Facebook's Valuation Is More Than Reasonable

Summary

• Facebook's growth potential remains high.
• Its current valuation is attractive according to several metrics.
• While the company currently faces headwinds, investors are still getting a sound business at a reasonable price.

Facebook (FB) continues to be one of the most widely used social media app in the world. As of Q3 2020, it had a total MAUs of 1,820 million worldwide. And while user growth has been slowing down, in recent years, as the company matures, the potential growth in ARPU combined with the continued adoption of online shopping and advertising worldwide still makes Facebook a company with attractive prospects.

Revenue and growth

Over the last 8 quarters, total revenue has been growing at a CAGR of 25% and combined MAUs for all apps at 9.8%. While MAUs growth is much lower than it once was, the difference between the two prior figures demonstrates the continued efficiency in monetizing the current user base.

Monetization of existing users also underlines the remaining growth potential in Asia-Pacific and Rest of World, where ARPU is much lower than in US & Canada at $3.67, $2.22, and $39.63 respectively.  On top of that, according to a Valuates report, the global online advertising market is expected to grow at a CAGR of 21% from 2021 to 2026. So despite slower MAUs growth in the US & Canada and Europe regions, revenue growth opportunities from existing users remain high.

Source: Investor Presentation

On another note, expenses as a percentage of revenue have been stables, which allows Facebook to retain its astounding TTM EBITDA margin of 38.3%. As a comparison, Pinterest and Snap have yet to achieve positive unadjusted margins, while Twitter stands at a mere 8.6%.

Source: Investor Presentation

All and all, this efficiency makes Facebook one of the few tech companies that might be currently undervalued. In fact, if its EBITDA follows the current consensus estimate through 2024, then, using a terminal EBITDA multiple of 20x, and discounting free cash flow at a cost of capital of 9%, it could be worth as much as $447.41 per share. It is, however, important to note that the current consensus, based on 51 analyst ratings, stands lower at $321.15. Nevertheless, this still represents a 16% appreciation from the current price (as of the close of December 18th).

When considering the recent expansion in valuation multiples across the market, including the high price-to-sales multiples of several companies that have yet to prove they can be profitable, Facebook is a much safer investment if we are only considering profitability.

Data source: Finbox and S&P Global Market Intelligence

Facebook is also cheaply priced according to several other metrics, including Price-to-Sales, Rule of 40, and Revenue Growth Forecast among others. One of my favorites, Price-to-Sales/Revenue gives it the winning position. It is also important to notice that it is the cheapest when considering sales while having the highest EBITDA margin.

Data source: Finbox and S&P Global Market Intelligence

Facebook will continue to earn astounding margins

The success of Facebook in the stock market is not due to chance. It reflects the superior capacities of its ads platform - a fact that would be readily acknowledged by most online advertisers. 

The reason why the company can offer a superior ROI for advertisers is two-pronged. The first one, which would be obvious even to the uninitiated, is the massive amount of personal data it has.  Users can be targeted by age, sex, region, interest, religion, political affiliation, and so on... The second one, which advertisers are familiar with, is the capacities of its Pixel and its integration with third-party apps. What is Pixel? Well, it can be thought of as the evolution of HTTP cookies.

As per Facebook:

Pixel is an analytics tool that allows you to measure the effectiveness of your advertising by understanding the actions people take on your website.

Indeed, when someone takes an action on your website, the Pixel fires and records it as an event. It becomes more powerful with time as it acquires more and more data. Eventually, it allows you to optimize the ad campaigns that you run, get more conversions, and earn a higher ROI. Pixel can be integrated with web apps using their SDK and is integrated by default with Shopify. Ultimately, the Facebook learning machine algorithm, comprised of 3 million lines of code, combined with Pixel and their user data makes this company a dominant player in the advertisement field. The result is quite apparent - high margins. 

Antitrust lawsuit

On December 9th, 2020, dozens of states and the federal government sued Facebook alleging that the tech giant has engaged in anticompetitive behavior. I believe that the risk represented by the antitrust is currently overstated. Taken as a worst-case scenario, the divesture of Whatsapp and Instagram could even be beneficial to shareholders, depending on how it takes place. If devised as a spin-off where shareholders receive proportional ownership in both companies, this might end up being quite lucrative. As a precedent, The Breakup of Ma Bell, which was the result of an antitrust lawsuit against AT&T, produced in 1984 a spin-off of 7 newly created companies that have returned 900 percent, including dividend reinvestment, over 15 years. The breakup was not only beneficial to shareholders but also created immediate benefits to customers, which further enhanced the value of these companies.

If a spin-off were to happen, investors would be left with shares of the high-margin business of Facebook, and the choice to retain ownership in faster-growing Whatsapp and Instagram. Unfortunately, the breakdown of MAUs isn’t provided for each app, but using partial data, we can see that Whatsapp has been growing at a CAGR of 39.5% from January 2013 to June 2018, while Instagram has been growing at a phenomenal 60% from April 2013 to March 2020. As a comparison, Facebook’s entire family of apps has been growing at a CAGR of 31.8% from Q3 2008 to Q3 2020.

Source: Statista

Source: Statista

Therefore, as a sequel, the antitrust might end up rewarding investors. The downside and darker side of the story would obviously be the uncertainty weighing on the stock for an extended period of time, costly legal fees, and a potential rushed cash liquidation if the divesture happens and doesn't take the form of a spin-off.

Conclusion

Even after several years of strong results, Facebook is still well-positioned to deliver substantial growth in the coming years. Investors should ignore the mediatic drama and focus on the business itself, which offers wide profit margins in a growing industry. The higher growth plays that are Snap and Pinterest might be more enticing in the short-term, however, Facebook does offer a proven time-tested business model that will, in my opinion, be rewarding to long-term holders.