La tesis de Matt Coffina, gestor de la cartera Hare del StockInvestor de Morningstar, cuando entró en FB hace 2 años. Ayer cerró al mismo precio.
I’ve made plenty of mistakes as an investor, but one of the worst–by my own reckoning–was selling Facebook FB over the course of 2013. At the time, I was worried about Facebook’s user engagement, the effectiveness of its ads, and (most of all) the stock’s valuation. In hindsight, it’s clear that my concerns were misplaced. Earlier today, I reintroduced Facebook to the Hare with a 3% weighting.
Facebook has incredible global reach, with 1.7 billion monthly active users. That represents about 23% of the world’s population and about half of all Internet users. It also reflects 39% growth since the end of 2013. No media or advertising platform in history, with the possible exception of Alphabet’s GOOGL Google, has ever had comparable global reach.
Furthermore, Facebook’s users appear to be more engaged than ever. Despite some anecdotal evidence of waning interest among teens, the ratio of daily active users to monthly active users stands at 66.1%, up from 61.5% at the end of 2013. At last count, users spend an average of 50 minutes a day across Facebook’s various platforms, up from 40 minutes two years earlier. Besides its namesake website and app, Facebook also owns Messenger, Instagram, and WhatsApp.
While Google has the dominant position in “search,” Facebook increasingly owns “discovery.” Google is where you go when you know what you’re looking for, Facebook is where you go to browse. While Facebook’s user growth will inevitably slow–it can’t get more than 100% of the Internet-connected population using the service (though I’m sure it will try)–I think there is still room to increase user engagement and time spent, particularly as Facebook pursues its “video first” strategy.
As impressive as Facebook’s user engagement is, I was most wrong about its earnings potential and valuation. The company is expected to bring in $27 billion of revenue this year–3.4 times as much revenue as it reported in 2013, reflecting greater than 50% compound annual growth over the past three years. In retrospect, I think I underestimated Facebook’s growth opportunity because I misunderstood its core product. I originally thought of Facebook as providing “display ads,” which have limited effectiveness and are inherently distracting from the main purpose of online media. In reality, Facebook has helped to pioneer an entirely new ad format, “native ads,” which look and feel just like any other content in the Facebook newsfeed. It turns out that native ads are much more engaging and effective than traditional display ads, because users don’t even realize they are ads until they’ve already absorbed the message. Facebook has been able to demonstrate the effectiveness of its ads in increasingly sophisticated ways, such as tracking consumers’ visits to physical stores.
Native ads are particularly well suited to brand advertising, as opposed to direct-response advertising (Google’s specialty). Brand advertisers don’t necessarily need consumers to click on the ad and follow through to an actual purchase. Instead, brand advertisers target consumers higher up in the “purchase funnel”–they want to build awareness or interest among a wide range of consumers, with the hope that they will become customers later on (perhaps years later). Consumer packaged goods firms are the clearest example of this kind of advertising: Almost no one buys a Coca-Cola online as a result of a Google search, but Coke still needs to get in front of consumers so that the next time they’re in the grocery store, they’ll put a 12-pack in their cart. Importantly, brand advertising has historically represented a much larger share of ad dollars than direct-response advertising. Other major brand advertisers include media, auto, financial services, pharmaceutical, and telecom companies.
That brings me to the opportunity that I still see in front of Facebook: Stealing ad dollars from TV. While digital advertising has enjoyed tremendous growth over the past decade, this mostly came at the expense of print media such as newspapers and magazines. Brand advertising’s most natural home has always been television, and TV has largely maintained its share of ad dollars. While pay TV subscribership has been declining only gradually, viewership has declined much faster. In place of traditional TV, consumers are spending more of their time on Netflix NFLX and other streaming services, social media, and Alphabet’s YouTube. I think it’s only a matter of time before the ad dollars follow the eyeballs. Since Netflix doesn’t show any ads, Facebook and YouTube stand to be the biggest beneficiaries of this shift.
(As an aside, Time Warner’s TWX relatively modest exposure to advertising–less than 18% of year-to-date revenue–was one of the reasons I chose this company over its media peers. I’m hoping that Time Warner can offset any advertising headwinds with increasing affiliate fees, growth in HBO, and content licensing. However, this remains a key risk for all media companies.)
Given the size of Facebook’s market opportunity, I actually find the stock’s valuation to be surprisingly reasonable. Don’t get me wrong: Facebook is by no means cheap, trading for 42 times 2016 earnings estimates (excluding stock-based compensation) and for a 3% premium to Morningstar’s fair value estimate. However, I view this as a fair price for a very fast-growing, wide-moat company. In 2013, Facebook grew revenue and adjusted EPS 55% and 66%, respectively, and the stock finished that year trading for more than 90 times GAAP earnings. This year, the company is projected to grow revenue and adjusted EPS 51% and 73%, respectively, and the P/E multiple is less than half of what it was three years ago. Of course growth will slow eventually–consensus calls for EPS growth in the mid-30% range over the next five years–but even that reduced growth rate should bring down the P/E relatively quickly over the coming years.
The biggest risk I see for Facebook would be a decline in user engagement–after all, there are dozens of other forms of entertainment constantly vying for consumers’ attention. However, on this front I think Facebook’s competitive position is stronger than ever. Most competing social networks have either failed outright (Google Plus), are past their prime ( Twitter TWTR), or have settled into specific niches that will be hard to expand from (Snapchat, Pinterest). The most important thing about any social network is whether your friends use it, and most of your friends are already on Facebook, Instagram, Messenger, and/or WhatsApp. That creates a high hurdle for consumers to even sample a new offering. In addition, Facebook has been aggressive about copying the best features introduced by competitors, such as Instagram stories and live video, which makes it very difficult for a new entrant to gain traction based on features. And Facebookhas become the key source of referral traffic to third-party content providers, so they mostly have to play by Facebook’s rules. Lastly, I think the algorithmic nature of newsfeed and a constant feedback loop of data makes it much more likely that the company can sustain user interest over the long run: If they do anything that hurts engagement, they should realize it and be able to correct it immediately.
Overall, I’m excited to have Facebook back in the Hare. While the stock isn’t cheap, I think it is trading at a fair price given the company’s growth outlook and very wide moat. My initial 3% weighting leaves room to add to the Hare’s position if a more attractive valuation becomes available in the future.
Transaction: Bought Facebook FB
Purchase Price: $130.46
Fair Value Estimate: $127
Price/Fair Value Estimate: 1.03
Economic Moat: Wide
Shares Bought: 100
New Weight in Hare Portfolio: 3.0%