META 0.00%↑ Key Statistics - Using Q3 2021 earnings
Market Cap = $900B
EV = $842B
FCF = $32.172B
FCF Yield = 3.3%
Debt / Equity = 8.3%
EBIT = $46.94B
EV/EBIT = 17.95
Introduction
Investing in Facebook is not original or imaginative, it’s not even contrarian. However, it has been an interesting October to say the least. A high profile whistleblower, the release of the ‘Facebook Papers’ and the name change to Meta. This is a month to remember for Facebook.
Every few years a new controversy comes to light, which results in Mark Zuckerberg being rolled out in front of congress to explain his company’s actions.
In October 2021, whistleblower Frances Haugen, publicly accused the social media giant of serially misleading investors about its approach to safety and the size of its audience. The stock was down 5% on the news and to make matters worse, Facebook, Instagram and WhatsApp went down for several hours the same day.
The complaint alleges that ‘For years, Facebook has misrepresented core metrics to investors and advertisers including the amount of content produced on its platforms and growth in individual users’
It has only been 3 years since the Cambridge Analytica scandal, in which 87m users had their data harvested and sold for political gain. The release of the Facebook Papers are another blot on an already tarnished reputation.
Facebook is no stranger to controversy. As the market is still reeling from these accusations, I thought it was apt to dive in and scratch beneath the surface.
The Zuck
Mark Zuckerberg, CEO - The poster boy of Facebook. He’s been in charge since he founded the company in 2004, over 17 years ago. Zuckerberg is the past decade’s Bill Gates or Steve Jobs. His ownership of Facebook is down to around 13%, from 28% at the time of the company’s IPO. Through the Chan Zuckerberg Foundation he’s sold shares on every trading day in 2021.
Mark Zuckberg is not likeable. During the most recent Facebook Connect, he was robotic, awkward and scripted. This makes him an easy target for the press and media and discounts the stock price. If Elon Musk took over as the Facebook CEO, the share price would explode.
Love Zuck or hate him, he has built one of the greatest businesses the world has ever seen. He thinks long and deep about capital investment and business direction. In leaked 2015 memos, he lays out his vision of why VR and AR will be the next major computing platform after mobile.
The Business
Facebook connects billions of users each day through their four main apps; the Facebook platform; Messenger, Instagram and WhatsApp.
Each quarter there are doubts as to whether Facebook’s Monthly Active Users (MAU) will slow or stagnate, but every quarter the numbers pleasantly surprise shareholders. In Q3 2021, the four Facebook platforms had 3.58 billion MAU. When a company gets to this size, you have to question, where does it go from here?
Facebook users spent 38 minutes per day on the platform in 2020, with younger generations using the platform less. According to time spent on social media, in order of time spent on apps, Facebook ranks first, WhatsApp second, and Facebook Messenger third. However, they are losing ground to apps such asTikTok. The Facebook and Instagram brands were the 6th and 18th most valuable in the world in 2020, with a combined worth of $310 billion.
It’s easy to criticise Facebook and poke holes in their platform, but this is a company with a serious long term vision. Separating out the Messenger App in 2011 demonstrates the level of Facebook’s foresight. As users have dropped off the main platform, they remain connected through the Messenger App.
The Facebook Platform
Facebook’s platform feels like a bad party, most of the popular people have already left and you’re trying to find a good reason to exit, otherwise you will be stuck with the elderly and those who have had too much to drink. The only person I know who uses Facebook religiously is my mum. It doesn’t bode well for the next decade that most of her peer group are retired. From the outside, the Facebook Platform feels like it is slowly slipping into a state of disrepair.
Daily Active Users - 1.908 billion
Instagram may be the best acquisition of the 21st century to date. Purchased by Facebook in 2012 for $1 billion, the app now generates around $22 billion in annual revenues. In 2020 this was 36.9% of total company revenue.
Instagram feels like the opposite of the Facebook platform. Personalised, engaging and growing. For users, there is no pressure to accept requests from your Dad’s cousin. You only engage with close friends and follow content you have selected (outside of any advertising).
Users spend an average of 29 minutes a day and over two thirds of total Instagram audiences are aged 34 and younger.
If Facebook Inc is going to be as dominant a decade from now, Instagram will have a large role to play.
Daily Active Users - 1 billion+
An average user opens the WhatsApp app 23-25 times daily. Acquired for $19 billion in 2014, WhatsApp has quietly grown into a global juggernaut and possibly Facebook’s secret weapon.
WhatsApp is the most popular global mobile messenger app with approximately 2 billion monthly active users. If you compare Facebook’s family of apps, WhatsApp appears to be the one with the strongest moat. Users can live without Facebook and Instagram, but WhatsApp is essential for day-to-day communication, especially globally.
The high number of WhatsApp users offers advertising opportunities. Facebook has announced it will not be moving ahead with its initial plan to offer ads placements. It’s clear that WhatsApp is not WeChat, so what does the future hold?
Daily Active Users - 2 billion?
Other Bets
In June 2021, Mark Zuckerberg told employees of an ambitious new initiative, the Metaverse. Described as ‘The “metaverse” is a set of virtual spaces where you can create and explore with other people who aren’t in the same physical space as you.’
Ready Player One imagined a dystopian world, whilst Matthew Ball set out to identify key characteristics of a metaverse.
Facebook has been positioning itself to take full advantage of this space for almost a decade. Facebook Reality Labs are spearheading their efforts in Augmented and Virtual reality.
Oculus - The Oculus Quest 2 retails for $299 / £299 and can draw the most direct comparison to the Ready Player One headset. Oculus is Facebook’s play on Virtual Reality, a race they are very much winning. Whilst Microsoft's’ Hololens is the poster child for AR, it retails at the $5,000 mark and focuses on commercial application, whilst Oculus targets the end consumer market.
Facebook’s non-advertising revenue was up in Q3 of 2021 to $734 million, up from $249 million in Q3 2020. Still less than 3% of total revenue, strong Oculus sales in the 2021 holiday season will drive growth. The Oculus App store takes a cut of 30% of revenue, with more than 60 Apps having generated over $1 million dollars.
Facebook Watch & Facebook Portal - Facebook Watch is the app that powers Facebook Portal. The integration is an easy way to take part in video calls directly from your TV. After 8 years under the radar, the Portal became an overnight success thanks to the global pandemic, connecting families around the world.
Glasses - In September, Facebook announced the launch of Ray-Ban ‘smart glasses’. They clearly wanted to avoid the fate of Google Glass, hence the partnership with Rayban. The shades let users take photos, video, listen to music and answer phone calls, but are yet to include AR.
Business Model
Facebook is a tax on the internet. Startups spend almost 40 cents of every VC dollar on Google, Facebook, and Amazon. If you are not advertising, you can be certain your competitor is. Facebook's advertising platform places a tracking pixel (their equivalent of a cookie) on your desktop, allowing the software to track your online habits and mirror them back to you, selling your behaviour and data back to advertisers. If you are not the customer you are the product…
The company has built, arguably, one of the greatest business models of all time, with average operating margins of 35% over the past 5 years.
The business suite and advertising platform is easy to use, allowing your even small businesses to promote. Facebook generates 98% of revenue from advertising. In comparison to the likes of Apple, Amazon and Google, this is an obvious lack of diversification.
It can also be argued that Facebook’s income is not properly represented by a traditional income statement. Facebook spends around 21% of revenue on R&D annually, mostly intangible costs. If a portion of the R&D spend was capexed, the P/E ratio drops into the low double digits.
The $15 billion spend on capex is the 13th largest in the world, ahead of the likes of Apple and Walmart. In October 2021, the board announced an additional $50 billion increase in share repurchases. It could be interpreted that the company is having trouble trying to figure out what to do with their capital. More likely though, they may be aiming to keep earnings growing by decreasing the number of shares outstanding, especially if revenue stagnates.
In October 2021 Facebook announced it would hire 10,000 new staff to work on its metaverse project. This is no longer the stuff of fiction.
One thing is clear about Facebook’s management team, they plan for the long term. Sharing 50% of all global advertising spend with Google cannot last forever. Facebook appears to be at a crossroads, with their technology offering investors optionality on the future of the internet. What will the family of Facebook apps crossed with Oculus/Portal look like a decade or two from now? Will Zuck usher in his 50th birthday as dictator of the Metaverse?
Bull Case
Underappreciated value on data - Outside of Google, Facebook has more data on humanity than any company in history. That’s a terrifying thought. If you watched the third season of Westworld, you’ll have a good idea of what could be in store. That data is also extremely valuable and will help Facebook build their next generation of platforms.
More growth in the advertising market than predicted - With about 25% of all global advertising spend, it seems unlikely that Facebook’s advertising revenue can grow at the current 15% CAGR. However, with the global shift from bricks and mortar to online there will be more competition for customers resulting in increased advertising.
An under monetized WhatsApp - WhatsApp is Facebook’s secret weapon. With over 2 billion users, no one knows how much revenue exactly WhatsApp generates because the parent company does not share the revenue breakdown. To the user, WhatsApp appears to generate next to no revenue. It’s easy to draw comparisons to WeChat. WhatsApp Pay, internal apps or user advertising, could be in the offering. Payments through WhatsApp are already available in Brazil and India. Facebook earns around $28 per user annually. Is WhatApp $50 billion in untapped revenue?
Instagram is still growing - 84% of US teenagers use Instagram. It generated 37% of Facebook Inc’s revenue in 2020. It could be argued that it can shoulder the main platform’s lagging numbers.
Optionality on the future / Metaverse - The 10,000 staff hires and name change have laid out the strategy. Investing in Facebook provides exposure to future technologies including artificial intelligence, virtual & augmented reality. The Oculus app store is a prime example of revenue evolution.
Globalisation - Ignoring China, where Facebook is banned, more and more countries will migrate online in the coming decade. When customers receive a new device, the first thing they do is download at least one of the Facebook apps and add their friends.
Bear Case
Tarnished reputation - The Facebook Papers, leaked by Frances Haugen, shed light on several disturbing revelations. It’s yet to be understood what the long term implications will be, but they may hinder hiring, customer growth and user engagement. There’s even the risk that there may be fraudulent reporting to advertising customers.
Ongoing decline in younger users - With competition from the likes of TikTok, Snap and Youtube, Facebook’s teen and young adult (18-24), DUA has been in decline since 2013. Only users over 25 are increasing their use of Facebook. As older users die or drop off the platform, this can only shift in one direction. Bloomberg reported that "time spent" by American teens on Facebook was down 16% year-on-year.
Market Saturation - Revenue and users are saturated in North America and European markets, with limited potential for further user growth. Some estimates suggest just 2-3% user growth.
Impact of iOS 14 on ads tracking - Apple’s change is expected to dramatically impact the ability of advertisers to target ads, since people won’t opt in to letting apps track their behaviour. The change decimated SNAP’s Q3 earnings. Facebook appeared to navigate this better than Snap, but longer term headwinds could still affect user targeting and revenue adversely.
A regulation clampdown - Changes in the regulatory environment could hinder Facebook’s ability to collect user data and therefore run effective advertising campaigns. The US government is attempting to break the company up, a package of bills making its way through Congress could potentially force the spin out of Instagram and WhatsApp.
They cannot pull off the Metaverse - Hiring 10,000 staff is ambitious and throws down the gauntlet. It demonstrates their strategy for the future, but what if they can’t pull it off? If blockchain is anything to go on, Web3 will be decentralised and not hidden behind walled gardens. Facebook’s monopoly will be torn down, block by block.
Lack of revenue diversification - With 98% of revenue from digital advertising, the company is attempting to diversify. At what point does the market become fully saturated? When are Facebook and Google broken up due to the scale of the monopolies?
Difficulty employing the best talent due to reputation - As we have seen, Facebook moves from one controversy to the next. At what point does this affect their reputation enough that they struggle to attract the best talent?
Zuckerberg leaving - Here’s a curveball, what if Zuck left? Microsoft has done fine without Bill Gates. Tim Apple has successfully sailed pst the trillion dollar mark since Jobs' death. Zuckerberg comes as part and parcel of Facebook. At only 37, he should have decades left, but at what if his 2021 stock sales are the tip of the iceberg?
Conclusion
Facebook is disliked by Wall Street and the media. Search Google for the latest news articles and the majority will be negative. It’s shares are treated like the company has already lost, despite 35% year-over-year revenue growth in Q3 21.
With 98% of revenue coming from advertising and shifting from one controversy to the next, something has to give. How much juice is left? Zuckerberg admitted that ‘usage was close to saturation’ back in 2018, yet they kept growing. One thing is clear about Facebook and the management team, they are a company that plans in decades. There’s no doubt they have been planning for the eventuality that users and revenue stagnates.
There will undoubtedly be more controversies to come plus regulatory and technical headwinds, resulting in volatility and stock pullbacks. At an EV/EBIT of 17.95, Facebook stock is historically cheap. Facebook has provided annual revenue growth of 20-30% from a management team who think in decades. Zuck’s Metaverse is not a kneejerk reaction, he’s been working on it for several years.
A $10 billion bet in Facebook Realty Labs is a direct result of this planning. This is not a bet on ‘the metaverse’, this is a bet on new revenue channels. The metaverse is a marketing term, it’s not a theme park that Zuck opens the door to one day for us all to ride digital unicorns. It will be integrated into the world around us, similar to the internet over the past three decades. Augmented reality will pop out of your Instagram story, you’ll have work calls through Facebook Portal and go to live sporting events on your Oculus. Only time will tell if Facebook (aka Meta) can pull it off.
hey great writeup on facebook! i’m long in my portfolio so I’m biased but i think you did a great job explaining the essentials of the business and some of the future potential! cheers!