Facebook, Inc.

FACEBOOK, INC.

Ticker:                          FBNature of Business:    Technology ServicesLocation :                               USA
Recent Price:           $2301.13     52-Week High/Low: $315.88/180.82Estimated Fair Value:      $307.46-$322.85
Expected Return:    14.8%Consider Buy:                   Below $322.85Business Risk:                     High
Financial Risk:      MediumEconomic Moat:               WideCorporate Governance: Strong

Company Overview
Facebook, Inc. (FACEBOOK), which provides social networking and messaging services to billions of people and businesses around the globe, was formed in 2004. The company owns the popular brands of Facebook, Facebook Messenger, Instagram and WhatsApp. FACEBOOK has subsidiaries in the United States of America (USA), Denmark, Ireland, Sweden and Singapore. While most of the subsidiaries are domiciled in the USA (Delaware), the company has offices in many countries.

FACEBOOK uses a combination of both organic and inorganic strategies to grow its business. It acquired Oculus, maker of virtual reality headsets, in 2014; WhatsApp was acquired in the same year. Continuous investment in technology has enabled the company to make improvements to existing products and produce new products.

Mark Zuckerberg is the chairman and chief executive officer of FACEBOOK. David M. Wehner functions as the chief financial officer. Peggy Alford, Marc L. Andreessen, Kenneth I. Chenault, Sheryl K. Sandberg, Peter A. Thiel and Jeffrey D. Zients served as directors during the year under consideration.

Investment Thesis
FACEBOOK relies on the revenue from advertisements on Facebook, Messenger, Instagram, third-party applications and websites. It has leveraged the wide reach of its platforms such as Facebook and Instagram to drive advertising sales.  Advertising sales accounted for over 90% of total revenue and have grown by 37.4% on a 3-Year Compound Annual Growth Rate (CAGR) basis to $69.7 billion in 2019; there was a 3-Year CAGR of 47.7% in the prior year (2018). Only $1 billion was realised from other sources in the year under review. Besides, other revenue as a percentage of total revenue has dropped from 15.9% in 2012 to 1.5% in 2019. In the light of the increasing competition in digital advertising, management must aggressively diversify earnings sources.

The USA and Canada have been producing close to 46% of total revenue in the past three years. Europe made a revenue of $16.8 billion in 2019, up from $13.6 billion in 2018. Revenue from other parts of the world is growing. We expect the upward trend in other geographical locations (apart from the USA, Canada and Europe) to continue in the foreseeable future as more businesses become web-based and embrace digital advertising.

Revenue growth is stable and at a high rate. It expanded by 49.9% on a 3-Year CAGR basis in 2019 (2018: 48.3%). Currently, the company does not pay dividends.  It invests in both hardware and software in order to enhance existing products and develop new products. This should sustain earnings growth and strengthen its competitive advantage.   The company’s investors only benefit from appreciation in the value of the shares bought.

The number of active users of the Facebook platform and other platforms has increased. The number reached 2.9 billion as at 31st December 2019. The number of advertisements rose and more people interacted with the advertisements. We are of the opinion that advertising revenue would increase due to the reach of the platforms of the company. Research and Development (R&D), which has been on the increase, jumped 32.4% to $13.6 billion in 2019; it has averaged 19% of revenue over the past ten years. The investment in R&D is expected to pay off and help the company build a durable economic moat.

Valuation
A share of FACEBOOK is worth between $307.46 and $322.85 from our valuation. We anticipate a return of 14.8% on FACEBOOK stocks.

Financial Overview
Income from operations dropped 3.7 percentage points despite a 26.6% revenue growth. FACEBOOK declared an operating income of $24 billion and a revenue of $70.7 billion in 2019.  The operating profit margin shed 10.7% from 44.6% in 2018 to 33.9% in 2019.  A $15.8 billion hike in costs caused a decline in operating income and operating profit margin. General and administrative expenses were responsible for the bulk (44.4%) of cost increment in the year under review. A $5 billion accrual related to the Federal Trade Commission USA (FTC) settlement and other legal-related costs were major contributors to a 203.3% rise in general and administrative expenses. Consequently, general and administrative expenses now accounted for 14.8% of revenue as against 6.2% of the previous year. Total expenses to revenue ratio leaped from 55.4% to 66.1% in one year.

Income before taxes contracted by $549 million while net income lost $3.6 billion due to a rise in provision for income taxes. Total comprehensive income dipped by 13.2% to $18.8 billion from $21.6 billion. Profit margins are among the best in the industry. The gross margin of 81.9% was 1.3% better than the average of ten years. But the pre-tax profit margin was 35.1%, down from 45.4%.  Profit After Tax (PAT) margin worsened by 13.5%.  Return on Average Equity (RoAE) and Return on Average Assets (RoAA) averaged out to 18.1% and 15.3% respectively.

Both total assets and total equity surpassed $100 billion. Total assets jumped from $97.3 billion to $133.4 billion; total equity increased to $101.1 billion from $84.1 billion. Liquid assets amounted to over 40% of total assets. FACEBOOK is not bogged down in debts and generates ample profit and cash flow to offset interest expense.  Though the current ratio fell from 7.2 times to 4.4 times, the company can still meet its maturing short-term obligations. In addition, its long-term solvency is not impaired.

Business Risk
The industry comprises innovative players that could cause major changes in a short period of time. Investment in technology and product development is required in order to meet the changing needs of both the existing and prospective users of its products. Failure to do this will reduce its brand preference and earnings.

FACEBOOK is also faced with potential litigations arising from breaches of security, data privacy and integrity of its platforms in different territories. If the outcomes of legal cases are unfavourable to the company, it may incur losses from its operations.

Recommendation: Buy

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