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The Science of Hitting
The Science of Hitting
Articles (656) 

Facebook: A Strong Start to 2020

A look at the company's 1st-quarter results

May 03, 2020 | About:

On Wednesday, Facebook Inc. (NASDAQ:FB) reported results for the first quarter of fiscal 2020. For the quarter, revenue increased 18% to $17.7 billion. As noted on the call, the deceleration from the fourth-quarter growth rate (up 25%) reflects the impact of decreases in advertising revenue beginning in the second week of March. (Following the steep declines near quarter end, management noted that advertising revenue stabilized throughout the first three weeks of April.)

Daily active users (DAUs) and monthly active users (MAUs) grew double digits in the quarter, with increased engagement across all of the company’s services as people around the world sheltered in place. As shown below, user growth has continued unabated in recent quarters.

There are now more than 2.3 billion people (de-duplicated) who use at least one of the company’s services (Facebook, Instagram, Messenger or WhatsApp) on a daily basis – with an additional 100 million people around the world joining that group over the past 90 days.

With help from higher engagement across feed and stories, ad impressions increased 39% in the quarter, offset by a 16% decline in ad pricing. The decline in pricing largely reflects a demand side shock as small and large advertisers alike pulled back in the last three weeks of the quarter.

A big part of the Facebook story (from an investment perspective) continues to be the outsized growth of expenses. Operating costs increased by roughly 35% in the first quarter (adjusted for the Federal Trade Commission settlement), with the outsized expense growth relative to revenue resulting in significant operating margin compression (to 33%, compared to 42% in the year ago period).

The company’s 2020 guidance doesn’t alleviate these concerns. Facebook expects $52 billion to $56 billion in operating expenses for the year, implying an increase of roughly 30% at the midpoint. Given what the company reported in the first quarter, and what’s likely in the coming months given recent business trends, I wouldn’t be surprised if revenue grew by less than 10% for the full year – suggesting meaningful margin compression, along with a year-over-year decline in earnings.

As it relates to capital allocation, I continue to be baffled by the company’s decision-making (I know I sound like a broken record, but this will have a material impact on per-share intrinsic value over the long run). What we saw in the first quarter further cemented that opinion.

Coming into the year, Facebook held more than $50 billion in net cash. When the stock fell from a high of $223 in January to $146 in March, I hoped it would repurchase shares more aggressively. The actual result? Facebook repurchased $1.25 billion worth of stock in the first quarter – equal to roughly 5% of its 2019 free cash flow, or less than 20% of the free cash flow generated in the quarter. As a result, the cash balance increased yet again, with the company holding $60 billion in cash at quarter end, or roughly $21 per share. (As a reminder, it will probably generate around $90 billion to $100 billion in free cash flow over the next five years.)

I continue to wonder what the company plans to do with its excess capital. I don’t question its ability to find smaller deals, such as the Jio Platforms investment ($5.7 billion), but I do not think it will spend tens of billions of dollars a year this way, which would be required to make a dent in the cash balance (the business continues to generate prodigious free cash flow). In addition, I remain skeptical that large acquisitions are in the cards (the regulatory risk is too high, especially after the Instagram deal). That leaves us with dividends and repurchases, but management continues to show a lack of interest in either of those routes. That suggests the growing cash hoard will sit stranded on the balance sheet.

Admittedly, this is a good problem to have – but I continue to believe investors who are valuing the dollars on the balance sheet as akin to cash in their own pocket are making an analytical error.

Conclusion

In the short term, Facebook’s business has been meaningfully impacted by the pandemic. In addition, it appears likely that this will continue to impact the business in the coming months. But as I outlined above, the company has ample financial resources and is in a position to weather any short-term storm.

In terms of the business results, it remains apparent that management is focused on long-term value creation, not short-term reported results. They have been investing (spending) aggressively to ensure the health and safety of the core platform, along with searching for new growth areas. We’ll see what happens in the long run, but I personally remain optimistic that these efforts, broadly speaking, will bear fruit.

Disclosure: Long Facebook.

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About the author:

The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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