Why Facebook Shareholders Shouldn’t Panic

Facebook saw its shares slip 6% after releasing its 2019 fourth-quarter results. Despite this, I’m more bullish than ever on its prospects.

I woke up last Thursday to a rude surprise. My shares of Facebook had fallen 6% in a single trading session, following the company’s 2019 fourth-quarter earnings results. A big jump in expenses during the quarter was the culprit. 

However, after reassessing Facebook’s position, I think the decline was unwarranted. In fact, I feel more optimistic than ever for the social network’s long term prospects and am more than happy to hold onto my shares. 

Why investors have been put off

Before discussing the reasons why I am bullish about Facebook, let me first say that I acknowledge that there are very real reasons why the broader market is sceptical of Facebook. 

The first possible reason is that Facebook carries a degree of regulatory risk. We can’t sugarcoat that.

In recent months, Facebook incurred a US$5 billion fine from the Federal Trade Commission due to a privacy breach and had to pay a US$550 million settlement for collecting users’ facial recognition data. In addition, there have also been a few threats from European regulatory bodies.

These regulatory concerns are, in turn, the reason why Facebook’s expenses have skyrocketed. The company has spent big hiring thousands of employees to update its platform and make it safer for users. 

The second reason is Facebook’s decelerating growth. Facebook enjoyed 36% annualised top-line growth over the last 3 years. However, that growth has since decelerated. Shareholders who have been accustomed to the 30%-plus growth rate may have been disappointed by the latest figures.

Despite these two factors, I think Zuckerberg’s brainchild is still a great investment. Here’s why. 

The numbers are still really good

Despite a slight deceleration in growth in recent times, Facebook is still posting solid numbers.

In the fourth quarter of 2019, Facebook saw revenue jump 25% and income from operations grow 13%. Looking ahead, management said that it expects revenue-growth in 2020’s first quarter to decelerate by a low to a mid-single-digit percentage point compared to 2019’s fourth quarter.

Although a deceleration looks bad, that still translates to a healthy 20% increase in revenue.

The social media giant is also now sitting on US$55 billion in cash and marketable securities, and zero debt. On top of that, its cash flow from operations in 2019 was 24% higher than in 2018.

Other metrics are healthy too

Besides its financials, the company’s all-important user engagement metrics are also very healthy. Daily active users, monthly active users, and family daily active people were up 9%, 8% and 11% respectively at end-2019 compared to a year ago.

The worldwide average revenue per user also ticked up 15.6% from 2018’s fourth quarter, demonstrating that Facebook is doing an excellent job improving the monetisation of its gargantuan user base.

Facebook is addressing the regulatory concerns

Zuckerberg and his team have also taken privacy concerns very seriously. Zuckerberg emphasised in his recent conference call with analysts:

“This is also going to be a big year for our greater focus on privacy as well. As part of our FTC settlement, we committed to building privacy controls and auditing that will set a new standard for our industry going beyond anything that’s required by law today. We currently have more than 1,000 engineers working on privacy-related projects and helping to build out this program.”

Facebook is also rolling out a privacy checkup tool to close to 2 billion of its users to remind them to set their user privacy control to the level they wish for.

I think with Facebook’s size, the task of managing privacy is going to be a multi-year process but Facebook’s commitment to addressing the issue is certainly heartening for investors. 

Becoming a Super App

While advertising is Facebook’s bread and butter, the social media giant has the potential for so much more.

It now has online dating features, e-commerce, gaming, Watch and other features. Although not all of these features will cater to everyone, they each appeal to a certain segment of people. This will grow user engagement and increase ad impressions per user.

This is similar to WeChat in China. The Super app of the East has built-in functions such as payments, e-commerce, bookings, and much more. Facebook, with its billions of users, has the potential to become the Super app of the world.

New functions also give Facebook a different source of revenue. One example is through implementing a take rate for payments made on its platform. This could be a new revenue growth driver as Facebook plans to roll out WhatsApp payment and payment services to facilitate Facebook Marketplace.

History of great capital allocation decisions

Although there is a lot to like about Facebook’s business going forward, I think the most exciting thing is how Facebook will use its massive cash pile, which is growing by the day.

As mentioned earlier, Facebook is sitting on US$55 billion in cash (US$50 billion after it pays off the aforementioned US$5 billion fine). That’s an incredible amount of financial resources and the possibilities are endless.

Most importantly, Facebook has a brilliant track record of spending its cash wisely. In the past, it bought Instagram for just a billion dollars in 2012, solidifying its position as the leading social media player in the world. On top of that, the outlay for the Instagram investment should have already been more than covered by the ad revenue that Facebook has generated from it.

More recently, Facebook has been aggressively buying back shares. In its latest announcement, it said it has earmarked another US$10 billion for share repurchases, which I think is a great use of capital given its stock’s ridiculously cheap valuation (more on that later). This again shows that the decision-makers in Facebook are doing the right things with its ever-growing cash hoard.

Valuation too cheap to ignore

It is no secret that Facebook is not the most loved stock on Wall Street. Despite growing its top line by 26% in 2019 and the numerous tailwinds at its back, the stock still trades at just 23.5 times normalised earnings (after removing the one-off fines and settlement charges).

That’s the lowest multiple among the FAAMG stocks. For perspective, Alphabet, Apple, Microsoft and Amazon trade at price-to-earnings multiple of 31, 25, 29, and 87 respectively.

I simply don’t see how Facebook can suffer a further earnings multiple compression unless there’s a market-wide collapse.

Even after factoring the deceleration in growth, Facebook is still expected to grow revenue and profits by close to 20% in 2020 and beyond. Moreover, Facebook has so much cash on hand, its growth could even be boosted if Facebook decides to make an acquisition down the road.

The Good Investors’ Take

With so many opportunities for growth and the heavy fines behind it, Facebook is likely to see double-digit growth to its bottom line for years to come. Its enduring competitive moat looks unlikely to be eroded any time soon and the capital allocation decisions have been extremely sound.

Just as importantly, the stock trades at unreasonably beaten down valuations. Given everything, I’ve seen, I like my position in Facebook.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.