FB - Facebook

[Broeb22]

I’m just trying to wrap my head around this.

 

FB currently has $14.3 per share in cash/investments on B/S. It will generate $3.5 per share again in earnings the remainder of this year, and assuming an immediate drop to 35% op. margins, mid-20’s tax rate, and 30% revenue growth in 2019, the company generates $6.6 per share in earnings in 2019. So there will be about $24-25 per share in cash on the balance sheet. CapEx is higher than in previous years so I think this might be a touch aggressive. Let’s say $20 per share in cash.

 

Net of cash at year end 2019, the stock price is $122 per share, on $6.6 of earnings, for an 18.5x PE.

 

From this level, earnings can grow at approximately the same pace of revenues. FB seems as likely as any company to continue to grow revenues at least 10% per year, and at 18.5x a quite depressed 2019 EPS number.

 

Amazon showed they are for real in the advertising space, but in my opinion Google’s ad business is more exposed to Amazon than Facebook/Instagram. You go on Google to find something, and the pages that pay big bucks are selling something. Amazon makes that finding process more efficient. There are still non-product, experience related ad spend that can go on Google (travel, events, entertainment) while currently not being a primary focus for Amazon (that I know of). Google and other ad venues will also continue to benefit from ad buyers not wanting to fund their primary competition. But I’m more worried about Google than Facebook for that reason. Facebook properties are the place you go when you have 2 minutes to waste, and want to plug in to what’s going on. This is a fundamentally different experience from what people are seeking relative to Amazon, so it seems less a direct risk.

 

In any event, what am I missing? With global scale, proven ability to defend turf against upstarts (see Instagram stories and Snapchat), there is a good argument Facebook continues to dominate the social world for years to come but it seems priced for user growth and revenue growth to decline materially, below 10% even, and for profitability to decline beyond current reduced margin targets.

[Jurgis]

In any event, what am I missing? With global scale, proven ability to defend turf against upstarts (see Instagram stories and Snapchat), there is a good argument Facebook continues to dominate the social world for years to come but it seems priced for user growth and revenue growth to decline materially, below 10% even, and for profitability to decline beyond current reduced margin targets.

 

You're not missing much likely.

 

The narrative is that likely Q3 numbers gonna suck (and politically speaking it would be good for FB to dump a lot of costs into Q3 to show how they are "fixing" democracy their platform), Q4 + 2019 guidance gonna suck, overall tech and FAANGs are overvalued and out of rotation, sell sell sell. And even if you're long term investor, short term trend is down down down, so why not wait and buy lower, etc. There has to be X0%+ crash soon sometime. Plus EU and US regulation will kill FB.

 

Personally, I don't think regulation will do much (although the regulation in EU may bite somewhat). And the bear narrative will turn at some point. I don't know when. So I'm just buying... but I was buying 20% higher too, so WDIK. And I won't be surprised if it drops another X0% ... or if it doesn't. 8)

[no_free_lunch]

I generally agree with you on it's business position.  This is a strong moat and what is lost by facebook will hopefully be picked up by instagram.  My only concern is that they have like half the planet on their app so I am not sure how much growth is left. 

 

I am not too concerned with amazon as I don't think that ad spend is inelastic.  I haven't run the numbers but it seems most of their ad spend is from small businesses who will spend and spend more if they are getting value, as opposed to megacorp with a fixed ad budget.

 

Thanks for putting some numbers down.

 

To nitpick, I am very skeptical on taking cash out of the market cap.  They paid a lot of money for whatsapp and I could see them doing additional acquisitions to maintain their monopoly.  I also think that 30% growth you reference will require acquisitions.  I don't see the cash being returned to shareholders anytime soon so I would exclude it.  It's not material anyways, but it does raise the PE to 21 or so.

 

That being said, the margin draw down may be temporary and should reflect considerable growth initiatives.  So even without revenue growth they may see profit growth in 2020 as these costs dissipate.

 

What do the IT people hear on facebook as an employer?  I have no connections but have heard it's sought after and that they hire high quality.

[Guest ajc]

 

 

I’m just trying to wrap my head around this.

 

FB currently has $14.3 per share in cash/investments on B/S. It will generate $3.5 per share again in earnings the remainder of this year, and assuming an immediate drop to 35% op. margins, mid-20’s tax rate, and 30% revenue growth in 2019, the company generates $6.6 per share in earnings in 2019. So there will be about $24-25 per share in cash on the balance sheet. CapEx is higher than in previous years so I think this might be a touch aggressive. Let’s say $20 per share in cash.

 

Net of cash at year end 2019, the stock price is $122 per share, on $6.6 of earnings, for an 18.5x PE.

 

From this level, earnings can grow at approximately the same pace of revenues. FB seems as likely as any company to continue to grow revenues at least 10% per year, and at 18.5x a quite depressed 2019 EPS number.

 

Amazon showed they are for real in the advertising space, but in my opinion Google’s ad business is more exposed to Amazon than Facebook/Instagram. You go on Google to find something, and the pages that pay big bucks are selling something. Amazon makes that finding process more efficient. There are still non-product, experience related ad spend that can go on Google (travel, events, entertainment) while currently not being a primary focus for Amazon (that I know of). Google and other ad venues will also continue to benefit from ad buyers not wanting to fund their primary competition. But I’m more worried about Google than Facebook for that reason. Facebook properties are the place you go when you have 2 minutes to waste, and want to plug in to what’s going on. This is a fundamentally different experience from what people are seeking relative to Amazon, so it seems less a direct risk.

 

In any event, what am I missing? With global scale, proven ability to defend turf against upstarts (see Instagram stories and Snapchat), there is a good argument Facebook continues to dominate the social world for years to come but it seems priced for user growth and revenue growth to decline materially, below 10% even, and for profitability to decline beyond current reduced margin targets.

 

 

I agree with your take, but I think you're missing the impact a substantial revenue-based tax could have.

Right now, I think it's the most likely major risk to tech stocks.

 

The fact is tech is now the most important sector across US markets by aggregate market cap. The problem is, tech companies tend to be massive tax avoiders.

While companies have always done this type of thing, they've tended mostly to pay a significant tax load.

Whether it's Exxon, Walmart, etc, the US has always been able to mostly count on getting a fair amount of tax revenues from the largest American corporations.

Not so with tech, and not just in the US.

 

Most everywhere, the tech giants avoid paying taxes and I think this will and should come back to bite them hard (and I say that as a tech investor who likes these companies). Essentially, they're trying to shirk their social responsibility and governments worldwide are losing a lot of money as a result. Once enough people get loud about this and turn their focus to it, tech companies are going to have to come up with some great answers pretty fast. They will end up being the ones blamed for that bridge collapse, or because a community couldn't afford to build a new school.

 

Anyway, long story short is you might want to build a substantial revenue-based tax into your calculations since I don't see anyway the most important corporate sector in many markets is going to be allowed to get away with this level of tax avoidance for very much longer. The EU and UK have already made some noise about this issue, and I can't see it being much longer before the rest of the world catches on.

 

Besides that, I'm on board with what you wrote.

 

 

 

[Broeb22]

 

To nitpick, I am very skeptical on taking cash out of the market cap.  They paid a lot of money for whatsapp and I could see them doing additional acquisitions to maintain their monopoly.  I also think that 30% growth you reference will require acquisitions.  I don't see the cash being returned to shareholders anytime soon so I would exclude it.  It's not material anyways, but it does raise the PE to 21 or so.

 

 

Ok, fair point on taking cash out of market cap. I think it was Liberty who said at one point that a DCF assumes the cash doesn’t get wasted, so it’s almost a maximum value of the business (under given assumptions), which was very insightful to me.

 

Anyways, practically speaking when you’re valuing a company, how much cash do you not give them credit for? Facebook probably isn’t returning cash for a while, so do you not give them credit for the next 5-10 years of cash generation and assume it gets spent on acquisitions/useless data centers/ Zuck’s pet projects?

 

For instance sometimes with a faster-growing company, I’ll do a rough calculation of I think Company X grows cash flow at 10% for 5 years, and I take a conservative guess at valuation with say a market multiple, and then I add the cash generated to the value of the business.

 

Would you say discounting that cash generation for poor or just defensive capital allocation is conservative?

 

Thanks for helping me think through this. I’m relatively new to the world of cash-rich tech behemoths since the rest of corporate America is up to its eyeballs in debt, so how to treat cash is not completely ironed out in my mind.

 

 

[Broeb22]

To finish my thought, if I assume 50% of cash gets spent defending its turf and not on growth, then doesn’t Facebook’s current multiple double?

[Spekulatius]

I would give them partial credit for the cash. Very likely FB will return cash via buybacks to shareholders p, because they just generate too much of it.

 

Strategically, I like what FB is doing. Instagram is basically burying the FB killer Snapchat. they do forays into online dating. Marketplaces is now a credible alternative to Craigslist and some people prefer it, since the seller isn’t totally anonymous. Video may have upside, plus afformentioned properties like Whatsup. The fact that half the planet is already on FB is not a deterrent on growth, the growth will come from ARPU. Europe and Asia’s ARPU is only a fraction of what it is in the US, and even the US has room to grow, if they find additional avenues. They need to create synergies between their various platforms and new functionality to drive user engagement, the rest will come on its own.

 

I do agree that short term the number suck, but I think they are doing the right things.

[frommi]

I agree with your take, but I think you're missing the impact a substantial revenue-based tax could have.

 

I thought about that a little bit, but i am probably wrong. I can only imagine this being some kind of VAT tax for some services like digital advertising etc., so the advertiser has to pay it when they pay an ad. Given that ad pricing is an auction and FB will probably auction the prices after these taxes (because they know where the advertiser is coming from), in the end the advertisers will pay these taxes. Assuming that these taxes are tax deductable for local companies, the only ones really paying them are companies that advertise heavily and that are using tax evasion strategies themselfs. (NFLX?)

 

I think the ad auction pricing is one most interesting things about FB as an investment, because as long as demand for online ads is outpacing ad space, ad prices only have one direction to go.

 

Thoughts?

[Guest ajc]

 

I thought about that a little bit, but i am probably wrong. I can only imagine this being some kind of VAT tax for some services like digital advertising etc., so the advertiser has to pay it when they pay an ad. Given that ad pricing is an auction and FB will probably auction the prices after these taxes (because they know where the advertiser is coming from), in the end the advertisers will pay these taxes. Assuming that these taxes are tax deductable for local companies, the only ones really paying them are companies that advertise heavily and that are using tax evasion strategies themselfs. (NFLX?)

 

I think the ad auction pricing is one most interesting things about FB as an investment, because as long as demand for online ads is outpacing ad space, ad prices only have one direction to go.

 

Thoughts?

 

 

 

My thoughts are way more general. There's an article in the FT today about the subject.

 

I think there will be two main drivers. First, tech stocks have become the economic heavyweights of the US and Chinese economies and I think they'll only get more like that for a while. The days of oil, auto, or bank companies dominating are likely gone for some time.

The argument for tech companies paying less tax in the mid-90's when the internet just got going, was reasonable. It encouraged growth for a nascent industry and allowed the web to flourish with the US leading.

At the same time, just like China has been treated like a WTO developing nation for too long, so big tech has gotten too much leeway for the last 5 years or more.

So, that's motivation one and I think there'll be a noticeable price to pay for it. I'm not sure there has ever been a sector that has grown so quickly, to such a scale, while creatively avoiding so many taxes.

I'd also add that the mood for big tech has been favorable overall for two decades now, in terms of how it's viewed as a net societal benefit. People also liked its underdog status and futuristic aura, to whatever extent.

My sense is that view might be starting to flip as big tech becomes the leader instead of the little guy, and it gets held to account.

At that point, it seems reasonable that a far brighter light will be shone on things like tax avoidance by them or job losses caused by tech automation.

For better or worse, the mood might be turning against tech instead of for it, as it becomes the new global economic 800-pound gorilla.

 

My second line of thinking is that while I think China and to some extent Europe, started most of the protectionist trend we're seeing in the US now. And, that kind of makes sense because the smaller or less powerful you are, the more protectionist you probably have to be. But, the US is now bringing it to the fore globally.

Meaning, we might be in for a decade or two of globalization happening more slowly or at least far more selectively and strategically.

One major side effect of that, as you can already see (eg. NAFTA), is that big consumer markets like the US, China, and the EU, will likely start to realize in way stronger terms how valuable access to their consumer market is and therefore they'll conclude that they actually have far more power to tax corporations than they currently think they do.

 

If the last few decades of globalization have resulted in corporations going offshore to avoid taxes and governments begging business to stay onshore so they can get taxes, I can easily imagine a scenario in a more protectionist world where every major government understands their pricing power and starts banning those businesses who don't want to pay their share.

In other words, if Facebook doesn't want to play ball but Snap or WeChat does, then those two companies will get access while the third won't.

Either way, I think in a protectionist world, the value of market access becomes far more obvious and central.

 

How that all develops, and exactly what numbers and regimes get decided on, I don't know.

All I would say though is that, as a tech investor myself, it seems like the tech sector needs to step up tax-wise because of its now worldwide leading role, and also governments are quickly beginning to understand the real value of market access in an increasingly protectionist world.

How or where the taxes get drawn from, is for me more of a technicality. I don't doubt that governments everywhere can be very creative when it comes to getting what they consider to be a fair tax rate for themselves.

 

That all said, I don't think there's a good reason to not invest in great tech companies, just that you'd wanna factor this stuff in.

 

 

 

[frommi]

All multi-national companies do these tax avoidance schemes. Nike, Coca-Cola, Daimler, really everyone. Thats a side effect of globalisation. In the end its always the consumer that pays the taxes. But that probably doesn`t belong into this thread. :)

[no_free_lunch]

To finish my thought, if I assume 50% of cash gets spent defending its turf and not on growth, then doesn’t Facebook’s current multiple double?

 

Yes.  However, they already have elevated expenses next year, and a pile of cash as a buffer.  Hopefully they are good for a few years in at least maintaining their position.

[Liberty]

Q3:

 

https://investor.fb.com/files/doc_financials/2018/Q3/Q3-2018-Earnings-Presentation.pdf

 

Third Quarter 2018 Operational and Other Financial Highlights

 

Daily active users (DAUs) – DAUs were 1.49 billion on average for September 2018, an increase of 9% yearover-year.

 

Monthly active users (MAUs) – MAUs were 2.27 billion as of September 30, 2018, an increase of 10% yearover-year.

 

Mobile advertising revenue – Mobile advertising revenue represented approximately 92% of advertising revenue for the

third quarter of 2018, up from approximately 88% of advertising revenue in the third quarter of 2017.

 

Effective Tax Rate – Our effective tax rate was 13%, which was lower than expected primarily due to the withdrawal in

August of an appellate court ruling in the case of Altera Corp. v. Commissioner.

 

Capital expenditures – Capital expenditures for the third quarter of 2018 were $3.34 billion.

 

Cash and cash equivalents and marketable securities were $41.21 billion at the end of the third quarter of 2018.

 

Headcount – Headcount was 33,606 as of September 30, 2018, an increase of 45% year-over-year

 

So FB increased headcount by 45% and capital expenditures went from $1.76 billion to $3.34 billion and they still had 42% operating margins? Anyone think they'll keep doing that every year or maybe they'll get back to operating leverage and margin expansion in the future?

[pcm983]

seems like not a great report to me - essentially admitting monetization turning down and arpu going down due to shift to stories and int'l growth.

 

kept saying investment and deceleration on call too

[walkie518]

seems like not a great report to me - essentially admitting monetization turning down and arpu going down due to shift to stories and int'l growth.

 

kept saying investment and deceleration on call too

before mobile was a product, Facebook threw money at the problem

 

now that the flagship isn't working as well, FB needs to find a way to make Instagram work better, the playbook seems to be to pay staff absurd amounts of money to solve hard problems

 

I imagine this works in many cases and/or there will be alternative solutions that will cannibalize the current business as mobile did? 

 

Alternatively, there will be a departure wherein the results remain unknown, but with the brightest and highest paid minds on it, it's unlikely to fail?  I'm not sure this is a winning strategy as free cash flow growth isn't supporting the current valuation despite getting slammed this year? 

[Spekulatius]

^ I beg to differ. any company that can grow their revenues by 33% YoY and generated any FCF at all is in pretty good shape.

 

It is correct they FB is currently throwing bodies at its problem (monitoring, security etc), but I think in due time, they will find way to automate these functions and margins could well reverse to 50% again. It is true that they will need to find new ways to stay relevant, it’s. Its not like coke where you can sell the same thing for almost a 100 years.

[JRM]

“The best minds of my generation are thinking about how to make people click ads; that sucks” - Jeff Hammerbacher

[Spekulatius]

“The best minds of my generation are thinking about how to make people click ads; that sucks” - Jeff Hammerbacher

 

Sez the guy who could retire semi rich, if he wanted to, after working for FB.

[Liberty]

“The best minds of my generation are thinking about how to make people click ads; that sucks” - Jeff Hammerbacher

 

Is that worse than going into investment banking or consulting?

 

The best minds are working on ads that help finance all the infrastructure that is running almost everything people do on the internet. When you zoom out a bit like that, it doesn't sound as bad...

[Guest longinvestor]

“The best minds of my generation are thinking about how to make people click ads; that sucks” - Jeff Hammerbacher

 

17 words that will be etched in fame in due course.

 

Two words "Opt in" if when regulated in will be giant sucking sound for the online ad scene.

 

[walkie518]

“The best minds of my generation are thinking about how to make people click ads; that sucks” - Jeff Hammerbacher

 

17 words that will be etched in fame in due course.

 

Two words "Opt in" if when regulated in will be giant sucking sound for the online ad scene.

I'm not sure you can opt-in to ads when the service is free?  I suppose you could opt to pay a subscription fee in lieu?

[Guest longinvestor]

“The best minds of my generation are thinking about how to make people click ads; that sucks” - Jeff Hammerbacher

 

17 words that will be etched in fame in due course.

 

Two words "Opt in" if when regulated in will be giant sucking sound for the online ad scene.

I'm not sure you can opt-in to ads when the service is free?  I suppose you could opt to pay a subscription fee in lieu?

 

Sure, let's see how FB fares in a subscription fee realm. Different ball game, good old competition will rule then. Everyone I know came in because it is free, they will  leave when it no longer is. "Free" is the perception that is now worth a couple of trillion of market cap. Those are deep pockets, now the daggers are coming out from all sides: Traditional media, old telecom, socialist nation/states, consumer advocacy.

[cameronfen]

“The best minds of my generation are thinking about how to make people click ads; that sucks” - Jeff Hammerbacher

 

17 words that will be etched in fame in due course.

 

Two words "Opt in" if when regulated in will be giant sucking sound for the online ad scene.

I'm not sure you can opt-in to ads when the service is free?  I suppose you could opt to pay a subscription fee in lieu?

 

Sure, let's see how FB fares in a subscription fee realm. Different ball game, good old competition will rule then. Everyone I know came in because it is free, they will  leave when it no longer is. "Free" is the perception that is now worth a couple of trillion of market cap. Those are deep pockets, now the daggers are coming out from all sides: Traditional media, old telecom, socialist nation/states, consumer advocacy.

 

I think what walkie is saying is that you can either recieve ads or pay a subscription fee.  At that point most people would opt-in to receive ads in lieu of paying a subscription. 

[JRM]

I would be shocked if FB every charged for an ad free service.  The amount people would be willing to pay is far less than what the ad space is worth to advertisers.  Especially the affluent crowd with disposable income.

 

Trying to figure out how to get people to click on ads is not the worst use of talent I can think of.  Real Estate agents come to mind first, followed closely by 80% of the financial services industry.

[Guest longinvestor]

“The best minds of my generation are thinking about how to make people click ads; that sucks” - Jeff Hammerbacher

 

17 words that will be etched in fame in due course.

 

Two words "Opt in" if when regulated in will be giant sucking sound for the online ad scene.

I'm not sure you can opt-in to ads when the service is free?  I suppose you could opt to pay a subscription fee in lieu?

 

Sure, let's see how FB fares in a subscription fee realm. Different ball game, good old competition will rule then. Everyone I know came in because it is free, they will  leave when it no longer is. "Free" is the perception that is now worth a couple of trillion of market cap. Those are deep pockets, now the daggers are coming out from all sides: Traditional media, old telecom, socialist nation/states, consumer advocacy.

 

I think what walkie is saying is that you can either recieve ads or pay a subscription fee.  At that point most people would opt-in to receive ads in lieu of paying a subscription.

 

That is as seen from FB's perspective. Some of the regulatory intent floating around starts with allowing consumers the choice of opting in even if the service is "free". That's because the world is now caught up with the monetization scheme and is staring at the deep pockets behind the 2 Trillion. Plus there are lots of well heeled losers of this, Murdoch for instance and someone as dear to COBF as Malone.

 

To me, the real revelation will be the blowing of the urban myth surrounding the efficacy of the online ad spending. 

[JayGatsby]

Most people don't really mind FB ads, and wouldn't pay to remove them. The challenge to FB is more of people just getting bored with social media in general. After a while getting likes loses its high.

 

Their ads do work very well though, at least for our business. We do Google and FB pretty heavily (by our standards). The two products don't compete at all. Google is conversions of people looking to purchase something, FB is general awareness that we exist. We're a weird business though, so that helps.