Alibaba And Tencent's Edge Over Facebook

Summary

• Facebook's valuation multiples have been on a downtrend even before the recent user data scandal.
• In fact, Facebook has traded below Alibaba and Tencent in terms of P/E and EV/EBITDA since 2016.
• Facebook relies almost completely on advertising revenue while Alibaba and Tencent are more diversified in their businesses.
• In addition, thanks to the more liberal attitude to personal data privacy in China, the Chinese firms can generate highly useful analytics and leverage that edge to retain and attract advertisers.
• As such, the two Chinese firms deserve to trade at higher multiples than Facebook. Read on to find out my justifications.

Facebook's User Data Scandal

By now, you should have read about the debacle over at Facebook (FB) with regards to its (mis)handling of user data. There's a good chance that the topic had surfaced between conversations among your family and friends during the Easter holidays. The fact that Facebook derives virtually all its revenue from advertising makes it vulnerable to regulatory tightening. Heightened scrutiny is inevitable given the media attention on the lapses at the company.

What couldn't have been worse for the social media titan was a leaked memo published by Buzzfeed which was written by supposedly one of Facebook CEO Mark Zuckerberg’s most trusted lieutenants. In it, the senior executive appeared to have prioritized corporate growth even if the consequences came at the expense of human lives.

“We connect people. Period. That’s why all the work we do in growth is justified. All the questionable contact importing practices. All the subtle language that helps people stay searchable by friends. All of the work we do to bring more communication in. The work we will likely have to do in China some day. All of it... So we connect more people. That can be bad if they make it negative. Maybe it costs someone a life by exposing someone to bullies. Maybe someone dies in a terrorist attack coordinated on our tools.”
- Andrew Bosworth, Vice President, Facebook

Facebook's Valuation Multiple Dipped Way Before The User Data Debacle

Given the big brouhaha, one might be forgiven for thinking that Facebook suffered a large drop in its share price. In fact, the valuation of Facebook only dipped slightly when viewed from its appreciation over the past three years. Even after accounting for the recent decline, the share price of Facebook is still nearly double that three years ago.

BABA data by YCharts

Hence, what is more notable regarding Facebook's valuation is actually its multiples falling below that of the other two Internet giants, Alibaba (NYSE:BABA) and Tencent (OTCPK:TCEHY)(OTCPK:TCTZF), some time in the latter part of 2016. Currently, Facebook trades at a P/E of 29.65x, compared with Alibaba's 47.93x and Tencent's 56.68x. On an EV/EBITDA basis, Facebook trades at a low double-digit 18x while Alibaba and Tencent are higher at 27x and 46x, respectively.

FB PE Ratio (TTM) data by YCharts

Strong Growth In Alibaba's Worldwide Ad Revenue Share

Sure, in terms of net display advertising revenue, Facebook still remains the clear leader by far (see the table below). Facebook was estimated to account for more than one-third of the global share at 35.2 percent and more than double that of second-placed Alibaba (13.3 percent) in 2017. eMarketer projected that Facebook would capture 38.9 percent of the share worldwide in 2019. In the same year, Alibaba would extend its share by 320 basis points to 16.1 percent.

(Source: Mumbrella Asia)

While Facebook was expected to maintain its lead in this projection, there are two things to take note. Firstly, this study was conducted before the user data scandal erupted. Considering the possible backlash against Facebook, its advertising prowess might be curtailed somewhat going forward. Secondly, going by percentage gains (2019 vs. 2017 - Alibaba: 16.1% - 13.3% = 2.8%, 2.8% / 13.3% = 21% growth; Facebook: 38.9% - 35.2% = 3.7%, 3.7% / 35.2% = 11%) in their ad revenue market share, Alibaba wins hands down among the top players as seen in the table above.

Similarly, Chinese social media titan Tencent was projected to have a fast growth in its revenue from advertising. eMarketer estimated Tencent would more than double its advertising revenue to $11.4 billion by 2019 with its 4.9 percent share of the online advertising market in that year. This was to be achieved by a 41 percent year-on-year increase in net digital ad revenue in 2019 alone, compared with 26.8 percent for Alibaba and just 17.9 percent for Facebook. The relatively lackluster growth at Facebook would be even worse if not for the contribution of a projected 52.9 percent growth from Instagram.

(Source: Bloomberg/eMarketer)

Facebook's Heavy Dependence On Advertising Revenue Is In Stark Contrast To Alibaba And Tencent

If you are an investor in Facebook, the virtually complete dependence of the social media giant on advertising revenue might be worthy of your attention. While its other tech peer, Alphabet (GOOG)(GOOGL), is also heavily dependent on advertising revenue, it does so through more platforms (e.g. search, YouTube, Gmail, etc.). On the other hand, Facebook relies on its flagship website and Instagram primarily.

(Source: Visual Capitalist)

This is in stark contrast to Alibaba and Tencent which have much richer sources of revenue. Even though as much as 60% of Alibaba's revenue is now derived from its advertising platform, Alimama, the e-commerce titan has many other businesses to fall back on (see the exhibit below). Tencent is similarly very diversified in its revenue sources. The large number of growth engines should itself explain the discrepancy in the valuation multiples of the trio. But there's more, as I will elaborate in the following section.

(Source: BCG analysis)

Vastly Different Mentality Towards Data Privacy In China

The brouhaha in the US and Europe over Facebook's exploitation of user data could actually also be happening in China. Readers might think I'm making an April's Fool joke but I'm not. The media has made the Chinese appear as though they are people who have no qualms sharing their personal information or that they have no control at all since the government makes the decision. The reality is not as extreme as often depicted.

Early this year, reports emerged that Alibaba was accused of attempting to expand its Sesame Credit scoring service capability through misleading users. Apparently, before users could access an usage report generated by the Alipay mobile wallet app, they would have to go past the landing page of the report that had a box checked by default. Essentially, the checked box meant that users consented to opt into the Sesame Credit scoring system, a third-party affiliate of Ant Financial, the finance arm of Alibaba Group. Ant Financial eventually apologized for the incident and removed the opt-in feature.

Nevertheless, many Chinese have indeed become resigned to the fact that their personal data are accessible by the government. Even their movement are constantly being tracked by the widespread video surveillance in the country. Since there is little control over their own personal data, the common train of thought is, why not make use of it? For instance, for those having good credit scores, they can redeem free test drives from Alibaba-Ford's giant car vending machines. They are also able to skip the placement of a deposit when they rent a flat.

With the vast data possessed by Alibaba through users' e-commerce activities, viewership patterns from Youku/Tudou, browsing history from UC web browser, etc., the company can leverage on and generate highly useful analytics. Alibaba can then utilize the intelligence gathered to its advantage to retain and attract ad expenditures. In fact, Alibaba has recently decided to make use of its leading mapping service to extend into carpooling which I wrote it is likely to extend further into ride-hailing, challenging China's Uber, Didi Chuxing (DIDI). The process will not just be to generate more revenue from providing the services themselves but the overlapping goal is to capture more data.

The same can be said of Tencent, whose valuation has since exceeded that of Facebook. Given the inherent advantage of the Chinese Internet giants by virtue of their operating environment, Alibaba and Tencent are expected to outperform in the ad revenue global market. Thus, they deserve to trade at a higher multiple than Facebook.

Conclusion

A few days back I wrote about why Apple's (AAPL) reluctance to exploit its customer data is detrimental to its leadership quest in areas like home assistants, even if it is willing to forgo the advertising revenue it is capable of earning. Facebook has apparently been much more liberal in its attitude towards its user data. That has come back to haunt the social media titan.

Chinese Internet companies like Alibaba and Tencent have less of such privacy concerns. It's not that the users are not cognizant of how their data have been used. Their users have been more willing to share their personal information partly due to the local practice and also due to the benefits such sharing can bring them. Furthermore, besides advertising revenues, Alibaba and Tencent have much more diversified income streams compared to Facebook. As such, the two Chinese firms deserve to trade at higher multiples than Facebook.

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Analyst’s Disclosure: I am/we are long BABA. 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.