Facebook (NASDAQ: FB) | Deep Dive

Updated: Aug 1

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Key Points

  • Facebook is the world’s largest social networking company

  • Monthly active users (MAUs) across its family of apps totaled 3.3bn in 4Q2020

  • Facebook derives 97.9% of overall revenue from advertising but it is leveraging its extensive user- and advertiser-base and expanding into related verticals like e-commerce and virtual reality

  • With cash and cash equivalents, and marketable securities totaling US$62.0bn and robust free cash flow generation, Facebook displays strong financial strength

  • However, current concerns surrounding privacy, antitrust and taxation have caused Facebook shares to be priced very attractively

  • Facebook's current P/E of 26x shies that of peers like Google (36x) and is even lower than the S&P 500 (39x)

  • Many investors are ignoring the optionality from new use cases like Shops and Oculus that can eventually become multi-billion dollar incremental monetization opportunities

  • DCF-backed fair value estimate of US$305.62, representing a possible upside of 18.3%

Company Overview

Facebook, Inc. is the world’s largest social networking company that develops social media applications for people to connect through various devices, share opinions, ideas, photos and other activities online. Its key products include Facebook, Instagram, Messenger, WhatsApp and Oculus.

The acquisition of Instagram and WhatsApp in 2012 and 2014 respectively, has allowed Facebook to build a complete ecosystem with various platforms having their own niche in the consumers’ social media experience.

Monthly active users (MAUs) - defined as a registered and logged-in user of who visited at least one of these family products through a mobile device application or using a web or mobile browser in the last 30 days as of the date of measurement) - across its family of apps totaled 3.3bn in 4Q2020. This means that almost half of the world’s population uses at least one of Facebook’s apps.

Advertising remains the key revenue driver

Facebook’s revenues are largely driven by advertising which made up 97.9% of overall revenue in FY2020. Advertising revenue is generated by displaying advertisements on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for these advertisements based on the number of impressions or actions taken by users.

Ad revenue is driven by both supply and demand dynamics. Supply refers to the number of users on the platform and their engagement which determines the number of ad spaces available for sale to advertisers. Daily/monthly active users (DAUs/MAUs) can be used as a proxy for supply. Demand refers to how much advertisers are willing to spend on ads which can be represented by average revenue per user (ARPU).

Facebook has experienced a steady increase in the number of MAUs worldwide, with less mature regions like Asia Pacific and Rest of World (includes all users in Africa, Latin America, and the Middle East) experiencing the fastest growth.

Note: While ARPU includes all sources of revenue, MAUs only includes users of Facebook and Messenger. The share of revenue from users who are not also Facebook or Messenger MAUs is not material.

Users in different geographies are also monetized at different average rates. The ARPU and revenue in the US and Canada are relatively higher due to the size and maturity of the digital advertising markets.

As a whole, the US and Canada still account for the majority of Facebook’s advertising revenue (48.2%) largely due to the much higher ARPU compared to other regions.

Advertising aside, other revenue streams include revenue from the delivery of consumer hardware devices and net fees received from developers using Facebook’s payments infrastructure and more.

Key Financials

Facebook has been experiencing healthy revenue growth over the years albeit at a decreasing rate. The declining y-o-y growth is mainly attributed to slowing MAUs growth. This is a result of user growth approaching a steady state in Facebook’s core markets of the US and Canada as internet and social media penetration rates approach their peaks.

Gross margins have been relatively steady albeit on a subtle downtrend over the years. This is largely attributed to growing data center capacity and technical infrastructure to support user growth, increased user engagement and the delivery of new ad surfaces.

EBITDA, EBIT and net margins have also declined in recent years as Facebook expands headcount across its engineering, technical, marketing and sales, administrative departments and more as it ramps up initiatives especially in research and development and security. Notably, the US$5bn FTC settlement expense caused a much larger decline in margins in 2019.

Compared to peers, Facebook boasts the highest gross and net margins.

Facebook also displays strong financial strength. Operating cash flow generation has been strong over the years, leading to robust free cash flow. The company has cash and cash equivalents, and marketable securities totaling US$62.0bn at the end of 2020 and no debt.

Investment Thesis

We expect Facebook’s revenue to expand at a CAGR of 13.5% to reach US$162bn by 2025. This growth is anticipated to be supported by: (1) tailwinds from growing online ad spend, (2) consistent product innovation to boost ad prices and user engagement, and (3) commission revenue generated from Facebook’s push into e-commerce. While recent antitrust concerns have led to near-term volatility in Facebook’s share price, we believe that Facebook's long-term prospects remain bright.

Thesis 1: Tailwinds from Growing Online Ad Spend

Even though Facebook is approaching full penetration in key ad markets, we expect ad revenue growth to remain supported by an expanding user base in emerging markets and increasing ad prices in mature markets.

In emerging markets, on top of higher internet users growth, we expect to see Facebook penetration rates trending towards that of more mature regions. While MAUs in US and Canada and Europe are only projected to gr