Facebook (FB) - Get Report offers investors the best investment opportunity in tech right now. Why? Because its business model is similar to that of a toll bridge, where a large number of users spend time on its platform every single month. As a result, Facebook generates cash flow like few other businesses, and its stock is also dramatically undervalued.
More Than Just A Website
Facebook is not just a social media website. Not even close. Facebook's family of apps is a platform where 2.7 billion users spend time on every month. To put this number into context, it is roughly three times more than Alibaba's (BABA) - Get Report monthly average users on mobile, and even bigger than those of Alphabet's (GOOGL) - Get Report YouTube and Netflix (NFLX) - Get Report combined.
This type of competitive advantage should command a huge premium, as some of its platforms such as WhatsApp are not even close to being monetized. Yet presently, investors' apathy towards Facebook could lead to strong positive returns for contrarian and patient investors.
The Most Important Question: How Fast Is Facebook Growing?
As the graph above shows, while the trend of Facebook's growth continues to decelerate, what's worth focusing on is not the trajectory, but the fact that Facebook still grows its revenue meaningfully above 20% to 23% year over year.
In other words, the question is not growth or no growth. I contend that if Facebook is able to sustainably grow at 20% or higher, that investors paying up $470 billion market cap are getting a terrific investment opportunity (more on valuation later).
In The Face Of Headwinds, Facebook Shows Confidence
Going into 2019, Facebook continues to spend billions to improves its platform's safety, security, privacy and digital well-being. Furthermore, Facebook has not been shy about acknowledging that 2019 will be a year of decelerating growth and investors should brace themselves for 40% to 50% growth in total expenses compared to 2018. This equates to expenses somewhere in the ballpark of $45 billion.
Thus, Facebook's top-line is forecast to reach approximately $68 to $70 billion, while in the same period, expenses will be somewhere near $45 billion. Accordingly, its operating income should hover around $25 billion.
However, we should note that unlike other companies, Facebook is extremely asset-light. Implying that, most of its operating income converts into free cash flow. Therefore, given Facebook's free cash flow generation prowess, it is perhaps unsurprising that Facebook used the weakness in its present valuation to return to investors nearly 1% of its market cap via share repurchases during Q4 2018.
From the above table, a few things should be evident. Firstly, that relative to its own historical valuation, Facebook trades more cheaply. Specifically, we can see that both on P/Sales ratio (8.9x vs. 15.9x) and on a P/Cash Flow from operations (16.9x vs. 26.1x), Facebook trades at a discount of approximately 40%.
Next, as the table demonstrates, as a group on a cash basis, the above companies are seeing their valuations sag. That's with the exception of Snap (SNAP) - Get Report , which doesn't generate cash flow and but still has seen its share price tumble by nearly 50%.
Additionally, as discussed above, although Facebook's forward revenue growth rate is highly uncertain, one thing we can be fairly confident of is that Facebook's revenue growth rate is likely to be around 20% or slightly higher. Consequently, this implies that Facebook's compounded annual growth rate (CAGR) is likely to match that of Alphabet and to outpace that of Twitter (TWTR) - Get Report . However, given its strong cash conversion ratio, I contend this demonstrates just how unreasonably cheap Facebook is.
Facebook shareholders have to show patience through this difficult transition time. The company's 2019 will be challenging and at times frustrating. But one thing we can be sure of is that Facebook's elevated expenses will come down in 2020.
As Facebook's costs align more closely with its revenue growth, which means its EPS number will get a boost in 2020. All in all, I strongly believe that Facebook's worst case scenario is already priced in, and anything above that is just icing on the cake.
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Michael Wiggins De Oliveira has a long position in FB.