After Zuckerberg’s comments Facebook remains below our fair value estimate in our conservative scenario.
Shares of Facebook (FB) fell roughly 5% as Zuckerberg announced that the company would refocus this next year on making sure that time on Facebook is “well spent.”
Ad revenue was over $10B in the latest quarter with +16% YoY growth in monthly active users and a +26% YoY increase in average revenue per user (ARPU). More than 95% of the revenue generated in the quarter was ad revenue. Thus, the news that Facebook was changing the algorithm behind this model spooked some investors to sell.
As a user of Facebook I agree that that my newsfeed has become overwhelmed with ads that I felt were irrelevant to me. Interestingly, I find this news to be better for the longer-term growth story of Facebook and merely a short term headwind. I picked up some shares in my personal portfolio on this news and also Facebook is a core holding of Robinhood Strategy’s “Wide Moat Profitable Growth” portfolio up 37% in 2017 and off to a strong start in 2018.
This short term headwind may actually cause ads to “pack more punch” and have higher price tags in the future since their will be the same demand of businesses trying to reach the over 2 billion user audience of Facebook but now less supply of advertisements. This will also help users feel that Facebook is not “ad swarming” them with irrelevancy and hurting the underlying business of connecting people.
R&D spending has paid off as Facebook has continued to improve their platform features which have warded off other social media competitors to some extend (ex: offering Stories and video enhancements once only found on Snapchat). Facebook also boasts a very strong return-on-sales or operating margin of nearly 45%.
Facebook generates significant free cash flow with 0.42 cents of each dollar of revenue heading straight into free cash flow.
If the move made by Zuckerberg hurts Facebook profitability in the short-term, we believe it will keep Facebook a more sustainable and highly profitable business in the long-term.
Applying a P/E (business multiple) to Facebook at 35 (well under other tech giants BABA, GOOGL, AMZN, TSLA, NFLX) and multiplying this by their low EPS estimate in 2018 we arrive at a fair value of $200 per share or over a 10% upside to current price. Using this same method and taking the average EPS estimate you would have ~30% upside to current share price.
Thanks for reading and best of luck in reaching your investment objectives!
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