A community larger than Christianity, 37.5% net margins and a market cap greater than the GDP of most nations. That’s what Mark Zuckerberg has managed to create in his 34 years on this planet. Investors who poured money in at the IPO now have nearly three and a half times their original investment. It’s a breathtaking achievement and an economic miracle, which begs the question - how long can it go on?
The past two years can only be described as a public relations nightmare. Facebook (FB) is no longer a scrappy startup trying to “connect the world.” Instead, it’s now seen as a corporate behemoth with the power to sway elections and moderate the public conversation. Industry experts like Kara Swisher, Franklin Foer, and Scott Galloway have choice words for FB’s leadership team and board. Swisher believes Zuckerberg is incapable of dealing with the crisis, Galloway believes the entire board is spineless, and Foer calls FB “an enemy of independent thought.”
I won’t go much into what they’ve said. Instead, I want to focus on the investment perspective and what impact FB’s deteriorating image will have on shareholders. I want to explore whether this PR nightmare could trickle down to the bottom-line, whether the company’s defences will hold up against all the possible ways it can be attacked by the public and governments, and whether a reasonable shareholder should buy more, hold tight, or offload everything in the coming years.
The Anti-Network Effect
The core strength of the FB platform is its network effect. Users sign up because that’s where all the other users are. With over 2 billion users, no other social platform comes even close to the same level of networking power.
So, any indication that users are leaving or using the core platform less will result in a reverse network effect. When your best friends and the most interesting users drop off the site, you’ll be less likely to sign on as well. Advertisers will see this reflected in the advertising rates.
So, after two long years of scandals and PR disasters, does it seem like people care enough to switch off? If you go by FB’s quarterly numbers, user numbers are at a record high although growth has plateaued. In the latest quarter, FB reported 2.27 billion monthly active users.
However, the Pew Research Center has been digging deeper into the numbers in recent years. Their data indicates that only 51% of US teenagers say they use FB, as opposed to 71% in 2015. Furthermore, 42% of all US adults say they have taken a break from checking Facebook for several weeks or more and 54% say they’ve adjusted their privacy settings to share less data on the site.
Pew’s data indicates two things - teenagers don’t find the platform cool anymore and the #deleteFacebook campaign had a noticeable impact on adult usage. However, this data is from the US. The US only makes up 10% of the company’s monthly active user base. India is now the biggest FB user base.
Although there isn’t any Pew-like study on Indian user behaviour here, I’m based in Mumbai, and I can tell you that the common man on the streets here doesn’t care much about the Cambridge Analytica or Russian interference scandals. My parents still use FB regularly, while people my age would find it impossible to communicate without Instagram or Whatsapp.
That fact about Instagram and Whatsapp is probably FB’s saving grace right now. Even the Pew study that found teenagers were logging off of FB found that Whatsapp and Instagram were growing in popularity. Most people who don’t read Seeking Alpha have absolutely no clue these two companies are owned by FB. In fact, a DuckDuckGo survey 50.4% and 57% of Americans had no idea that FB owned Whatsapp and Instagram respectively.
For FB, that’s where the future money is.
Does a kid eating a burger with Heinz ketchup care about the Berkshire Hathaway-3G ownership of the company? Does an athlete drinking Naked Juice as part of a healthy diet care that it’s owned by the same company that makes Pepsi and sells Doritos? Nope.
If there’s any reason for an investor to be optimistic about the future of Facebook, it’s the fact that the general public lacks the incentive or inclination to care about the internal dynamics of Facebook and how it’s affecting Instagram and Whatsapp. The original founders of all these companies bolted out the door earlier this year. In fact, Whatsapp co-founder Brian Acton even publicly issued a statement saying everyone should delete Facebook? You think the average teenage Insta influencer cares about what Acton has to say? Nope.
Whatsapp has over 1.5 billion users while Insta has over 500 million. 80% of these users are outside the US, and 72% of teenagers say they log onto Insta at least once a day. I’m not a teenager, but I can tell you that I have absolutely no way to abandon either platform without socially isolating myself and becoming single again.
Together these two platforms immense untapped potential for monetising. People have already started selling stuff on Whatsapp and tagging fashion items in Instagram pics. FB can take a cut of every ad served, good sold, and service rendered on these two wildly popular and completely differently platforms. It plans to roll out ads in Whatsapp Status videos that resemble the annoying ads that have recently cropped up in Instagram stories. It’s already upgrade the Whatsapp Business API to allow businesses to send messages with promotions, updates, and delivery confirmations directly to people’s Whatsapp chat windows. You can expect more serious and invasive monetization strategies down the line.
So what’s the likely impact of monetizing these two massive and rapidly expanding platforms?
According to Andy Hargreaves, a research analyst with KeyBanc Capital Markets, Instagram generated an estimated $2 billion, or about 15 percent, of Facebook’s $13 billion in ad revenue in the latest quarter. By 2020, he reckons the app will account for 30% of overall sales and 70% of new sales. By this measure, Instagram will be generating roughly $25 billion by 2020 (assuming FB total sales grows to $83.5 billion by then).
The monetization of Whatsapp is slightly trickier. I think the best way to estimate the ad revenue FB can generate on the platform is to look at other standalone messaging platforms and FB’s own Messenger service. LINE recently revealed that it generates $10 million a month from the sale of sticker packs. Meanwhile, KakaoTalk said selling games and game related services generated $311 million in revenue.
Both LINE and KakaoTalk are smaller platforms than Whatsapp, so a better comparison would be China’s Tencent-owned WeChat. In the third quarter of 2018, WeChat reported over 1 billion monthly active users. The team recently added a feature that lets users pay through the app. It takes a 0.1% handling fee for every transaction. The app also hosts over 500 mini games on the platform.
No one knows how much money WeChat is making through these handling fees and games, however its parent company Tencent is on track to generate $40 billion in revenue this year.
LINE Corp, meanwhile, is a company listed in Tokyo, so its revenue figures were easier to find. In fiscal 2017, it generate $1.5 billion in revenue. LINE reportedly has 217 million users, which means Whatsapp should be able to generate nearly seven times the revenue based purely on the user base. That implies an estimated $10.5 billion in revenue after full monetization sometime in the mid-2020s.
Together, Instagram and Whatsapp could contribute nearly half the company’s revenue within 5 years. I have no doubt profit margins will be similarly high.
That’s not to mention the fact that FB has over $40 billion in cash on its book. Whenever the next big app with network effects emerges, you can be sure Zuckerberg will be at the auction. He’ll cut another massive check, keep the company structured as an independent subsidiary, put up with expert criticism, and keep making money off teenagers who couldn’t care less.
Investors could apply a 20x multiple to free cash flow in the year 2023. The free cash flow over the past twelve was roughly $16 billion. Let’s assume this doubles within 5 years (a modest 14% CAGR), which leads to $32 billion.
That means the future market cap could be $640 billion. Discounted back to present value with a discount rate of 6% means FB is worth $480 billion. That implies a 18% discount to intrinsic value at today’s market price of $139.
Regardless of your personal or political beliefs, it’s hard to deny the fact that FB is now a money-making juggernaut with a lot of untapped potential. The biggest concerns over the near-term remain an anti-network effect on the core platform, government regulations, employee churn, and a talent retention problem.
However, FB’s biggest growth engines will be Whatsapp and Instagram for the next five years. These two brands are quarantined from the PR disaster that has engulfed the company’s leadership team. At the end of five years, FB will be sitting on a larger cash pile which can then be deployed to buy the next sexy startup.
For investors, this may be a great time to buy a company that seems to be more lucrative and resilient than big tobacco.
When will the FB profit gravy train end? Seemingly never.
Disclosure: I/we 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.