rate you give Facebook as previous 5yr growth rate has been 42%, but as the company becomes larger and larger it does become harder to move the needle.
From a price to sales standpoint, at 10.12 (TTM), it is close to Twitter’s 10.89 (TTM), but is way better than Snapchat’s 19.90 (TTM).
One other nice item is that Facebook has around $12.28 billion dollars available and authorized to purchase back stocks which would also deliver value to shareholders as they reduce the total amount of shares outstanding and investors that own shares would have a larger ownership of future profits.
The DOJ (Department of Justice) and FTC (Federal Trade Commission) have raised antitrust concerns over Facebook currently and in the past. It mostly has to due with past acquisitions and whether or not Facebook is deliberately stifling competitions growth or becoming a monopoly. (Source: https://www.nytimes.com/2020/07/17/technology/ftc-facebook-investigation.html).
This isn’t specific to just Facebook either, all the large tech firms in the US are being investigated as the current administration has been vocal on the power of these tech companies.
The outcome of this potential investigation could be additional fines or if determined to be a true monopoly, could split the company into segments or be forced to sell off certain assets. This would obviously stifle synergies that Facebook has created across platforms.
This isn’t the first time Facebook has dealt with these parties, as they did settle a $5 billion charge with the FTC over privacy violations from a 2012 FTC act. (Source: https://www.ftc.gov/news-events/blogs/business-blog/2019/07/ftcs-5-billion-facebook-settlement-record-breaking-history).
So after that settlement from back in 2019, the company has to follow a new set of rules when it comes to privacy of users.
As an investor, if there are future small fines or additional rules set on the company that is fine to me. I obviously don’t condone malicious or illegal activity.
Regulations need to be set to protect people, and I believe Facebook can work with the government to make sure it operates in a way that satisfies those regulations/protections. If they don’t they should be fined and learn from those penalties going forward.
With all that said, I believe Facebook is fairly valued and with the current financial standing of its balance sheet and opportunities for growth going forward there is still plenty of room for the stock price as well.
I think FB will be worth at least $508/share in 5 years time which represents around a 14% annualized return from todays price point. This would put the EPS at $20 and a PE ratio at 25 in 5 years. I know that doesn’t seem like crazy growth, but I think that is a safe expectation and any pull backs from here provides larger returns.
Based on a DCF model I completed, the short term intrinsic value is around $310/share representing a 17% upside short term.
https://corporatefinanceinstitute.com/resources/templates/excel-modeling/dcf-model-template/ if you want the base model