- Facebook’s growth may come from three main branches: users, Facebook and advertisers.
- Relevance is only measurable in hindsight, but a powerful revevnue stream (akin to pricing power).
- Conservatively expect 5-6% Net Income CAGR, net of inflation, at the current price of 320$/share.
This is my attempt at forecasting Facebook’s growth in the next 10 years, and therefore it is a quantitative analysis.
Facebook’s ad engine
We are looking at the business from the advertiser’s perspective now. If I’m advertising on their platforms, I’m looking at return on investment (ROI). Each customer has a lifetime value (CLV), as Peter Thiel would say. If I’m acquiring the customer (CAC) at below CLV, I’ll be making a profit from that customer.
Facebook’s bidding engine allows competition to maximize Facebook’s profit as a function of advertiser ROI’s. If I put up a few ads and my ROI is 10x, you can be sure that someone will want my lunch sometime soon. This reduces both mine and my competition’s profits, but increases Facebook’s profits until CAC of that business segment equals CLV (ROI is 0). This ends up being more complex because each ad space serves to show multiple ads from different business areas.
Where does Facebook’s growth in revenue come from?
Facebook’s growth may come from three main branches, representing the three parties involved: users, Facebook and advertisers. This order represents the power each one has: without users, there could be no business. Then we have Facebook over advertisers, because advertisers want the ROI and won’t leave a good source of revenue for non money issues so easily.
First branch: Growth from users
If the number of users grows 5%, advertisers can now potentially reach that many more people. That will bring new revenue equal to the ARPU of the users we are considering, because if the aggregated web of businesses reaches 5% more people with the same money ROI will in average increase 5% and attract competition (the ad engine we talked about). Some individual businesses won’t benefit from these new users, simply because they are not their target.
We can measure them with monthly active users (MAU), and because we will later recur to average revenue per user (ARPU) – we should stick to MAU. This is because ARPU is calculated from average MAU over a quarter.
MAU growth is expected to come from two areas:
- Network effects: my friends are using the platforms, so I may starting using them too so I can connect to them;
- Content displayed on the platforms may also help. For example, Bitcoin users love twitter so they may use it to get news on the subject, regardless of social media purposes. The same can happen for content inside Facebook.
MAU and Total Addressable Market
I expect it to slow down because they already have a huge chunk of the world users with internet access. We have 7600M people in the world at the time of writing, of which ~5000M have internet. Let’s also say that they can’t get any chinese internet users, meaning we will substract the 55% of China’s population that has internet: 800M.
Total Addressable Market = 5000 - 800 = 4200 M
They already captured 2500M users, so 60% of the market. And there is an important caveat: the 40% of users not captured are more likely to be from developing countries, simply because developed markets are more saturated:
|Population with internet||333||728||1307||1832||4200|
|MAU market share @FY2020||74%||54%||79%||45%||59%|
This forces us to look at MAU and ARPU by geography, avoiding overestimating revenues by pegging to the high US ARPU’s. More on actual estimates later. I exclude China from the Asia-Pacific (AP) segment because I don’t expect China to unban Facebook use anytime soon, even though we know that many chinese people use it despite this.
Inflation and user spending
Finally, putting more money on users’ hands will make them potentially spend more. That means that I will be more prone to spending when I see an ad, because I now have this stimulus check that I didn’t really need (some people did). That is why I argue that Facebook’s engine comes with inflation protection. When users spend more with the same volume of ads, ROI goes up and you know the story.
Second branch: Facebook’s growth from relevance
Facebook has what you can consider it to be a worse version of tobacco’s pricing power. If they do a good job showing the right ads to the right people, everybody is happy: users because they get something useful, advertisers get ROI, Facebook gets revenue. The same ad can bring a lot or no revenue at all, and the key is relevance. If the ad is more relevant to me, I’m more prone to interact with it and fulfill the ad’s purpose. That may be a sale or simply brand awareness.
Digging a bit deeper, how can Facebook show me more relevant ads? The answer is user data. If they know more about me, better chances of me engaging with the ads (clicking) occur. We can measure this by looking at what targetting options we have as advertisers, and see if new insights about users surface up. We can also track it as a user, by judging how much more relevant the ads they show us are.
Unfortunately there is no quantitative way of estimating this, we will only see the result on the top line. That doesn’t mean this great asset is useless. It’s almost as powerful as tobacco pricing power; not as much because they can’t do it at will.
And how do they get better at doing the job of relevance? With machine learning and user feedback. That’s why we see companies like Alphabet providing the like/dislike button for ads, and randomly asking if we’ve seen any Colagte ad on youtube recently. At the root of this we have great engineers, building these algorithms and feedback tools. Thus, another important growth metric to follow is headcount.
Third branch: Advertisers
These are the ones who spend the money. Growth from advertisers may come from several sources:
The first one is digitalization of existing businesses. There are increasingly more businesses pushing for online presence, increasing platform adoption (and vice-versa). This trend is shifting ad investments from offline to online, and Facebook is going to get some of it. Take a look at what’s happening in the US:
|Digital ad spending worldwide||161,77||232,27||325,02|
|% of all ad spending||28,40%||39,70%||50,30%|
But why is this happening? Businesses must be where customers are. If they are now spending less time going to physical stores and increasingly shopping online, they have to be present digitally too. In the past, if I wanted to find someone to repair my case, I would ask my friends and family and go to the place physically. Now, I’ll probably do a Google search first, potentially leading me to Joe’s Facebook page or website. And if Joe is not online, he might lose me to a competitor.
And how much more can digital ads steal from offline ad spending?
This question leads us to the second force of increased online ad spending: better ROI than elsewhere. If I can target my audience in Facebook better than in TV, I will get a better ROI using online ads. And this can be quantitatively forecast. More on it later too.
Thridly and finally, we have the creation of new businesses, with part of them going online. This is measured by worldwide GDP: more goods being produced means increasing user demand, thus more ad revenue for Facebook.
Forecasting Facebook’s growth
Let’s gather all the metrics of Facebook’s growth mentioned along the way and give our best estimates. We can be as fancy as we want with forecasts. More importantly, we need to be directionally right in the estimates. Margin of safety should take care fo the rest. We’ll take a 10 year outlook.
1. How many new users do you expect?
US is almost saturated, so is AP ex-China. On the other hand, ROW and EU still have a runway. Network effects and content displayed are expected to support the continuation of user growth.
|Actual MAU||248||394||1038||817||2 497|
|FY2020 population share||74%||54%||79%||30%||59%|
|10Y future CAGR||0%||3%||0%||7%||4%|
|10Y Future MAU||248||530||1 038||1 607||3 423|
|Future population share||74%||73%||79%||88%||81%|
How much revenue will these users bring?
|10Y MAU increase||0||136||0||790||926|
So that’s 26B$ of revenue at today’s ARPU’s. We’re not accounting for ARPU growth here because increased ad spending is a consequence of all the factors we are forecasting.
2. How much market share will Facebook grab from offline advertising?
First of all, I don’t expect Facebook to grab nor lose market share from Google or Amazon, as they all serve their purpose. There is some overlap, but each one of them has a very unique ecossystem: Facebook has social media, Amazon is where people go to buy specifically products and Google has search engine queries.
But I expect Facebook to grab a cut of offline ads, because I think that online advertising is more effective than them at targetting. If you put up a local radio ad the best you can expect is to be talking to everyone in a specific region. With online ads I can talk to mothers of teenagers using iPhones in that same region, for example.
|Digital ad spending worldwide||162||232||325||603|
|% of all ad spending||28%||40%||50%||75%|
|Total ad spending worldwide||570||585||646||803|
|CAGR since last period||1%||5%||2%|
|Revenue shifting to onlinesince last period||71||93||278|
Even if you consider the ad industry as a whole grows at 2% a year, if 75% of all ad spending will be online by 2030 (which I consider conservative) there are 278B$ for companies like Facebook to grab. If they take 20% of it as they are doing now, that’s 55B$ in the next 10 years.
3. What multiple will the business be worth in 10 years?
If you take a look at the biggest online ad players in the industry – that is mostly Google and Facebook (Amazon and Alibaba are not pure advertising plays) -, they have been trading at minimums of 20x EV to Net Income and averages of 25-30x.
Because I expect top line growth to decay as Facebook matures, I consider 25x to be a fair multiple for a company with the great competitive advantages and cash generation power they have. So somewhat lower than today’s multiple of 30x.
4. How much does ad relevance contribute to Facebook’s growth?
There is also the added benefit of ad relevance, that unfortunately is not quantiavely measurable. But judging by the historic 3Y ARPU CAGR’s of 12-23%, I’d say they are doing a good job presenting more relevant ads. According to my estimates, 60% of the top line growth since 2015 comes from the shift from offline ads to online ads and 15-20% comes from MAU growth. That leaves 20% of the growth for ad relevance.
There is evidence to keep believing this growth to exist: as users keep interacting in Facebook’s platforms, they gather more intel about them. The data gathered is proportional to the time spent on the platforms. That allows for further ad placement optimization.
All of the factors above excluding the 4th result in Facebook’s top line doubling in 10 years, a 7.2% CAGR. If we assume ad relevance will contribute to 10% of the growth, it becomes a 8% CAGR. I also don’t see net margins contracting, so I expect this 8% CAGR to bleed down to Net Income and consequently stock price (capital gains). This growth is net of inflation, due to the business model being spending friendly as explained before.
But considering that EV/NI will contract at a -2% CAGR over 10 years (31x to 25x), it leaves us at a 5-6% Net Income CAGR at the current price of 320$/share.
There’s a ton of talk about AR/VR, and also a lot of investment. I value it at 0 for now and focus on the core. The same goes for payment revenues. We get those two for free.
Analyst's Disclosure: I am/we are long fb.
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