The recent stock market rout has been unkind to hyper-growth glamour stocks, and especially so to Facebook (NASDAQ:FB). The digital-advertising and social-media juggernaut has been plagued by data-protection scandals, regulatory threats, slowing growth, and falling margins, all against the backdrop of a market worried about a looming recession. Net result? Facebook stock has dropped 40% off it’s all-time highs in just 4 months.
But, this isn’t time to throw in the towel. Instead, this recent selloff makes me think of an old Warren Buffett saying: be greedy when others are fearful.
At this point in time, everyone is fearful when it comes to Facebook stock due to a plethora of recent headline risks. But, if you back out and look at the big picture, not much has really changed about the core long term fundamentals of this business.
From that perspective, there’s plenty to like about Facebook stock at its current prices. You could get further weakness in the stock in the near term due to persistent headline risks. But, those headlines will eventually improve, and when they do, this stock will head way higher.
Long-Term Growth Drivers Are Rock Solid
Facebook stock has been mired in multiple headwinds recently.
First, you had the Cambridge Analytica scandal, and that opened a can of worms which has created multiple regulatory and media headaches for Facebook on the data protection front. Then, the numbers started to get worse. User growth slowed. Revenue growth slowed. Margins dropped. Profit growth fell flat.
All of this has come together to weigh on Facebook stock in the near term.
But, if you zoom out, none of this is that big of a deal in the multi-year picture. Data scandals are a temporary phenomena that will ultimately correct itself once the media and regulators realize that companies using data is a net positive for everyone (Facebook’s targeted advertising allows brands to spend ad dollars more effectively, and gives consumers relevant ads they actually care about).
Meanwhile, user growth slowing after 2 billion users really isn’t all that worrisome, and Facebook, Instagram, Messenger, and WhatsApp are all still adding users. Revenue growth slowing is also temporary as Facebook is always exploring new ways to place them, such as the still growing Stories format. And, depressed margins are a temporary byproduct of increased security spend.
In the big picture, there are really only two things that matter here: users and advertisers. Neither of those parties are quitting the platform. Despite Cambridge Analytica being more than six months old, all of Facebook’s properties and features are still adding users. Meanwhile, ad dollars always follow engagement, and because engagement throughout the Facebook ecosystem remains unprecedented, ad dollars continue to flow into the platform en masse.
As such, the long-term growth drivers for Facebook are still rock solid. So long as users stay in the ecosystem, and advertisers continue to dedicate more dollars to the digital channel, Facebook’s fundamentals will remain healthy.
Valuation Is Anemic
Because of abundant fear regarding the go-forward growth prospects of this business, Facebook stock presently trades at an anemic valuation.
The forward multiple on Facebook stock is 18. By comparison, low growth giants Coca Cola (NYSE:KO), Proctor & Gamble (NYSE:PG), and McDonald’s (NYSE:MCD) all trade above 20x forward earnings, and they are growing revenues at a fraction the rate of Facebook.
The trailing EBITDA multiple is 12. The aforementioned slow growth trio of KO, PG, and MCD all trade between 15x and 22x trailing EBITDA. Meanwhile, Facebook’s closet comp, Alphabet (NASDAQ:GOOG), trades at 15X trailing EBITDA. Twitter (NYSE:TWTR) trades at 25x trailing EBITDA.
All together, Facebook stock is just really cheap. It’s being priced for growth to completely fall out. But, that won’t happen. And as the company continues to report big-growth quarters, this stock will inevitably bounce back.
Potential Multi-Year Upside Is Huge
There are two ways to look at the long-term revenue potential of Facebook.
The first is by understanding that between Facebook, Instagram, WhatsApp, and Messenger, Facebook has the opportunity to monetize 6 billion users across all four platforms. While Facebook reports 2.6 monthly users, that number does not count the users who use multiple Facebook-owned platforms. If you add 2.2 billion Facebook users, 1.5 WhatsApp users, 1.3 billion Messenger users and 1 billion Instagram users, the number of total advertising opportunities swells to 6 billion. After all, you can advertise to the same user on both Facebook and Whatsapp.
Currently, Facebook is only monetizing about 3.2 billion of these users (Facebook + Instagram), and are doing so at an ARPU of roughly $17 and rapidly growing.
Eventually, Facebook will fully monetize its messaging apps. Also, ARPU will keep running higher thanks to secular tailwinds. Thus, in five years, Facebook will likely be monetizing 6 billion users at a $20 ARPU, implying $120 billion in revenues.
The other way of looking at Facebook’s revenue potential is top down. Facebook controlled about 17.5% of the global digital advertising market last year, and is projected to grow its share to 20% this year, according to eMarketer.
This market is projected to grow to $430 billion by 2022, and will likely hit $450 billion by 2023. Assuming Facebook’s market share continues to grow to 25% due to ramped up monetization on Instagram, Messenger, and WhatsApp, that implies fiscal 2023 revenues of about $110 billion.
Either way you look at it, this company has the potential to more than double revenues over the next five years to $110 to $120 billion. Call it $115 billion at the midpoint. Operating margins were once 50%. Now, they are in the 40’s and dropping. Long term, they should settle around 40% as security spend ramp moderates.
If you throw that 40% margin on $115 billion in revenue and take out 20% for taxes, you’re looking at roughly $37 billion in net profits in five years. Applying a market average 16 forward multiple on that, you arrive at a four year forward valuation of nearly $600 billion, roughly 60% higher than the company’s current valuation.
Bottom Line on FB Stock
At current levels, the long-term upside on Facebook stock is compelling. It’s anyone’s guess as to when this selloff will end. But, because the fundamentals remain strong, it inevitably will, and when it does, Facebook stock has a long runway to run way higher.
As of this writing, Luke Lango was long FB, GOOG, and MCD.