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Dilantha De Silva
Dilantha De Silva
Articles (182)  | Author's Website |

Facebook Delivers Yet Another Strong Quarter

Why I think the social media giant remains undervalued

January 29, 2021 | About:

Facebook, Inc. (NASDAQ:FB) is a classic example of a company that continues to beat Wall Street expectations consistently. On Jan 27, the social media giant reported fourth-quarter 2020 earnings per share of $3.88, beating the Wall Street estimate of $3.24.

The market price of the stock, however, declined 3.5% during regular trading and another 2% in after-hours trading as company executives painted a gloomy outlook for 2021, underpinned by increased regulatory scrutiny and competitive pressures. Facebook stock fell another 2% on Jan. 28.

After a careful evaluation of its long-term prospects, I believe the company is still well-positioned to create substantial shareholder wealth in the long run, and the price dip only provides more opportunity for investors to buy at a more favorable level.

Earnings recap

The earnings beat came on the back of strong growth in daily active users that helped Facebook grow its advertising revenue. As illustrated below, active users grew by a handsome 11% year-over-year, once again proving that the company is not too big to grow.

Source: Investor presentation

What is also important to note is that the Asia-Pacific region is growing at a healthy rate, which is a good sign considering the untapped potential of this region. The operating margin improved from 42% a year ago to 46% in the fourth quarter, which is another promising sign that the company is keeping costs in check even though it continues to invest in new ventures. Free cash flows came in at a record $9.2 billion for the quarter, leaving Facebook with ample liquidity to pursue value-accretive growth opportunities in the form of acquisitions.

The headwinds discussed by the management

Facebook executives highlighted a couple of headwinds that could make it difficult for the company to grow in 2021.

First is the low exposure of the platform to the services industry. Facebook generates the bulk of revenue from ad dollars spent on marketing products, not services, and this was one of the drivers of earnings in 2020 as consumers directed their savings toward buying goods in the absence of travel and leisure activities. The management expects this trend to reverse in the second half of 2021 as the easing mobility restrictions and the expected success of Covid-19 vaccinations could trigger a massive boost in traveling, resulting in consumers focusing less on purchasing goods online the way they did in the last year.

Second, the company highlighted its tensions with Apple, Inc. (NASDAQ:AAPL). Even though many investors consider federal antitrust concerns to be the biggest threat for Facebook, the company said it considers Apple an even a bigger threat. Apple's new operating system is designed in a way that companies have to take permission from the users before collecting, storing, or distributing consumer data. Facebook's business model is built on using consumer data without their knowledge or consent to enable marketers to reach the correct audience at an affordable price. This strategy will come under immense pressure in the coming year as some Apple users are likely to disable sharing data with third parties, including Facebook. With over a billion installed Apple devices in the world, Facebook is facing the threat of losing its appeal as a marketing platform if these issues cannot be resolved quickly.

On the other hand, Apple's iMessage platform is gaining traction as a reliable alternative to WhatsApp, which is not good news for Facebook as its future growth plans depend largely on monetizing WhatsApp and Instagram.

Facebook CEO Mark Zuckerberg is not hiding the fact that Apple is increasingly becoming one of its biggest competitors. In the fourth-quarter earnings call, Zuckerberg said:

"Now, since I try to use these earnings calls to discuss aspects of business strategies that I think are important for investors to understand, I do want to highlight that we increasingly see Apple as one of our biggest competitors, iMessage is a key linchpin of their ecosystem, it comes pre-installed on every iPhone, and they've preference it with private APIs and permissions, which is why iMessage is the most used messaging service in the U.S. And now, we are also seeing Apple's business depend more and more on gaining share in apps and services against us and other developers. So, Apple has every incentive to use their dominant platform position to interfere with how our apps and other apps work, which they regularly do to preference their own."

I think both these headwinds will impact the short-term profitability of the company, but there's reason to believe that Facebook is still in a strong position to grow its earnings by double-digits in the long run.

The case for Facebook

Even if we assume that Apple's policies will hurt Facebook in 2021, the long-term impact will likely be minimal in my view. Facebook currently generates next to nothing from WhatsApp, and the platform has over a billion active users. Even if 25% of these users shift to iMessage permanently, the company would still be left with a userbase of around 750 million that remains under-monetized. The company has already drawn plans to introduce WhatsApp Pay globally, and the ultimate plan is to transform WhatsApp into what WeChat is doing in China. The instant messaging platform will go through radical changes in the coming years, enabling consumers to shop on the platform itself, and Facebook is hopeful this will create a billion-dollar revenue stream. By my calculations, this is not priced in at the current market price because analysts are not talking about it enough, which leaves ample room for the stock price to move up.

Another factor that is yet to be reflected in the market price is the expected growth in the Asia-Pacific region. Internet penetration in Asia is still below 60% according to data from Eikon but has been increasing steadily in the last few years with the increased infrastructure spending of governments.

Wall Street remains bullish on the company

Even after considering the many risks associated with investing in Facebook, analysts continue to believe that the company will deliver stellar returns in the coming years. According to data from Eikon, the median analyst target price for Facebook is $341 per share, implying an upside of over 28% from the market price of around $265 on Jan. 29.

Takeaway

Facebook delivered yet another strong quarter, but the stock price fell in the market as investors weighed in the negative impact of headwinds identified by the company management.

This seems to be an overreaction in my opinion, as the company is well-positioned to mitigate any losses resulting from these challenges by efficiently monetizing its products that remain under-monetized at the moment. Growth investors with a long-term investment time horizon can safely ignore market gyrations and patiently wait for the company to deliver results.

Disclosure: The author owns shares in Facebook.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I\\\'m a CFA level 3 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). I am a registered candidate for the Chartered Wealth Manager program as well. During my free time, I enjoy reading.

Visit Dilantha De Silva's Website


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