Stocks Investment

Facebook: Proceed With Caution

(Source: Author, Article Summary)

Recent Developments

Facebook (FB) is the world’s largest social media company that owns Instagram, Messenger, WhatsApp, and is involved in VR development with the Oculus hardware and software offerings. The goal of Facebook is to connect people, family, businesses and groups together. Their main source of revenue is the targeted advertisements that Facebook sells to their advertisers. Their business environment faces rapid innovation, change, disruptive technology and competitors emerging on a regular basis. They compete with any company that sells targeted advertising online including social media, media outlets, and messaging apps. FB competes not only to attract users but to attract advertisers.

In July 2020 FB began labelling posts from Biden and Trump saying all posts and ads from politicians about voting will be accompanied with links to authoritative information. They are doing this to counter the perception that there is a lot of misinformation on the web. They also do not want to come across as arbiters of truth. So to me, a business watcher and occasional FB user this comes across as a reasonable middle of the ground approach to dealing with the hot button subject of online misinformation vs censorship.

Recently there was a push by activists to cancel advertisers from Facebook and Instagram. Ben and Jerrys, Best Buy, Campbell Soups, Chipotle, Chobani, Clorox, Coca-Cola, Consumer Reports, CVS Health, Denny’s, Beverage giant Diageo, Eddie Bauer and the list goes on, have either cancelled ads for the month of July 2020 or have cancelled for longer. It’s hard to question what effect that will have going forward since FB and a few other online companies just announced earnings that beat expectation. The big news from July 30 2020 was that Facebook reported 11% revenue growth despite the pandemic slowdown. Facebook also reported that its monthly user base has grown from 2.99 billion to 3.14 billion people this quarter compared to the same time last year. This growth in users highlights the power of FB. Even if some advertisers decided to jump ship, there will be many more that want to potentially access 3.14 billion people. Also in early July it was reported by CNN that FB is considering banning political advertising days leading up the November election.

Recently as well, there has been a movement afoot of people who are generally dissatisfied with the likes of FB. They are looking for alternatives to the mainstream behemoth for what some characterize as censorship and too many ads. As was reported by USA Today recently, “MeWe is a social network that says it has no ads, spyware, targeting, political bias, or news feed manipulation” and “Parler is a social media app with one point of view: conservative. It’s a place for folks who don’t like the spin at Facebook, or as it describes itself, “free expression without violence and a lack of censorship.””

Quality of Leadership

Mark Zuckerberg is a very good leader that has driven the growth of FB from the very beginning. Currently he has either beat back competitors or purchased them. He comes across as very astute to real world pressures facing FB. Recently there was an open letter from former FB employees addressed to Mark Zuckerberg regarding policies around the way it handles posts from politicians. The letter asks management to fact-check politicians and label harmful posts. This letter comes after a post by Trump where he mentioned “when the looting starts, the shooting starts”. Marks response of putting labels on politician’s posts comes across as a wise middle of the road response. In today’s polarized political climate, he will not be able to satisfy everyone enough. I think he is hoping to reduce the hate directed at FB from both political directions to hopefully avoid accusations of censorship. His efforts may be too little, too late. After watching the House Judiciary subcommittee on antitrust hearing it is very clear that both Democrats and Republicans are unhappy. The Democrats were focused on anti-competitive behavior and the Republicans were focused on conservative censorship. Ultimately if FB is broken up, those independent companies would not have the dominant position as one unified ecosystem.

In the short-term you probably will not see any one competitor rise to challenge FB or Messenger or WhatsApp or Instagram; but in the long-term it will be much easier for competitors to take on those independent services on a one-to-one basis if FB is broken up. The challenges are rising for FB, the time for good leadership is important now more than ever to ward off competitors and politicians. Mark Zuckerberg has proven himself able to beat back competitors in the past, now we still see if he can beat back the government.

Insider Trading

When considering an investment, I feel it’s always good to look at what the insiders are doing with their shares. I’ve pulled recent insider trading activity of FB from Nasdaq. So from the data, we see that yes, in the last year, there has been purchases, but in the last 3 months there has only been sales. For the year as a whole, there has been significantly more selling then buying. I won’t lie, when I look for an investment, I would like to know that the insiders are also buying the stock if I consider buying the stock for myself.

(Source: Nasdaq.com)

(Source: Nasdaq.com)

Facebook’s Competitive Position (SWOT)

There are many elements that are working in FB’s favor. It has a strong brand that is well known globally. Companies that they have acquired-Instagram, Whatsapp- also have a strong brand and presence in the market.

Mark Zuckerberg is always looking to grow his portfolio of offerings. From Oculus (VR peripheral), Workplace (business collaboration tool), Calibra (electronic payment wallet) to Libra (cryptocurrency). So far he has been successfully in expanding his digital ecosystem.

Not only do they have a strong brand name they have a large user base, which give them a market dominance that is rivaled by no other social media company. Their dominance has given them the financial means to acquire competitors in the past and invest heavily in R&D. In 2019 they invested over $13.6 Billion in R&D as is shown from their last annual report.

(Source: Facebook’s 10-K, Dec. 2019)

We can also see FBs strength from Statista’s graph of active monthly users for online platforms. Companies that are owned by FB have a monthly active user base of +6 billion people.

Infographic: Facebook Inc. Dominates the Social Media Landscape | Statista

(Source: Statista)

A huge area of concern to FB and Investors will be user’s Privacy Concerns. More people are worried about their personal information online and when a breach happens people are becoming more concerned. With the introduction of the General Data Protection Regulation introduced on May 25th 2018 within the European Union, companies can be fined up to 4% of global revenue for privacy violations. The question becomes, will these expensive penalties migrate to other countries?

Opportunities present to FB are plenty. FB can expand their current offering such as marketplace, online video streaming, e-wallet app, business tools and their dating app. On top of this, officially licensed music videos have started streaming on FB this August 1st in the USA.

A huge threat facing FB is being broken up with anti-trust laws. As I mentioned earlier, the recent hearings that happened on the 27th of July made clear that law makers on both side of the political spectrum have a problem with the big tech company’s dominance. Anti-trust hearings and sentiments can also bring with them regulation of the sector. We all know that that regulation of anything not only causes the costs to go up to comply, but regulation can also limit growth opportunities depending on how restrictive the law is. Another potential threat to FB is the elimination or revision of Section 230 of the Communications Decency Act. This law allows social media companies, websites and community blogs to provide a forum for users to post and discuss without being held liable for the users post. A great example of this would be a phone company. Phone companies are not charged when someone commits a crime using a telephone. Social media companies have taken criticism for their moderation of content which many say is excessive. Many say social media companies are no longer passive websites for people to exchange ideas which is what section 230 covers. “Legal experts say that removing those protections, and putting web services in legal jeopardy, would radically change how they operate. The companies would either have to vet user content before it’s posted or allow only non-controversial topics to be discussed-possibly obliterating their business models in the process.”: Fortune.

Industry profitability (Porters 5 Forces)

Bargaining Power Of Buyers? Medium

END USER: There are alternatives to FB for end users, but FB has developed a very large following with many people connected. There are many people that use the platform to stay connected with people they met many years ago.

ADVERTISER: There are alternatives to FB for advertisers, but FB has developed a large user base with extensive information on individual people that help target advertisements to individuals. This is very attractive to advertisers.

Bargaining Power Of Suppliers? Low

I’m not sure FB has any significant suppliers. They write their own code and run their own platform.

Threat Of New Entrants And Substitutes? High……let me say it again….High

There are entrants coming into the social media field all the time. Yes, up to this point they have not been able to dethrone FB, and with FBs sheer size they probably won’t be able to for a while, but the fact is, new entrants are coming into this space all the time.

Let’s look at recent history as a lesson. My Space was over taken by Facebook. ICQ was overtaken by AOL Instant Messenger (NYSEMKT:AIM), AIM was overtaken by Yahoo! Messenger, Yahoo! Messenger was overtaken by MSN / Windows Live Messenger. IChat used to be big, so did Google Talk-which is on its way out. MySpaceIM was also very popular at one time when My Space was big. For all those who have invested into FB who are asking themselves what’s an ICQ; beware, one day, your kids could be asking you, what’s a Facebook? Yes, all these apps in their time seemed like the coolest things, and no one could have imagined how they would (could) be replaced, but they were. New innovative companies are coming in all the time, that’s the just reality of this fast paced business.

Competition Among Rivals? Medium

There is no other social media platform that does everything that FB does. Now, considering what I just mentioned, FB does compete with many other platforms which earn advertising dollars through online content. At end the of the day, if people are engaging with YouTube, WeChat, TikTok, online TV, Video games and so on; they are not engaging with FB. So FB does a great deal of competing for viewers, but FB does not have one rival similar to itself, in size or scope.

One large positive for the tech industry as a whole, are users willingness to post more and more personal information online. More and more of our lives are going online. At work we are using more technology, at home we are using more technology to be connected to work. We are sharing more and using the internet as a place to connect with people we have not talked to in a long time. This trend will not reverse in the near term. No doubt there will be more competitors in the future, but the industry as a whole will continue to grow-which presents huge opportunities.

Valuation

?Source: Author’s table, Facebook F/S Data)

Using the H-model of the DDM, which takes into account the super-fast growth that we are currently seeing in FBs revenue and earnings is an appropriate model to use. Currently the company does not pay a dividend, but they do return money to shareholders in the form of stock buybacks. So I will be substituting dividends with stock buybacks.

In the last 4 quarters, they have given back $4.86 Billion in the form of buybacks on earnings of $20.96 Billion ttm. In the last few years they have basically grown their revenue at the same high rate.

(Source: Yahoo Finance)

Assuming the growth rate continues like that for 3 years and stabilizes at a reasonable 10% the company is fairly valued at today’s close (July 30) 239 with after-hours trading of 249. The model gives FB a fair value of $259/share.

Now, let’s assume recent anti-trust hearings turn into real world legislation-negatively effecting FB; how would the fair value look if we cut the high growth rate to only one extra year.

(Source: Author’s table, Facebook F/S Data)

The fair value with only 1 more year of high growth decreases the fair value of FB to only $226/share.

Another simple metric to look at is the simple P/E ratio.

Source: Yahoo Finance

Again, for a fast growing tech firm a forward P/E of 24 and Trailing P/E of 32 is very reasonable.

From the analysis, FB looks fairly valued.

Risks

  • Privacy breaches-that can cost them customers and fines.
  • Anti-trust rulings-that could affect how they conduct their business.
  • Regulatory change-which could see the social media company lose its Section 230 protections from litigation.
  • Governments demanding more data protection or hardware and software that needs to be located within a specific countries borders will only increase costs.
  • Some governments may seek to censor Facebook or their other products in their country entirely.
  • Governments may also impose strict restrictions on how, when, or who FB can advertise too.

In the short-term I feel nation states are the biggest threat to FBs future growth. There could always be a chance that Mark Zuckerberg and team start to stumble on product development and execution, but I doubt that; he has grown the company successfully from the beginning and I do not see anything to indicate otherwise now.

Rationale For Investment Decision

Hold the stock, if you currently have it, and hold off on buying if you don’t have the stock. When you look at the company by itself, it’s full of potential and good leadership. When you look at the company within the current tech environment, it’s hard not to see the risks building. The stock currently looks fairly valued, but you also have clouds of anti-trust and regulatory change growing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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