- Facebook's share price has reached a new all-time high, but we believe they are attractively-priced even now.
- With Facebook shares at approx. $308, we expect an exit price of $467 and a total return of 52% (11.8% annualized) in just under 4 years.
- Our first key assumption is a long-term mid-teens EPS CAGR, supported by Facebook's strong revenue growth and potential margin expansion.
- Our second key assumption is a 30x P/E, justified by the quality of earnings and long-term interest rates, even after the recent spike.
- Upcoming events include Q1 results (on April 28), iOS 14 tracking changes, a potential U.S. tax hike and the post-COVID recovery.
Facebook Stock Price at All-Time High
We review Facebook (FB) after shares have just reached a new all-time high, at approx. $308 on Tuesday (April 5) morning.
We initiated our Buy rating on Facebook in March 2019, and reiterated it multiple times since. By Easter weekend, Facebook shares had already risen 74.4%, doubling from the start of 2019 and rising 9.3% year-to-date:
Facebook Share Price vs. Alphabet and S&P 500 (Since 2019)
Source: Yahoo Finance (04-Apr-21).
Is Facebook Overvalued?
At $308, Facebook stock is trading at a P/E of 31.3x and a Free Cash Flow ("FCF") Yield of 1.6% (net of cash worth 6% of the market capitalization):
Facebook Net Income, Cashflows & Valuation
Source: Facebook company filings.
FCF is likely lower than it can be, as Facebook, Inc. has been in investment mode, spending large amounts on both capital expenditure and buybacks to offset stock-based compensation.
Whether Facebook shares are overvalued depends on the prospective return from the current price. With Facebook shares at approx. $308, our forecasts (which remain unchanged from our January update) indicate an exit price of $467 and a total return of 52% (11.8% annualized) by 2024 year-end, which mean shares remain attractively-priced:
Illustrative Facebook Return Forecasts
Source: Librarian Capital estimates.
Our return is driven by the 2024 exit price, in turn determined by the 2024 EPS and the exit multiple. The two key assumptions are thus a long-term mid-teens EPS CAGR and a 30x P/E, which we believe reasonable for reasons set out below.
Mid-Teens EPS CAGR Assumption
The mid-teens EPS CAGR assumption is supported by Facebook's record of strong revenue growth and potential margin expansion.
Revenue growth has been primarily driven by the number of users, the number of ads per user, and the average ad price - all of these remain powerful drivers. Apart from a brief COVID-related interruption in Q1 and Q2 of 2020, year-on-year ad revenue growth is still consistently exceeding 20%:
Facebook Ad Revenue Growth Y/Y (Since 2017)
Source: Facebook company filings.
While the Facebook social network may now be more mature, Instagram is still relatively new, and Facebook is also pursuing initiatives in e-commerce, Augmented Reality, payments, etc. In addition, Facebook has shown the ability to utilize its scale and existing user base as a “fast follower” on products and features, helped sometime by acquisitions (like Instagram and WhatsApp). We are confident that Facebook will continue to grow revenues strongly.
The mid-teens EPS CAGR assumption is also supported by the potential for margins to expand. We believe Facebook's current profit margin is lower than it can be - while EBIT has grown at double-digits in recent years, this represents a lag behind revenue growth. As Facebook is a platform business with low incremental costs, it should have natural operational leverage, but at present this is held back by intentionally high R&D costs:
Facebook Revenue & EBIT Growth Y/Y
Source: Facebook company filings.
Actual spending has been consistently lower than guidance, showing the degree of management control over expenses. For example, for 2020, management had guided to $54-59bn of OpEx at the start of the year but ended up at $53bn; likewise, for 2019, management had guided to $43-46bn, but ended up at $42bn. The same pattern is also evident in CapEx.
30x P/E Assumption
The 30x P/E assumption is justified by the quality of Facebook's earnings and long-term interest rates.
We look at equity valuation through the Equity Risk Premium – equities should pay a premium over the risk-free rate, with the premium determined by the resilience and growth of the earnings.
For the risk-free rate, despite the recent spike, 10-year U.S. Treasuries still have a yield of 1.7% and 30-year ones have one of 2.4%; the yields have been below 2.5% and 3.0% respectively for most of last 5 years:
U.S. Treasury Bond Yields
Source: Marketwatch (04-Apr-21).
Compared to such fixed coupons, a multi-year compounder like Facebook growing at double-digits is attractive even at a 3.3% EPS Yield (i.e. a P/E of 30x). Facebook stock's current 31.3x P/E (on 2020 EPS) is also lower than the multiples for Alphabet (GOOG) and Microsoft (MSFT), both around 36x.
Regulatory & Political Risks Overstated
Regulations and political controversies have been top-of-mind for investors, but these are manageable and may even entrench Facebook's position.
Facebook has a good record in managing regulatory issues. The European Union's 2018 Global Data Protection Regulation contained wide-ranging rules, yet Facebook's revenues in Europe grew by more than 20% in both 2019 and 2020. The Cambridge Analytica controversy involved the 2016 U.S. presidential election and 50m user profiles, yet Facebook ultimately resolved it with only a $5bn fine in 2019 and still made a $24bn EBIT that year.
Facebook has actually called for more regulation on content:
“I don't think each service should individually decide what content or advertising is allowed during elections, or what content is harmful overall. There should be a more democratic process for determining these rules and regulations … That's why I've called for clearer regulation for our industry.”
Mark Zuckerberg, Facebook CEO (Q4 2019 earnings call)
Due to Facebook's scale, regulations will be a manageable cost for them, but potentially a barrier for new entrants.
Facebook's business model - keeping users engaged to show them more ads, knowing enough about users to show them relevant ads - ultimately does not need political content, and Facebook has already been de-emphasizing this:
“We stopped recommending civic and political groups in the U.S. ahead of the elections … now we plan to keep civic and political groups out of recommendations for the long term, and we plan to expand that policy globally … we're also currently considering steps we could take to reduce the amount of political content in News Feed as well … one of the top pieces of feedback we're hearing from our community right now is that people don't want politics and fighting to take over their experience on our services.”
Mark Zuckerberg, Facebook CEO (Q4 2020 earnings call)
Facebook CEO Mark Zuckerberg's testimony before Congress about online misinformation in March 2021 passed without incident.
Facebook is also on strong grounds on anti-trust issues - being free to consumers, almost by definition it cannot cause "consumer harm", a key requirement in anti-trust laws in many countries; there is also plenty of choice in digital advertising for businesses.
Some governments have tried to force Facebook and Alphabet to pay traditional news media for content, but this has also been manageable. In the last few months Facebook has reached its own agreements in the U.K. and Australia, following an existing template used in recent years (as has Alphabet).
Competition with Other Big Tech
There have been some investor concerns about competition with other Big Tech, particularly Apple (AAPL). As Zuckerberg himself stated:
“We increasingly see Apple as one of our biggest competitors ... we’re also seeing Apple’s business depend more and more on gaining share in apps and services against us and other developers. Apple has every incentive to use their dominant platform position to interfere with how our apps and other apps work, which they regularly do to preference their own.”
Mark Zuckerberg, Facebook CEO (Q4 2020 earnings call)
One key development has been the App Track Transparency ("ATT") changes within iOS 14 in spring 2021, which will govern how apps target users and measure their activity. (The changes have already been delayed from their original September 2020 launch date.) This was singled out by Facebook management as a potential headwind in 2021:
“While the timing of the iOS14 changes remains uncertain, we would expect to see an impact beginning late in the first quarter”
Dave Wehner, Facebook CFO (Q4 20 earnings call)
However, ultimately we believe that Apple and Facebook (along with other Big Tech) will co-exist as "frenemies". Apple needs to provide the best consumer experience, and it generates significant income from other Tech companies (including an estimated $8-12bn annually from its Search partnership with Alphabet), so it cannot do everything on its own. Facebook's position is protected by its Technology, consumer loyalty, the Network Effect, and its platform synergies, just as we have described for Alphabet at our initiation. Regulations and anti-trust concerns will also likely prevent a “winner takes all” outcome in digital advertising.
It is worth noting that most attempts to challenge an emerging category leader in Technology have failed in the past: Alphabet tried to challenge Facebook with its own Orkut social network, but gave up in 2014; Facebook itself ended up buying WhatsApp (for $19bn in 2014) and Instagram (for $1bn in 2012) after its own challenges had failed.
Potential U.S. Tax Hike
Over the past few weeks, the Biden administration has proposed several tax increases that may affect Facebook:
- An increase in the U.S. corporate tax rate from 21% to 28% (compared to 35% before the 2017 tax cut)
- An increase in the GILTI tax (on overseas earnings) from 11% to 21%
- A global minimum tax of 21%, to be agreed with other countries, to counter offshore tax havens
For context, Facebook is currently expecting its 2021 tax rate to be “in the high teens”; it was 14% in 2020 and 20% in 2019.
Goldman Sachs has estimated that there will be an average 9% EPS impact for Tech companies:
Biden Tax Proposals’ Expected Impact on EPS by Sector
Source: Financial Times (05-Apr-21).
We believe the impact on Facebook's share price will be marginal. While a higher tax rate would reduce the equity value of Facebook stock, it would do the same for other stocks, and would be offset by the improving macro outlook as COVID-19 is brought under control.
When Should You Buy Facebook Shares?
As a long-term investor, we do not try to time the market, and instead base our buying decisions on each stock's prospective return and the alternatives.
Given the quality of its franchise and the size of its long-term potential, we believe Facebook shares to be among the most attractive in the market today. The time to buy is now.
Facebook is set to announce its Q1 2021 results post-market on April 28. Existing guidance points to continuing strong growth, partly due to a weak prior year:
“In the first half of 2021 we will be lapping a period of growth that was negatively impacted by reduced advertising demand during the early stages of the pandemic. As a result, we expect year-over-year growth rates in total revenue to remain stable or modestly accelerate sequentially in the first and second quarters of 2021. In the second half of the year we will lap periods of increasingly strong growth which will significantly pressure year-over-year growth rates”
Dave Wehner, Facebook CFO (Q4 2020 earnings call)
With Q1 2021 results, we will likely also get a glimpse of the impact of the ATT changes in iOS 14. As we progress through the year, we should see the gradual end of the COVID-19 pandemic and how this affects Facebook. COVID-19 is now under much better control in the U.K. and U.S. thanks to vaccinations, but is worsening in Europe and LATAM.
Facebook's share price has reached a new all-time high, but we believe Facebook shares are attractively-priced even now.
With Facebook shares at approx. $308, we expect an exit price of $467 and a total return of 52% (11.8% annualized) in just under 4 years.
Our first key assumption is a long-term mid-teens EPS CAGR, supported by Facebook's strong revenue growth and potential margin expansion.
Our second key assumption is a 30x P/E, justified by the quality of earnings and long-term interest rates, even after the recent spike.
Upcoming events include Q1 results (on April 28), iOS 14 tracking changes, a potential U.S. tax hike and the post-COVID recovery.
We reiterate our Buy rating on Facebook stock.
Note: A track record of my past recommendations can be found here.
This article was written by
Analyst’s Disclosure: I am/we are long FB, MSFT. 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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