Facebook, Inc. (NASDAQ: FB)
Sector: Technology
Industry: Internet Content & Information
This blog posting will serve as the first issue of our monthly Portfolio Spotlight. The purpose is to highlight one of our major holdings each month to give you, our clients, a better idea of where your money is being invested. Ultimately, when you look at your portfolio we want you to understand why all of those tickers are there and what purpose they serve for your investment goals.
Executive Summary
Facebook, Inc. (Facebook) was founded on February 4th, 2004 and is based in Menlo Park, CA. Facebook produces useful and engaging products that enable people to connect with one another through their mobile devices, tablets, and/or personal computers.
In the second quarter of 2017 the company updated their mission statement, “to give people the power to build community and bring the world closer together.” Facebook’s products are used by people to share and express what matters to them, stay connected with friends and family, and discover what’s happening across the globe.
During the third quarter earnings call on November 1st, 2018 Mark Zuckerberg, CEO of Facebook, addressed the user and earnings growth (which were fantastic and we’ll dig into later), but then went on to say that “none of that matters if our services are used in a way that doesn’t bring people closer together” speaking about Russian use of the platform during the 2016 election. Zuckerberg has stated that Facebook is taking immediate and intense steps to increase security on the platform. The goal is to make advertising on Facebook more transparent, says Zuckerberg.
Prices date sensitive - current as of 11/22/2017
“Protecting our community is more important
than maximizing our profits” – Zuckerberg
The tone and confidence behind this statement gave investors reason to believe profits would take a hit and this was reflected in the price drop shortly after the earnings release on November 1st.
Revenue Streams
Let’s take a look at how Facebook has monetized its business as a social media giant. Then we can talk about the outlook and sustainability of those revenue streams.
Below is a slide from the 3Q earnings report published by Facebook, Inc. on Nov. 1st, 2017.
As you can see from the graph above 98.2% of Facebook’s revenues during the third quarter of 2017 came from advertising. The other 1.8% is accredited to payments and other fees.
Advertising: (98.2% of Revenue)
The advertising revenue is generated from ads being shown on all of Facebook’s platforms (facebook.com, Instagram, messenger, and third party affiliated apps or websites). Facebook revenue is based on clicks, actions, and impressions by each advertisement shown on their platform. This is what makes advertising on Facebook so appealing to businesses – the advertiser pays for exactly what they get. The better their ads do, the more they pay and vice versa. Along those same lines, the more a company pays, the greater their reach becomes.
Payments and Other Fees: (1.8% of Revenue)
This includes fees from games and purchases of virtual and digital goods.
Sustainability
After notating that 98.2% of Facebook’s revenue comes from advertising it is important to take a look at the advertising market and assess if this revenue is sustainable. Questions like this are relevant when considering the outlook for an advertising company: How did companies advertise in the past? How do companies advertise now? How will companies advertise in the future? Please bear with me as we look at a couple of charts to paint a picture of where advertising is going and how Facebook will play into the trends.
This graph by emarketer.com makes it easy to see the trend of advertising and how digital (online) ads are growing at a much higher rate than TV advertising.
The breakdown of ad spending in this chart is helpful because it shows the rotation of where ad dollars are projected to be spent.
Increasing Market Share:
~ Digital
Decreasing Market Share:
~ TV
~ Radio
~ Out-of-home
~ Directories
The purpose of showing these forecasts is to acknowledge that money is moving into digital advertising. In order to take advantage of that, investors need to be aware of companies that will see revenue growth as a result of this transition in advertisement spending.
For greater detail on ad spending forecasts please see: emarketer.com
Now that we know where advertising budgets are moving (digital) we need to know which companies are going to benefit from this shift. As it stands, Google (parent company Alphabet, Inc.) controls 40.7% and Facebook controls 19.7% of the U.S. digital ad market. (Source) The two companies dwarf the next competitors by comparison. Being the second largest (and closing the gap to the largest) advertising company in the digital advertising market bodes well for Facebook’s future.
Growth and Opportunity
We are going to walk through a series of charts that may have you scratching your head. These charts are all straight from the slides of the 2017 3Q earnings release by Facebook, Inc.
Daily Active Users: “We define a daily active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day."
"Daily active users (DAUs) were 1.37 billion on average for September 2017, an increase of 16% year-over-year” – Form 10-Q
Monthly Active Users: “We define a monthly active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement."
"Monthly active users (MAUs) were 2.07 billion as of September 30, 2017, an increase of 16% year-over-year.” – Form 10-Q
"Revenue was $10.33 billion, up 47% year-over-year, and ad revenue was $10.14 billion, up 49% year-over-year." - Form 10-Q
First, take note of the approximate 16% Year over year growth of DAUs and MAUs and the 47% year-over-year revenue growth.
Second, you may have noticed, if not you can always scroll back up, U.S. & Canada make up 11.53% of the MAUs and 13.52% of DAUs and yet account for 48.73% of the revenue. When approximately 12% of the users drive nearly 50% of the revenue, that means either the U.S. & Canada spend way more on advertising or there is a huge opportunity for monetizing the Europe and Asia-Pacific markets as well as the rest of the world. Based on the statistics it’s likely a mix of both. According to Statista the United States, the largest advertising market in the world spent $190 Billion on advertising in 2016. This more than doubles the amount spent by the second largest ad market in the world, China. However, even if U.S. & Canada spend twice as much on advertising than anywhere else in the world. That should still only account for approximately 25% of the revenue, based off of DAUs and MAUs and yet it accounts for nearly 50% of the revenue. Following this line of logic it would seem there is significant opportunity for Facebook to monetize its user base and the markets outside of the U.S. and Canada. That opportunity for growth doesn't take into account the fact that Facebook’s user base has a current growth rate of 16% year-over-year.
Ease of advertising has and will continue to be another catalyst for growth. Facebook has a platform called Facebook Blueprint, which provides free online training for advertisers on Facebook. Also the ability to target specific audiences makes a huge difference when spending advertising dollars.
Would you rather spend $200 to print flyers that might or might not be seen by anyone in your target audience or spend $200 dollars to run an ad that is shown only to the audience you specify and provides feedback on exactly how many people viewed your ad and what their reactions were? Plus, only pay when someone views your ad. Seems like a no-brainer... and that is exactly why a major shift in the advertising industry is happening right now.
Competition
Facebook faces competition on two fronts that intertwine. It competes for popularity in the social media arena (where it currently dominates) and it competes for business from companies that want to advertise. These fronts intertwine because as the popularity grows, Facebook becomes more attractive to advertisers because the audience reach increases.
Competing for business - As we discovered earlier, digital advertising is taking off in relation to other common forms of advertising (TV, newspaper, radio, etc.). Facebook currently chases Google to be the largest digital advertising platform in the world. While they do directly compete for market share of the digital advertising industry, both companies can enjoy growth simultaneously because money is pouring into digital advertising. They aren’t battling back and forth for a static portion of advertising dollars. They can both feed their top lines with dollars entering the digital advertising market. As it happens, Facebook is closing the gap in terms of market share.
Competing for popularity – It isn’t news that social media is a volatile business to be in because it relies heavily on popularity, which can come and go with the seasons. However, Facebook has a distinct advantage at this point. Seen most recently with Snapchat (SNAP) – known for sending pictures that disappear after viewing for a few seconds. Facebook made several offers to buy Snapchat because it was an emerging and increasingly popular form of social media. Declined multiple times, Facebook then replicated many of the features that people love about Snapchat on its own platforms (Instagram, Messenger, and Facebook) and many users now view these additional features as being better than the ones pioneered by Snapchat itself. Having the ability to replicate features or buyout any potentially threatening companies makes the horizon for Facebook seem exceptional. At the same time going against the social media giant is daunting for others.
Market Indicators
Put/Call Ratio: .676 (as of 3:05 pm 11/22/2017)
The put/call ratio is an indicator of market sentiment (the higher the ratio, the more bearish the sentiment) It is important to note what the market Is doing because stock prices rise and fall based on supply and demand. If the market in general is selling a stock more than buying it, then the price is inevitably going to fall.
P/E Ratio: 35.05 (as of 3:05 pm 11/22/2017)
The price to earnings (P/E) ratio is exactly what you would think - The current share price divided by the earnings per share (EPS). This is another dynamic ratio which is constantly changing as the current share price changes.
A typical P/E Ratio lies in the 20-25 range. Moving above that could indicate a growth prospect or an overpriced security in comparison to other companies.
What's Up and Coming?
Workplace by Facebook - a collaborative platform run by Facebook used by corporations for task management and collaboration.
New initiatives in Messaging and What's App.
Oculus Connect and Oculus Go
Facebook Marketplace - a place to buy and sell things.
We hope you have found this Portfolio Spotlight to be both enlightening and encouraging.
Happy Thanksgiving to you and your family!
*Please note that all financial data is date sensitive and is current as of today, November 22, 2017 or the date specified in each of the sources.
Authored by: Jeffrey Gardner, Financial Advisor The information presented above has been prepared for informational purposes only and the commentary represent the opinions of the author and are subject to change at any time due to market or economic conditions or other factors.