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Investment Thesis
Facebook (FB) will see some irregularities in 2020. Facebook’s first quarter results from Facebook were largely unaffected by our work environment from home, as Facebook was only significantly affected in the last few weeks of the first quarter 2020. By April, Facebook revenue is unlikely to record growth compared to the same period last year and a sequential decline of 17%.
However, that news is already priced on many occasions, and since your shares are only priced at 26 times free cash flow, this is a great investment opportunity. Investors who are willing to accept some irregularities in 2020 will be rewarded in the next 12 months.
First quarter 2020 results: I expected a lot, but this?
Facebook is much, much more than just Facebook’s platform. And we constantly hear people closing their Facebook accounts. However, these are the facts: 2.6 billion people use the Facebook platform per month. Note, these are duplicate accounts So where are the ones who supposedly close their Facebook accounts? There are some anecdotal user stories, but this number is colossal.
If that figure didn’t speak to the power of Facebook as a whole, consider this: 2.3 billion people using at least one of Facebook, Instagram, WhatsApp or Messenger to day. If Alphabet (GOOG) (GOOGL) comments earlier this week are even accurate, we will no longer live again before COVID-19. In the future, our demand for online tools, socialization will now be part of the new normal.
This immediately forces the question: Does Facebook see its numbers decrease after the crisis? CEO Mark Zuckerberg stated in a preemptive move during the comment on Facebook’s earnings call that, while there is a spike in numbers, there has long been an underlying trend toward using private online communication as a form of socialize.
The importance of a high quality business
(source)
In Warren Buffett’s 2019 annual letter, he said
To build a reputation as a good manager, just be sure to buy good deals.
Similarly, Zuckerberg signaled his determination to continue investing in Facebook regardless of the recession. In fact, Zuckerberg noted that recessions bring new opportunities, but ultimately argued that he recognizes the importance of operating a high-margin business.
Meanwhile, although other large companies will be forced to withdraw their investments, Facebook may continue to take offense. Not only did the number of employees increase 28% year-over-year during the first quarter of 2020, but by 2020, Facebook will hire approximately 10,000 more people for product and engineering functions. Additionally, Facebook deployed $ 5.7 billion on Jio platforms in India. Therefore, Facebook continues to invest on all fronts.
What about the short term?
Advertising was greatly affected from the first week of March. For now, Facebook believes that in April its income has stabilized. Unsurprisingly, Facebook was somewhat elusive in terms of the magnitude of its hit during this period, but Facebook noted that this pullback came from both small and large customers.
Overall, enough details were disclosed for investors to understand that during April there was a sharp increase in volume as well as a significant decrease in prices. Consequently, during the first three weeks of April, Facebook’s year-over-year comparisons would imply that its earnings are flat and 17% sequentially.
CFO David Wehner notes that a global contraction will have a severe impact on the advertising industry. Furthermore, Wehner admits that having less revenue and continuing to invest for the future means that Facebook’s operating margins for the rest of 2020 will continue to compress compared to its more normalized expected outlook for 2021.
Valuation – Strong in reverse long term
Facebook’s performance in 2020 will be abnormal: Facebook will have less revenue growth to balance its ongoing investment projects.
Put another way, for many investors, aside from the fact that their shares shot up 11% after hours, many investors will question their investment once Facebook’s second-quarter 2020 results are released. Because, ultimately, Facebook’s Q1 2020 results were only affected in the last weeks of March. Currently, many companies are still struggling, such as those that are exposed to travel and cars.
The best guiding measure I’ve found to illustrate that Facebook is undervalued is that it trades its free cash flow 26 times. However, as noted throughout, the rest of 2020 will see Facebook’s free cash flow compression. On the other hand, this is free cash flow and not profit, investors long for higher tangible free cash flow.
The bottom line
Paying 26 times the free cash flow, for the engaged Facebook monopoly audience, is a bargain investment opportunity. In particular, if Facebook can again increase its revenue by about 18% -20% in 2021.
In the short term, 2020 is still expected to cut Facebook’s revenue, making it an abnormal year for Facebook. However, investors willing to be patient and stick with 2021 should be rewarded.
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