Equities

As I look back on the US reporting season, one stock that I believe delivered an outstanding set of numbers is Facebook.

The third quarter was volatile, both for Facebook and the internet sector as a whole. Macro uncertainties, political noise, disappointing tech IPO’s and quantitative factors have driven the returns of the group to a much greater extent than the fundamentals. However, with the earnings season, the market tends to go back to the basics of the business. On that front, there is little doubt that this is a company executing well. Users and advertisers are still using the platform, despite what the headlines may have us thinking.

Facebook reported year-over-year revenue growth of +28.6%. If one accounts for the impact of a strong US dollar, constant currency revenue growth was even stronger at +31.7%. Diluted EPS of $2.12 grew by 20.2% year-over-year and beat the estimated number of $1.76 handily.

Importantly for a platform company built on a network effect, the number of daily average users across the entire Facebook family of apps (Facebook, Instagram, WhatsApp, and Messenger) moved up to 1.62bn from 1.50bn a year ago. Monthly users grew to 2.45bn from 2.27bn over the same period. Put differently, roughly 21% of the entire population of the planet use a Facebook product once per day – an amazing feat, if you think about it.

User growth is now mostly coming from APAC and the 'Rest of World' region, where average revenue per user is lower, but starting to trend upwards. 

Source: AIM Estimates

Global ARPU is $7.26, an increase of around 19% from 3Q18. As such, it’s worth noting that the majority of revenue growth is now being driven by the improved monetisation of the user base.

Source: AIM estimates

Looking at the result from a cash flow perspective, cash from operations grew by 24.2% to $9.3bn for the quarter, and cash conversion (cash from operations/adjusted net profit) remained very healthy at 152%. When extending the scope to cover the year to date, adjusted net profit is being converted to cash at an impressive 158% ratio, and cash from operations grew by 25.7% to $27.2bn.

The balance sheet remains robust, with the company sitting on ~$52.2bn of cash and only $9.1bn of debt. Despite an arguably lazy balance sheet, we calculate the company has generated a normalized ROA of 18.4%, ROE of 24.4% and ROIC of 22.2% over the past 12 months after adjusting for the legal settlements they have entered into this year.

On current consensus estimates, Facebook is trading on 22x 12-month forward EPS, and offers prospective EPS growth of roughly +21% - a PEG ratio of 1.1x. The forward EV/EBIDTA multiple is just 11.7x – and keep in mind that Facebook has nearly 10% of its market cap in cash. While there is currently no dividend payment, there is an active stock buyback programme.

This is a business that is executing solidly, and the business model is delivering the excess returns on capital we look for in a structural compounder. The biggest risk is of the headline variety, spilling over into possible regulatory intervention at some point.

This past week has seen Facebook perform well on the news they have developed a payment tool across their family of apps. The company appears be shying away from its controversial Libra cryptocurrency idea (which we always thought was going to be a tough sell to get past regulators). The message is clear, however: any developments that the market feels lowers regulatory scrutiny on Facebook leads to the stock doing a little better.

Regulation remains a key risk that we monitor closely, but at current levels we believe there is a sufficient margin of safety for that risk to remain fully invested.

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James Bingham

Completely agree. In my opinion Facebook still has a massive growth runway ahead of it. I feel the potential to further monetize Instagram is huge, as they expand shopping and payment functions within the app. On top of this they have WhatsApp and Messenger which they haven't even begun looking to monetize at this stage. Seems like the company is positioned to continue its strong growth for the foreseeable future. At 22x P/E with a net cash balance sheet I'd say your more than rewarded for any regulatory risk.