Facebook – A Safe Value Proposition

By Ee Hsin Kok. Edited by Arjun Chandrasekar.

Overview

Facebook needs no introduction, it is the largest social media company in the world, owning 4 of the 5 most popular social media platforms worldwide. As of 10/16/21, it has a market cap of 913B, making it the 6th most valuable company in the world.  It is listed in the US under the ticker symbol ‘FB’, and at its current market price of $324, offers an insane amount of value. In this article, we analyze why Facebook is probably a good investment for you. 

The Recent Fall

Over the past 5 weeks, Facebook has fallen almost 16% from its highs due to a series of unfortunate events. The initial correction was not a big deal, as the market as a whole was going through a correction, and Facebook simply followed suit. However, on October 5th, a 6-hour outage of Facebook’s social media platforms caused the stock to fall 5% in a single day. Following that, a whistleblower who collected hard evidence against the company, came out to ‘expose’ the company over unethical practices. This has led to further scrutiny over Facebook, and while the S&P has been recovering from its correction, Facebook’s stock price has continued to fall. 

A Fear Of Regulation

The whistleblower has exposed Facebook’s algorithm as one that promotes extreme and hateful topics since that is what results in the most clicks. She claims that Facebook has ignored its ethical obligations in its pursuit of maximizing user engagement and the subsequent ad revenue. This has led to an increased fear of regulation by governments worldwide, as Facebook could be forced to change its algorithm, which would result in less user engagement, and subsequently less advertising revenue. 

Positives To Regulation

In the event that there is increased regulation, there might actually be a silver lining too. Advertisers generally do not like advertising on controversial content in the first place, so by reducing the exposure of these posts on Facebook, more advertisers will be willing to come in. This would improve the sustainability of Facebook’s platform, and improve its image. All of which would eventually improve Facebook’s bottom line in the long run. Additionally, unlike companies in China where the government holds massive control over them (like Alibaba and Tencent), Facebook mainly operates in Democratic countries and hence is safe from regulatory powers. In other words, regulators only have so much power over Facebook, and wouldn’t be able to do significant damage to the company even if they wanted to. 

Why Most Of This Actually Doesn’t Matter

When we invest, we take a long-term perspective on things. And in the grand scheme of things, none of this will matter. This is not the first scandal the company has gone through. In 2018, the Cambridge Analytica scandal drew huge criticism and fines from governments, but the earnings still continued to grow at a rapid pace, and the stock has since more than doubled. The fact of the matter is that it doesn’t matter if the public perception of Facebook is hurt by this because over time people will forget. But more importantly, people rely on Facebook’s platforms far too much to be able to stop using them. Ask yourself whether you have stopped using Facebook, Whatsapp, or Instagram (all platforms owned by Facebook). Chances are, you haven’t. And if you haven’t, what makes you think others will? 

A Great Company

Since we have established that all the news surrounding Facebook is meaningless background noise, let’s actually take a look at how great of a company Facebook is. Starting with its balance sheet, Facebook has an extremely conservative debt structure, boasting a 5.4 current and a Debt to Equity Ratio of 0.00. In other words, Facebook has close to no debt. Next, Facebook has a strong track record of generating and growing income, with a great Return on Equity of 30%, and a 50% annual growth rate over the past 5 years. Finally, Facebook is projected to grow at a pace of 28% every 12 months over the next 3 to 5 years, which is very realistic considering its previous 50% growth pace.

Growth Drivers

As mentioned above, Facebook is projected to grow at 28% annually over the next 3-5 years, so what is driving that growth? The first is increasing the commercialization of its platforms. This means establishing marketplaces within its social media platforms. For example, if you are an Instagram user, you might have noticed Instagram Checkout, which enables you to buy products of brands directly from Instagram. Additionally, its second-biggest platform, Whatsapp (which has 2 billion users), has yet to even be monetized. And when Facebook starts monetizing the app in a similar way that Tencent has done with WeChat in China, it would be a fountain of future earnings growth. The next driver of growth would be increasing internet penetration rates. While the western world has nearly maxed out its internet penetration rate, many other regions such as Central and Southern Asia, as well as most of Africa, are significantly lagging behind and will be catching up soon. For example, Southern Asia has only a 45% penetration rate, and India is expected to grow its active internet users from 625 million to 900 million by 2025 (a 45% increase in 5 years). Facebook has already proven it can capture users from India, with 340 million users from India alone. So as more and more people gain reliable access to the internet, Facebook will continue to grow its user base. 

The Value, And Why It’s Time To Buy

Using a 20 year Discounted Cash Flow valuation on Facebook, we arrive at an intrinsic value of $388. Other sites such as Morning star have the company valued at around $407. Additionally, it is selling at an extremely low PEG ratio of 0.84, and an uncharacteristically low P/E of 24. So if you bought Facebook today, you would be getting at least a 15% discount on its intrinsic value, which for a company as great as Facebook, is a massive steal!

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