Why Facebook Remains Undervalued

| About: Facebook (FB)

Despite the fact that shares of Facebook (NASDAQ:FB) are trading near all-time highs, I believe the company is still undervalued and the mid to long-term prospects are under appreciated by investors. There are five reasons why I believe that shares will be trading higher and delivering impressive returns for years to come.

Five simple reasons

1) Facebook has more than 1 billion users, and is still growing this tally above 20% year over year. The massive amount of data that the company has already collected (and will continue to collect) from the billion plus users will be an extremely valuable asset that can be utilized in various ways to generate revenue.

2) Facebook has a vast array of growth opportunities that have yet to be rolled out or even discovered. Specifically, in the near term, the company will roll out video advertisements for U.S users, which can be rolled out internationally over the coming years.

3) Facebook currently has huge investment plans, which include maintaining data servers to keep up with a growing user base. The company has already spent $595 million in 2013 and expects its investments on infrastructure to total $1.6 billion by the end of 2013. In the short term this can lower margins, but an increased investment is a positive aspect as the company continues to expand internationally and gain new users.

4) Management has silenced the bears and nay-sayers who were convinced that the company couldn't meaningfully monetize on mobile users. The company has, so far, addressed what I believe to be the biggest bear argument and only valid thesis against owning shares. Mobile ad revenue represents 41% of the company's revenue mix and is still in its infant stages with significant growth opportunities over the years. In terms of actual numbers, in the second quarter of this year, the company sold $656 million of mobile ads, an increase from $375 million in the previous quarter.

5) Although engagement levels are always a concern, Facebook's measure of daily average users and monthly average users has remained consistently high and showing no signs of faltering. In July, the company reported its daily active users totaled 699 million for the month representing an increase of 27% year over year. In the same month, monthly active users totaled 1.15 billion users, an increase of 21% year over year.

The value of advertising
RBC Capital Markets conducted a survey of over 1,200 advertising professionals to evaluate their general sentiments toward using Facebook as part of a marketing strategy. The study concluded that advertisers plan to increase their spending budget over the next year and allocate more funds toward advertising on Facebook.

One of the biggest takeaways from the survey revolved around a question where the respondents were asked to provide a ranking of online advertising sites in terms of their ROI importance. Using a 1-6 scale (with 1 being the most important, and 6 being the least important) respondents ranked Google (NASDAQ:GOOG) as number 1 with a score of 2.1, and Facebook with a score of 2.22. Somewhat surprisingly, Facebook came in a very close second to Google which has had a 10 year head start in demonstrating and refining its ROI-attractiveness.

One can conclude that Facebook is "closing the gap" with Google and in less than two years has placed itself almost on par with the online advertising platform, Google. This has been accomplished before the much anticipated video ads have even been rolled out. Facebook is showing the potential to have at least an equal impact (if not greater) in the online advertising space, which should cause concern for Google shareholders if Google starts to lose market share. The total value of online advertising for 2013 is estimated to reach $117.6 billion. As Facebook continues to gather momentum, the company appears poised to steal Google's online ad share which is expected to total $38.6 billion in 2013. This objective fits in perfectly with Facebook's "three pillars of strategy" which is "Build, Grow, and Monetize."

Three risks of concern

The path to dominating the online social space will be full of risks and headwinds over the years. Facebook has tremendous potential and tons of opportunities, but like every other company, risks do exist. As such, investors should avoid an overweight investment that is significantly large compared to other holdings. Over time, I would hope that Facebook will ease these concerns either through positive remarks from management or data released by the company.

1) Users defect and spend more time on other social media platforms such as Twitter and Pinterest. While many wouldn't consider either of these platforms a direct competitor to Facebook, nevertheless a decrease of time that users spend on Facebook makes the platform less attractive in the eyes of advertisers.

2) As a follow up to my first point, Facebook faces the risks of needing to spend more money on aggressively retaining users. Also interesting to note will be a potential expensive acquisition a la Instragram (which as of now, has yet to be monetized.)

3) Privacy concerns and government intervention seem to be a very "hot topic" these days and is likely to gather steam. According to Mark Zuckerberg, users are trusting Facebook less after NSA revelations were exposed.

Final remarks

The future remains bright for Facebook and another major catalyst for the stock can be the company's inclusion within the S&P 500 index. The company fits the guidelines for inclusion as Facebook is a well established leader within the advertising space. Some of the criteria for inclusion in the index include a $4 billion market cap (check), a 50% public float (check), and four consecutive quarters of positive net income (likely to be checked in the upcoming third quarter). Interestingly, November would mark the 18-month anniversary of the company's IPO, which is approximately the same time period it took Google to be added to the index.

Finally, Wall Street analysts are also optimistic on share prices. CLSA has a street high price target of $60 with JPMorgan having a $53 target and Goldman Sachs having a $52 target. These price targets from some of the top tier firms further goes to show that investors of Facebook are likely to see strong returns over the years.

Disclosure: I 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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