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Jay Bhagat is a graduate of the University of Connecticut Class of 2014. He majored in Finance and served as the Co-President for the Finance Society and Undergraduate Student Government School of Business Senator. Jay is actively learning about the value investing methods of Benjamin Graham and... More
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  • Facebook Five Force Analysis (Based On HBR Case)

    The Internet is a Big Place

    Facebook is looking to be the homepage of the Internet. Zuckerburg is on a social mission to rewire the way that people spread and consume information. Today, the conversation starts from the bottom up and is rapidly disrupting established institutions such as the recent Donald Sterling incident as the way up to the Presidential Races. People buy into this mission without even knowing it because it is designed to benefit the end user. Facebook operates to build everything for the end users and charge companies to help them do it. Society has reached a tipping point and now people all around the world can share experiences and support for one another.

    C.R.E.A.M. (Cash Rules Everything Around Me)

    The majority of Facebook's revenue comes from advertisements. In its most recent annual report the company highlighted that over 90% of its revenue came from advertising. Can they annuitize this revenue stream? In order to better understand this, let's think about Google. Google makes $60 Billion in revenues from advertisements, has multi-year contracts and relationship managers to attract and retain advertisers. Google has shown 30% CAGR since 2006 and showed 88% CAGR between the first year it went public in 2002 to 2006. Facebook is poised to see similar growth. Google went public with less than half a billion dollars in revenue to becoming a behemoth with $60 Billion. Analysts arrived at the $100 Billion valuation based on 30% CAGR in revenues. Facebook is developing supplier relationships with companies such as Zynga by innovating and their marketplace business model. More recently, Facebook has innovated a new mobile ad network that allows advertisers to target Facebook users within other apps that use Facebook logins. As a result of this, mobile ad revenue accounts for 59% of revenue this past first quarter compared to 30% last year. Below is an analysis of Michael Porter's Five Forces that will support my faith in Facebook to achieve double-digit growth over the next ten years.

    Marketplace Model

    Facebook has created a Platform similar to Apple's iTunes. The Platform is a way for third parties to contribute content to users. This marketplace model where Facebook paves a way for advertisers to develop top-notch content and create revenue from Facebook. Facebook has built an incredible environment for other companies such as Zynga and Spotify to grow. Facebook earns part of profits those companies earn and those content suppliers become dependent on Facebook and advertise on Facebook. Zynga makes up 12% of Facebook's revenue and Facebook's goal should be to enable developers the same way that McDonald's did for its suppliers. This customer intimacy for Facebook will help annuitize income through these relationships. Facebook announced its earnings report for the first quarter and it upped revenue 82% to $2.5 Billion with $1.08 Billion EBITDA. Fourth quarter earnings will dwarf the first quarter earnings during the holiday season and free cash flow will grow 50% this year if they continue on this trajectory. Facebook vamped its advertising strategy by finally tapping into mobile advertising and there will only be more improvements to come.

    Supplier Relationships

    Facebook's global expansion will expand its supplier base. {The end user is the supplier. I must admit, the switching of the end user as the supplier and the content provider as the customer is not completely inverted. They share many qualities how to develop intimacy and relationships to neutralize bargaining power.} The pursuit of global expansion has tremendous opportunities for growth and future monetization. Membership growth in Asia is 20% year-over-year and opportunities for growth within Latin America and Africa will increase rapidly as mobile technologies are beginning to penetrate emerging markets. Africa shows the largest growth in cell phone usage around the world and nomadic tribes are purchasing generators to charge their smartphones. The smartphones are connecting them to the world and serving as their computers. Facebook is the home of the Internet and will capitalize on these markets with its multiplatform messaging service (WhatsApp), search capabilities and entire mobile platform.

    Facebook will need to begin distributing content similar to the telecommunications industry to retain its user. They will need to be at the complete center of the Internet that requires them to be in charge of directing the traffic from Facebook to the content that people want. The threat of neutralizing supplier power is medium at the moment because the buyer can easily start searching through vertical content providers like Netflix, YouTube and BuzzFeed.

    Boxing out the Competition

    Facebook is constantly criticized based on current competitors such as Google+, Snapchat, Path, Twitter, Tumblr as well as the threat of new entrants. In this section I will break down how Facebook neutralizes both threats that paves the way for sustainability.

    Facebook dominated Google+ through innovation. Facebook attached its "Like" button to just about all content on the Internet through Open Graph. With three simple lines of code, everything on the Internet could be "liked" and shared thus, making Facebook the king of content without actually providing content. Constant innovations are being made to box out the competition.

    Facebook has a try it before you buy it mentality before it completes an acquisition. First, Facebook creates their version of popular social media networks (Facebook Poke to Snapchat, Facebook Messaging to WhatsApp, Facebook Camera to Instagram, Instragram Video to Vine to name a few). Facebook is identifying real threats to their future business model and makes value acquisitions. They buy top talent using equity, not cash, while the acquired company is growing faster than Facebook and hasn't built out its infrastructure far enough to attain its full value.

    A quick note on new entrants entering social networking: government regulation requires compliance on networks with over 5,000 users thus hindering new entrants competing on a mass scale. Additionally, apps do not have the capacity to support over a billion people and do not benefit from PC access the same way that Facebook does. Server capacity drives up costs.

    The Hacker Way

    The missing piece to Facebook's success is operational excellence. Facebook is in its early stages and is celebrating its 10th birthday this year. Success at Facebook comes through iterations. They are still trying to see what works and what does not. Their management style supports this by embracing the Hacker Way. At Facebook, code wins arguments not rhetoric or numbers. The Hacker Way is to constantly improve and Facebook hosts Hack-a-thons where their teams stay up for hours together in a room building individually while collaborating with each other and debating ideas. Additionally, Facebook has its own development program for new hires called Bootcamp to get them ready to help Facebook on their social mission. Facebook is not operationally excellent just yet, but like a young boy going through puberty their voices will soon deepen and grow into a great man with these great values already set in place.

    Valuation

    Facebook saw 30% CAGR in revenue from 2011 to 2013 and is poised to see 50% in cash flow growth this year. Using Google as a comparison, which saw 30%, CAGR from 2006 - 2013 I believe Facebook will see double-digit growth. Facebook has yet to really start monetizing on mobile advertising as well as in Asian markets that supports my growth model. I set the WACC to 13% to account for the cost of human capital and future government regulations that may increase costs. This led me to valuing Facebook at $32.06 per share, but I will mention that my model does not account for business model risk. Using a margin of safety of about 30%, Facebook is a great buy at $22 per share.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    May 04 5:21 PM | Link | 1 Comment
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