Facebook: A diamond in the rough

Company Overview

Facebook Inc. is the world’s largest social media platform. The Evolution of Facebook has ranged from a single Facebook app to multiple apps, such as the photo and video sharing app Instagram and the WhatsApp messaging app, owing to acquisitions. Along with in-house developed Messenger, these apps now form Facebook’s family of products used by almost 3 billion people every month.

Facebook uses metrics like daily active users (DAUs) and monthly active users (MAUs) to measure its user base. As of Q2, 2020, DAUs and MAUs were 1.785 billion and 2.701 billion, respectively. Newly introduced metric, which is the family daily active people (DAP) that measures daily users of its family of products, was 2.47 billion.

Facebook generated revenues worth $70.70 billion in 2019. Advertisement accounted for 98.5% of revenues. Marketers buy ads that can appear on multiple platforms including Facebook, Instagram, Messenger and third-party applications and websites.

Facebook, thanks to its huge user base gained a significant market share in the advertising space wherein it faces tough competition from Google, Twitter, Amazon and Snapchat-parent Snap.

The Company also faces significant competition from the likes of Apple (messaging), YouTube (advertising and video), Bytedance (social media) and Tencent (messaging and social media).

Facebook’s core app enables people to connect, share, discover and communicate with one other on mobile devices and personal computers. Facebook fosters user engagement via its News Feed, which displays an algorithmically-ranked series of stories and advertisements customized for each user.

Instagram is a community for sharing photos, videos and messages, enabling people to discover interests that they care about. People can express themselves through photos, videos and private messaging via Instagram Feed and Stories.

Messenger helps people to connect with friends, family, groups and businesses across platforms and devices. WhatsApp is a simple, reliable and secure messaging application. Regular people and businesses around the world use WhatsApp every day to communicate privately.

Facebook also offers virtual reality (VR) products through its Oculus division.

Reasons To Buy Facebook

  1. Continued Growth in Ad Revenue. Facebook continues to witness significant traction in online and mobile advertising spending. The company intends to capture the opportunity presented by ever-increasing video viewing on social media platforms. Online video is the most lucrative component of digital advertising. As video ads generate more revenues than its photo and text-based substitutes, Facebook is trying to incorporate more and more video-oriented content to bring in more ad dollars. Facebook has launched Watch, a dedicated tab for video viewing, to achieve its goal and now, they’ve also integrated music videos within this tab.
  2. Increased Monetization of Instagram. Instagram has emerged as an important cash cow for Facebook after introducing its ad platform to worldwide advertisers. To attract more advertisers (over 3 million and counting), Facebook has unveiled tools to promote posts and evaluate business performance directly on Instagram. Moreover, Facebook is also looking for ways to monetize Instagram Stories, and adding the Checkout feature to the platform is a step toward that direction. The feature allows Instagram users to browse and purchase products from 23 top brands in the United States, all within Facebook’s app. Greater monetization opportunities via the Explore tab, which hosts more than 50% of Instagram users every month and as the company starts to place ads in this space, it expects to drive the top line.
  3. Increased Adoption of WhatsApp Business. Transience and end-to-end encryption are also driving the popularity of WhatsApp. Per the company, WhatsApp Status is the most popular Short Stories product in the world. Facebook continues to promote WhatsApp business as a private way of interaction between businesses and customers. The rapid adoption of WhatsApp Business by small and mid-sized businesses is noteworthy. The company is building new tools like product catalogues that entrepreneurs can use for free to attract prospective customers. Moreover, increased communication enhances the chances of Facebook penetrating the lucrative payments market. The company continues to test the payments feature on WhatsApp in India and intend to launch the same in other countries soon.
  4. A 0 to 1 Initiative. Facebook is investing heavily to develop VR content ecosystem. Launch of VR headset, Rift and Oculus Quest, its first all-in-one headset with no wires and full freedom of movement is a step forward to that goal. AR/VR technology is fast emerging as a lucrative business opportunity. Plus, Facebook said it will be spending over $3 billion in the next 10 years on VR.
Peter Thiel: Going from Zero to One
  • Facebook Enjoys A First Mover’s Advantage in this market, as it pioneered the concept of social networking. However, as developed regions mature, Facebook has taken measures to drive penetration in emerging markets of South East Asia, Latin America and Africa. Of all places, India deserves a special mention in terms of user growth. The world’s second-largest populated country offers tremendous potential for the company. With China off the radar, India can prove to be a terrific growth engine for Facebook. This is primarily due to a burgeoning well-educated middle class, increasing spending power and rapid adoption of smartphones in the country. Facebook’s investment in with Reliance Jio is a step towards gaining a significant footprint in the country.
  • Facebook has a strong balance sheet and generates significant cash flow, which makes it an attractive stock for investors. The company continues to invest in developing its platform and products. I believe that Facebook’s ability to generate strong cash flows will help it to make further investments in product development and acquisitions in the future.

Reasons To Sell Facebook

  1. Ad Boycott. Facebook maintains a cautious stance on revenue growth due to coronavirus-related headwinds. The company expects lower ad-sales within the travel and automotive industries. Further, several companies including Starbucks, Coca Cola, Walmart among others have announced plans to freeze ad spending on Facebook due to its failure to eradicate hate speech and misinformation. This will hurt top-line growth, at least in the near term.
  2. Increasing Competition. Facebook currently faces stiff competition from other big and small social media players. In the ad space, we believe that Google continues to have a significant competitive edge, owing to its scale and diversified product offerings. YouTube, Snapchat and Pinterest offer tough competition as far as user growth is concerned. Moreover, Amazon’s ad business is growing rapidly. Intensifying competition for ad dollar is a major concern for the company.
  3. A plethora of controversies over the company’s treatment of user data and increasing regulations related to user privacy are key concerns.

Earnings and Revenue

Facebook’s Q2 Earnings and Revenues Soar Y/Y

Facebook’s second-quarter 2020 earnings of $1.80 per share, soaring 96% year over year. Revenues of $18.68 billion also rose 10.8% year over year.

Geographically, the Asia-Pacific revenues grew 10.9% year over year, whilst the United States & Canada had 14.5%, Europe 9.5% and RoW decreased by 6%.

Average Revenue per User (ARPU) growth was highest in the United States & Canada, increasing 13.5% year over year followed by Europe’s 11.4%. ARPU in the Asia-Pacific and RoW grew 10.1% and 5.3%, respectively. Worldwide ARPU rose 8.3% to $6.95.

Facebook’s second-quarter results were better-than-anticipated. Despite declines in advertising revenues due to coronavirus pandemic, advertising revenues jumped 10.0% year over year to $18.32 billion.

Management stated that ad revenues showed signs of stability in the first three weeks of April. Although the metric is steady on a year-over-year basis, trends reflect weakness across the company’s all user geographies due to coronavirus-related lockdowns.

However, Facebook didn’t provide any specific revenue guidance for the second quarter of 2020 as well as the full year due to aggravating macro-economic uncertainty related to coronavirus (COVID-19).

User Base Expands in Q2

Monthly active users (MAUs) were 2.701 billion, up 11.8% year over year. Daily Active Users (DAUs) were 1.785 billion, which increased 12.5% year over year and represented 66% of MAUs.

Family Daily Active People (DAP) defined as a registered and logged-in user who visited at least one of the Family products (Facebook, Instagram, Messenger and/or WhatsApp) on a given day. DAP was 2.47 billion, up 15.4% year over year.

Family Monthly Active People (MAP) increased 13.7% year over year to 3.14 billion.

The above community metrics reflected increased engagement with Facebook products during the reported quarter as more and more people were compelled to stay at home due to the coronavirus (COVID-19) outbreak.

Asia-Pacific DAUs were up 13.6% year over year to 699 million. DAUs in the Rest of the World (RoW), Europe and the United States & Canada grew 16.8%, 6.6% and 5.8% each to 583 million, 305 million and 198 million, respectively.

MAUs in Asia-Pacific, RoW, Europe and the United States & Canada grew 13.8%, 14%, 6.5% and 4.9% each to 1.14 billion, 892 million, 410 million and 256 million, respectively.

Guidance

The company expects to realize operational expense savings from areas such as travel, events, marketing and administration. Facebook is planning to hire at least 10,000 more people in product and engineering roles during 2020.

Facebook expects total expenses for the current year between $52 billion and 56 billion, down from the prior range of $54–59 billion. Moreover, in the ongoing year, Facebook expects capital expenditures to be $14-$16 billion, down from the previously guided range of $17–19 billion.

Outlook

Regardless of the controversies, Facebook has continued to attract ad dollars as users and their engagement on Facebook’s platforms continued to grow, displaying the resilience of Facebook’s network effect.

Amid the Pandemic Facebook has launched Facebook Shops to let businesses set up a storefront and sell across their apps, which is scaling rapidly.

Over the long term, Facebook much like the other tech giants, is looking to leverage network effects and create communities around their products. The introduction of commerce, payments, games, music and VR will allow continued usage of the app across multiple industries with increased social connectivity.

Summary

Facebook is benefiting from growth in Instagram Stories and Feed, and an expanding user base in the Asia Pacific. The company helped people connect during the coronavirus pandemic. Notably, voice and video calling more than doubled on Messenger and WhatsApp. The launch of Messenger Rooms for video call, which can accommodate 50 people, and WhatsApp video support for up to eight users are noteworthy in this regard. Shares have outperformed the industry year to date. However, Facebook expects ad-sales to be hurt by weakness in travel and automotive industries. Moreover, numerous companies have announced plans to freeze ad spending on Facebook due to its failure to eradicate hate speech and misinformation. As a result, this is expected to hurt top-line growth, at least in the near term.

Referred Sources:

Facebook Q2 2020 Results, Facebook 2019 10-K, and predictions made by the Author’s understanding of the company.

Disclosures:

This report contains independent commentary to be used for informational purposes only. The analyst/author contributing to this report does not hold any shares of this stock at the time of writing. The analyst/author contributing to this report does not serve on the board of the company that issued this stock. Additionally, the analyst/author contributing to this report certify that the views expressed herein accurately reflect the analyst’s/author’s personal views as to the subject securities and issuers.

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Sai Penukonda

Sai Penukonda

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