Company description and History:
Facebook Inc. functions as a worldwide social networking company. Their mission is to enable people with the power to build community and bring the world closer together. The firm’s products include Facebook, Instagram, Messenger, WhatsApp, and Oculus. This company’s products help people discover what’s going on in the world around them and enables people to share their opinions, ideas, photos and videos, and more. The majority of their revenue comes in the form of selling advertisement placements to marketers. The marketers that use this company’s platforms can reach people based on a number of factors such as age, gender, location, interests, and behaviors. In addition to their networking apps, Facebook also owns Oculus which engages in the development and manufacturing of augmented reality (AR) headsets which include the Oculus Rift and Oculus Quest lines.
Total Addressable Market (TAM)
When looking at the social networking side of Facebook, it seems that their total addressable market would be anyone with access to the internet. While the number of people with internet access may not be the total 7.67+ billion people on earth, it’s certainly increasing everyday as more people are receiving internet access. In Facebook’s last earnings presentation, they stated that they have 1.87 billion daily active users (DAUs) and 2.8 billion monthly active users (MAUs). Certainly their user base has room to grow considering that they aren’t even at half of their TAM in terms of MAU and DAU. Oculus on the other hand is a different story. The global virtual reality market was valued at $15.81 billion in 2020 and is expected to grow at a CAGR of 18% from 2021 to 2028. When looking at the chart on the virtual reality market below, we can see that HMDs are driving much of the growth in this industry. Head mounted displays (HMDs) are used in various industries such as aerospace, engineering, research, gaming, etc. Thus, Facebook has significant room to grow as their total addressable market is one of the largest in the world.
NOTE* HMD – Head mounted display, GTD- Gesture tracking device, PDW – Projectors and display walls
Facebook/Messenger/WhatsApp – Facebook has been under scrutiny the past decade for various reasons such as privacy concerns, fake news, being an unproductive app, etc. It seems that the 2.2 star rating from 1.1 million respondents reflects the concerns that have been and continue to be echoed by many. What’s interesting is that Facebook is still used by 69% of adults. However, the picture is different with the youth as a 2018 study showed that 51% of teens age 13 to 17 said they use Facebook and that’s down from the 71% reported in the 2014 – 2015 survey. These numbers are concerning but I believe it will certainly take quite a while before we see the end of this social media app. Messenger on the other hand is perceived relatively well with a rating of 4.1 stars out of 5 and 1.2 million ratings. 1.3 million people use Facebook Messenger each month and as of January it is the 2nd most popular global mobile messaging app. Messenger usage could decrease as Facebook slowly becomes out of favor, however WhatsApp is also owned by Facebook and it’s extremely popular with over 2 billion MAUs. WhatsApp was purchased by Facebook back in February 2014 for $16 billion and it’s a great addition to the ecosystem of apps that Facebook offers. WhatsApp is rated 4.7 stars on the App Store and is #3 in Social Networking.
Instagram – Instagram is Facebook’s best app in terms of ratings. With 1.2 billion active users and a 4.7 star rating with 20.9 million reviews there is no doubt that this app is extremely popular. 71% of the 1.2 billion active users are under the age of 35 which points to the fact that Instagram is just getting started. Also, 71% of U.S. businesses use Instagram to sell products, market their business, network, and more. Furthermore, Instagram users on average spend 53 minutes a day on the app. The aggregate of these facts points to how strong Instagrams attraction is for both businesses and casual users. More attraction means more revenue for Facebook in the form of ads.
Oculus – The Quest 2 is Oculus’s most recent headset and it received 4.5 stars from pcmag.com. Looking at the chart below that came from pcmag.com, we can see that they see the short battery life as the only drawback to this headset. Looking online, I was able to find that the battery life runs somewhere between 2 – 3 hours depending on if you’re watching media or playing a game. In terms of the breadth of games that can be found through the in-game store, users can also enjoy more games by connecting their headset to their PC via a link cable (offered by Oculus for an additional $79). The Tethering option is important because it gives users access to the Oculus PC and Steam VR stores as well as offering more power to the unit. With all that being said, pcmag.com rated the Quest 2 the best VR headset for the price and Editors’ Choice.
First Quarter 2021 Financial Results
Important points to address
“We expect second quarter 2021 year-over-year total revenue growth to remain stable or modestly accelerate relative to the growth rate in the first quarter of 2021 as we lap slower growth related to the pandemic during the second quarter of 2020. In the third and fourth quarters of 2021, we expect year-over-year total revenue growth rates to significantly decelerate sequentially as we lap periods of increasingly strong growth. We continue to expect increased ad targeting headwinds in 2021 from regulatory and platform changes, notably the recently-launched iOS 14.5 update, which we expect to begin having an impact in the second quarter.”
Oculus says BigBox VR and Downpour Interactive are joining Facebook (June 11, 2021 & April 30, 2021) – Facebook recently announced that they would be acquiring BigBox VR (the company that created POPULATION: ONE). Mike Verdu, VP of Content at Facebook, said “We believe that these powerful social connections are paramount to accelerating the growth of VR, and we continue to invest in content and teams that share this perspective. One of the most popular social experiences in VR has proven to be POPULATION: ONE, the breakout battle royale from BigBox VR. POP: ONE came out about 9 months ago and has consistently been ranked as one of the top-performing titles on the Oculus platform. POP: ONE can bring together up to 24 players at a time to engage in competitive play.
The news that Facebook was acquiring BigBox came shortly after they announced that they would acquire Downpour Interactive. Downpour Interactive is the creator of the successful multi-platform MilSim Onward. Mike Verdu stated that “Downpour Interactive leads the VR industry as a best-in-class example of a developer working in tandem with its loyal community to create the best possible social and gaming experience… As part of the Oculus Studios team, Downpour Interactive will expand upon its ethos of creating stand-out games that evoke the human spirit and give players a “downpour” of emotion.” Facebook’s choice to acquire these companies in order to grow them and further invest in A.R. tells us just how driven they are to become #1 in the A.R. gaming space. The future seems bright for Oculus.
Apple’s iOS update hurts Facebook’s business (April 26, 2021)- When it comes to privacy, Apple and Facebook have not come to many agreements. Apple’s recent update requires that app developers explicitly ask for permission to track users’ behavior across Apple’s app store and the internet. This development hurts Facebook as it hinders their ability to deliver targeted ads. Apple CEO Tim Cook declared that privacy should be a human right and Facebook CEO Mark Zuckerberg said that Apple’s demand hurts small businesses and raises costs across the internet. In a blog post in Febuary, Mark Zuckerburg said “Every business starts with an idea, and being able to share that idea through personalized ads is a game changer for small businesses… limiting the use of personalized ads would take away a vital growth engine for businesses.” In the past, Facebook has been under government investigations with regards to privacy concerns and they’ve taken some large fines. We’ll have to see how Facebook’s financial figures will be impacted as a result, but it’s likely that they’ll take a hit.
The future of the industry
We’ve seen various social platforms develop and grow to be more than just apps where you can reach old friends and connect. The trend that is here to stay and continuously keeps growing is social commerce. Emarketer.com estimates that social commerce sales will rise by 34.8% this year to $36.09 billion. Looking at the chart below, we can see that the number of U.S. social commerce buyers has been increasing rapidly. With the rise in social commerce also comes the rise of influencer marketing. According to influencermarketinghub.com, influencer marketing is expected to grow to be worth $13.8 billion in 2021. For context, the influencer market size was estimated to be $9.7 billion in 2020. Additionally, the survey that influencermarketinghub.com conducted in 2020 showed that 90% of the respondents believed influencer marketing was an effective form of marketing. Luckily for Facebook, they own Instagram and recently rolled out a shops feature in May 2020 that allows businesses to create a storefront and brand right on the app. This feature I believe is a game-changer as it allows companies to grow substantially all on an easy to use platform.
Facebook’s investments in augmented reality are likely to pay off going forward as many industries will be using A.R. in one form or another. What’s not so clear is as to when we will see augmented reality hardware and software become mainstream to the point where A.R. devices are being used in most households. The chart below points to a number of obstacles that industry experts say will need to be crossed before mass adoption occurs. The two largest hurdles are the user experience (bulky hardware, glitches, etc.) and content offering (lack of quality content and amount of content available). With these two obstacles in mind, Facebook will need to continue to invest in building out their library of games and the design of their AR devices in order to further capture the attention of the consumer. I’ve heard this set of challenges be expressed by multiple people who have purchased the Oculus headsets. Oftentimes they note that the product is very exciting but lacks the necessary design, quality, and game selection that they would’ve liked to see from an expensive piece of equipment. Nonetheless, I don’t doubt that Oculus will be successful in the future.
Comparison to Competitors
Facebook is quite a diversified company as they have their foot not only in social media but also in V.R. Since most of their revenue comes from ads in relation to their social media platforms, I wanted to focus on comparing Facebook to other social media platforms such as Snap inc. (SNAP), Twitter Inc. (TWTR), and Pinterest Inc. (PINS). On a NTM P/E basis, Facebook is trading at a far better valuation compared to their competitors. Snap, Pinterest, and Twitter all have extremely high NTM P/E ratios at 249x, 70.8x, and 78.08x respectively. While Snap, Pinterest, and Twitter all have double digit revenue growth rates based on Q1 2021 YoY numbers (66.67%, 78.31%, and 28.2% respectively), Facebook also grew 47.55%. Thus, Facebook is trading the cheapest in terms of NTM P/E and they’re still posting revenue growth in range with their competitors. All that doesn’t even touch on the fact that Facebook is net income positive and the others are all losing money on the bottom line. Furthermore, Facebook has a diversified business model with the V.R. side of their business while their competitors don’t have as much going on besides their platforms.
Perhaps it’s unfair to compare Facebook with such early stage companies like Twitter, Snap, and Pinterest. Thus, we should compare Facebook to Google and Microsoft. Google and Microsoft are similar to Facebook in the sense that they obtain a good portion of their revenue in the form of ads and have market caps higher then that of Snap, Pinterest, and Twitter. Google and Microsoft grew 34.39% and 19.09% in Q1 2021 on a YoY basis and those numbers lag that of Facebook. Additionally, Google and Microsoft trade at higher multiples on a NTM P/E basis with ratios of 28.23x and 32.20x respectively. For contrast, more than 80% of Google’s revenue and a portion of the 31% of Microsoft’s “More Personal Computing” revenue segment comes from ads. Although, all three of these tech giants reported impressive Q1 2021 YoY net income growth as Microsoft and Google grew 43.76% and 162.29% respectively. With those net income numbers in mind, it’s important to note that a year ago the world was shut down and thus the growth numbers posted are a bit inflated when compared to previous years. Nonetheless, Covid was a net positive for Facebook and their competitors as people were stuck at home and spending increasing amounts of time online. In the aggregate, I believe Facebook is trading at some attractive prices compared to their competitors. While I could choose to go more in-depth into Facebook’s competitors, I’ll leave that up to you.
Founder, Chairman and Chief Executive Officer – Mark Zuckerberg
Mark Zuckerberg founded Facebook in 2004 with a few college roommates from his dormitory room at Harvard University where he studied computer science. In 2007, at age 23, Zuckerberg became the world’s youngest self-made billionaire and he is now one of the top 10 richest people on earth. He is responsible for developing the direction and product strategy for the company. Since 2008, Time magazine has names Zuckerberg among the 100 most influential people in the world. In December 2016, he was ranked 10th on Forbes list of The World’s Most Powerful People.
Chief Operating Officer – Sheryl Sandberg
Sheryl Sandburg overlooks Facebook’s business operations in addition to serving on their Board of Directors. Prior to her position, Sheryl was the global Online Sales and Operations at Google, Chief of Staff for the United States Treasury Department under President Clinton, a management consultant with McKinsey & Company, and an economist with the World Bank. Sheryl co-authored Option B: Facing Adversity, Building Resilience, and Finding Joy and author of Lean In: Women, Work, and the Will to Lead and Lean In for Graduates. In addition, she is the founder of the Sheryl Sandberg & Dave Goldberg Family Foundation.
Chief Product Officer – Chris Cox
Chris Cox leads the apps (Facebook, Instagram, WhatsApp, and Messenger) at Facebook. Chris earned his bachelor’s degree in Symbolic Systems from Stanford University in 2004. Shortly after, Chris joined Facebook as a software engineer and helped develop some of Facebook’s key features such as News Feed. In 2008, he became Facebook’s director of human resources and set the tone for the culture at the company. By 2008, Chris became Facebook’s Vice president of design and put together the initial management and design teams, before being promoted to Chief Product Officer in 2014. Cox spent time researching and pursuing new projects focused on climate change from 2019 to 2020 before returning to Facebook in June 2020.
Management not mentioned – David Fischer (Chief Revenue Officer), Jennifer Newstead (General Counsel), David Wehner (Chief Financial Officer, and Mike Schroepfer (Chief Technology Officer).
What could go wrong
Apple’s iOS update weighs heavily on Facebook’s Revenue – On April 26, Apple released its iOS 14.5 update that requires apps downloaded through the App Store to provide users a prompt that allows them to opt in or out of tracking their activity across third-party sites. The chart below from Flurry Analytics shows us some early data in which only 6% of U.S app users have opted into ad tracking for any apps. On a global scale, 13% of users have opted into ad tracking for any apps. Facebook CFO Dave Wehner said with regards to the update that, “We continue to be concerned about the impact that this update is going to have on the ability of small businesses to use their advertising budgets effectively. That said, the impact on our own business, we think, will be manageable.” This update may prove to be a blessing in disguise and CEO Mark Zuckerburg said “We may even be in a stronger position if Apple’s changes encourage more businesses to conduct commerce on our platforms.” The mobile commerce market is expected to register a CAGR of 27% by 2024. If Facebook is able to pivot well from the negative impact they’re expected to take as a result of the iOS update, investors could be seeing substantial growth in the years ahead.
What we want to see in the future
I’ve already touched on what I believe to be all the growth catalysts for this company. Going forward investors will be paying close attention to how Facebook will respond to Apple’s update and how the growth of Facebook shops can offset that. Another thing to keep track of is how the phasing out of Covid will impact Facebook’s ad revenue. As shown from the chart below, Facebook has a solid history of consistently bringing in more revenue per user.
Additionally, it’ll be interesting to see how Facebook’s recent acquisitions in the V.R. gaming space play out, although I don’t expect much of a return on investment until V.R. becomes more widely adopted. I suspect that they will continue to spend large amounts of money doing research and advertising Oculus. Luckily, Facebook has a recurring revenue business model and a ton of free cash flow to finance such activities.
Overall, I think Facebook is a cash flow machine with a great business model and a sticky family of products. When looking at the chart of the most popular social networks worldwide as of January 2021 I put up toward the beginning of this post, we can see that Facebook is dominating the rankings with 4/5 of the platforms being owned by this company. While the recent Apple iOS update will likely set this company back slightly, Facebook’s competitors will be hurt also. I believe businesses will likely be looking at Facebook’s family of apps to advertise on since they command large audiences. Additionally, Facebook shops will only be growing in the future as brands and individuals look to market and sell their products. In terms of valuation, Facebook is trading at a discount (refer to DCF below) and if there happens to be a dip in the near-term I will likely be a buyer. Facebook currently makes up 5.5% of my portfolio and I’m up 82%. I wish I had bought more when I did but I can’t complain with the gains I have and this stock will likely continue to be in my portfolio for quite some time.