Facebook (FB) - Get Report has had a very volatile performance this past year. And this past month as the market has sold off in response to the coronavirus crisis, Facebook saw its share price drop more than 30%. Although there is huge uncertainty over the impact of coronavirus over the global economy, Facebook is well-positioned to not only navigate this storm but may actually come out stronger at the other end.
As it now trades for roughly the same price as it did two years ago, this high growth tech company is being too cheaply valued at present. Here's why:
Coronavirus and Work From Home Culture
On the back of this global movement towards social distancing over the next several months, the demand for a digital social connection is going to soar. Which companies are most likely to benefit? That’s the question on every investor’s mind.
And while investors were quick to reprice higher many software-as-a-service (SaaS) companies that would ensure seamless productivity, this social media juggernaut appears to have been forgotten.
Furthermore, we know that advertisers are having to pivot their physical ad strategies to embrace the fact that consumers are going to spend significantly more time at home and online. Thus, while we do not know how advertisers will shift their ad-spend dollars, it is entirely realistic to expect them to increase their portion of digital spend.
Even if we assume a more conservative outlook, one where the total ad spend would get cut back in a global recession, it's reasonable to assume that the impact on tier-one premium advertising platforms would get have the smallest impact -- and this has in this author's opinion already been factored into its valuation, given the recent share price sell-off.
Consequently, it is as part of this secular movement that I believe that companies, such as Facebook, that post the highest return on ad investment, through tools such as click-to-message businesses, features available on Messenger or WhatsApp will stand to benefit the most.
After all, brands need to connect with consumers wherever consumers find themselves. Given that consumers are going to spend significantly more time on digital devices over at least the next several months, I believe that Facebook will be one company that is well-positioned to benefit.
Financial Position Is Rock Solid
Here is the reality of the coronavirus’ impact on the global economy: nobody actually knows when it will be fully dealt with and economies can start to grow once again.
As investors, we can embrace bad news. But uncertainty is even worse than bad news. With uncertainty, the mind goes wild into how bad things can get. Once the bad news is faced head-on, investors can start to quantify and attempt to price in its implications.
Warren Buffett teaches us that we never know who is swimming naked until the tide goes out. Accordingly, whereas some of Facebook’s peers were playing a dangerous game by leveraging their balance sheets, Facebook has consistently been debt-free.
In fact, it presently carries around $55 billion in cash and equivalents, a sum that approximates 13% of its market cap.
Moreover, given that Facebook has more cash than it needs, it had already set about repurchasing its shares. As of its latest update, it had $15 billion allocated for share repurchases. Thus it will be interesting to observe how aggressively Facebook has repurchased its shares this past month when it reports its Q1 2020 in approximately a month’s time, as to how confident it feels about its operations.
Valuation - Large Margin of Safety
The near-term impact of the coronavirus on Facebook’s revenue growth rates is highly uncertain. Therefore, any attempt to predict how Facebook is going to report next quarter or the one after is a foolish endeavor.
Investors should accept that the coronavirus outbreak will be dealt with at some point in time, rather than attempting to market time their entry.
Here's a back of the envelope calculation showing why Facebook is being cheaply valued:
For 2020 Facebook has guided that it expects to deploy approximately $18 billion towards capital expenditure. Assuming that Facebook grows its revenues in line with consensus estimates or even 200 basis points below recent consensus, this implies revenue growth of 19%-21% year-over-year.
Consequently, this would very approximately mean that Facebook is likely to generate $21 billion to $22 billion of free cash flow -- a figure that puts its market cap on a 20x-21x multiple to clean free cash flow.
Put another way, Facebook is still in high growth mode, and in no way taking its foot off the pedal in terms of investing in its operations, yet it still trades for just 20x free cash flow -- a rare investment opportunity.
The Bottom Line
The most successful investors don’t attempt to time the market but spend time invested in the market. Looking back to the financial crisis, the best time to invest was when others didn’t want to invest for fear of the unknown. I believe a similar situation is present here today. This investment is too compelling to be ignored for too long.