Why Is It Out of Favor?
Facebook remains a highly controversial investment. Investors are concerned about the impact of regulation and privacy, as well as whether user numbers can grow further or even remain stable.
I contend that investors are not thinking about Facebook on the correct terms. Instead, investors should consider Facebook's moat. No other social media platform even compares in terms of monthly active users (MAUs). And the amount of hard cash Facebook continues to generate, quarter after quarter, is truly impressive.
Investors shouldn't be focused on whether MAUs can continue to grow. What investors should focus on is whether Facebook is likely to be able to continue to successfully monetize these users. Given Facebook's track record, odds are very much tilted in its favor.
And even if Facebook does not succeed in monetizing its users any further, given its depressed valuation, the downside for new shareholders would be very much limited.
Watch Out For Facebook Watch
Growth in user numbers is important, no doubt. But what's also important is user engagement. For example, Facebook Watch, its video platform, is going to be a huge game changer for the company.
As of the latest figures from Facebook, there are already 75 million users spending 20 minutes a day on Facebook Watch. To give this figure context, let's step back and think about Netflix (NFLX) - Get Netflix Inc. Report . Netflix only has 150 million subscribers on its platform. And Netflix's scripted content is extremely expensive to create. In fact, Netflix is going to deploy around $15 billion on its content library in 2019 alone.
For now, Facebook is not intending to monetize Watch. But if we have learned anything about Facebook over the years, is that it has an uncanny ability to monetize its platforms. Netflix's market cap is around $160 billion with 150 million members, but with no ability to generate free cash flow yet. Shouldn't Facebook's Watch with already half the numbers of Netflix's users be worth something, too?
Facebook's Ability To Generate Cash
Facebook's 2018 was a year for heavy investment back into the company. However, when all was said and done, Facebook still generated approximately $15 billion in free cash flow. The company says 2019 is going to be a very capital intensive year, too. However, Facebook is determined to complement safety with strong engagement, and for that, it is going to have a very capital-intensive 12 months.
From a balance sheet point of view, despite strong reinvestment and close to $13 billion allocated for share repurchases, Facebook still ended Q4 2018 with $41 billion of cash and equivalents and no debt.
Consequently, it is perhaps unsurprising, given the recent weakness in its share price, that Facebook has freshly announced a $9 billion share repurchase plan. These repurchases will not only offset any compensation dilution, but also positively reward long-term shareholders.
Valuation - Irrationally Priced
Over the long haul, fundamentals do matter. But over the short-term, which often feels like a very long time, sentiment is all that matters.
Point in case, Netflix remains so much in investor favor that its valuation remains priced on little more than hope. For as long as Netflix can continue to aggressively grow its top line and user numbers, investors appear willing to ask the tough questions, such as, what is the company actually worth?
On the other hand, Facebook is evidently undervalued at a market cap of $485 million, with its cash flows are not being sufficiently appreciated. However, at some point in time, maybe 12 months or maybe as much as two years out, as Facebook continues to prove to investors that its platform is stable and its user base meaningfully engaged, investors will return to reprice it back on multiples close its historical averages (see the table above).
The Bottom Line
In summary, I argue that Facebook's family of platforms are not being accurately priced relative to its full potential. Facebook's 2019 will be a year of heavy investment, but going out into 2020, Facebook is determined to align its costs more closely with its revenue growth. And when that moment comes, investors will surely look back to today's price and realize that Facebook was cheap at a market cap of less than $500 billion.
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Michael Wiggins De Oliveira is long Facebook.