As a deep value investor, I never thought I would be able to claim that I invested in one of the FAANG stocks. But not all FAANGS are the same, right?
And Facebook (FB) is not like the rest. I contend that while investors have fallen out of favor with this strong free cash flow-generating conglomerate, that the time to invest is right now. Investment opportunities like Facebook, at this valuation, are few and far between.
What’s Wrong With Facebook?
For me to be invested in a stock, right off the bat, something has to be wrong. I don’t invest when everything is performing well and the outlook is rosy. I invest when others won’t.
On the face of it, Facebook’s 2019 strategy offers up more questions than answers. What we do know is that 2019 will be a period of meaningfully elevated expense. We know that the company is guiding for expenses to grow in the range of 40-50% compared with 2018, with total operating expenses reaching approximately $45 billion.
Furthermore, this period of elevated expenses coincides with Facebook’s top line decelerating to somewhere in the ballpark of 22% a year. Altogether, the effects of operational leverage will be pronounced during 2019, meaning that the company’s operating income should hit around $25 billion in 2019 – somewhat flat with 2018. But do its business opportunities die in 2019?
The Long Road Ahead – E-commerce
Facebook has many opportunities at its fingertips. One such opportunity which appears to be gaining traction is its e-commerce platform.
For now, this is still a nascent business. Although, CEO Mark Zuckerberg discussed during the last earnings call how he will be devoting his focus to growing this opportunity. And how Facebook will be rolling out its e-commerce on Instagram in the first instance as it looks to iron out the inevitable kinks in its business model.
Furthermore, Zuckerberg believes that Instagram is the perfect platform to get brands closer to the right consumers and to take advantage of Instagram’s influencer culture and give new brands stronger marketing power.
Additionally, further down the road, Facebook is thinking up ways to make the transaction feel increasingly seamless and offer a more positive and rewarding experience.
Does Facebook’s Cash Flows Actually Matter?
The short answer is yes. Cash flows are not only key drivers of a company’s intrinsic value, but ultimately, strong free cash flows offer Facebook plenty of firepower.
Said another way, Facebook’s free cash flow is its moat. Its balance sheet carries no debt. Think about that for a moment. Here is a company whose market cap is made up of just over 8% in cash and equivalent.
While at the same time, it should be noted that Facebook is not a hugely cyclical company that is hoarding cash for a vicious downturn. Not at all. Facebook’s downturn is a period of time where its revenue is not growing at more than 15%.
The company has not been in the least bit shy letting investors that 2019 will be a very capital-intensive period for Facebook. Nevertheless, despite this elevated period of cash outlay, the company has shown it is determined to use the share price weakness to its advantage and has announced a $9 billion share repurchase program.
Valuation – Too Cheap For Too Long
Source: Author’s calculations, Morningstar.com
From the table above, a few characteristics stand out. Relative to its own historical valuation, Facebook trades cheaply. In more detail, we can see that both on P/Sales ratio (8.8x vs. 15.9x) and on P/Cash Flows from operations (16.9x vs. 26.1x), the stock trades at a discount of approximately 40%.
Next, its peers overall have seen their multiples come down. The market lost some steam in Q4 2018, and it would appear that investor sentiment has waned slightly towards tech. However, as highlighted throughout the article, sentiment towards Facebook appears to have been hit the hardest.
In summary, as described throughout the article, Facebook is an asset-light business with strong cash conversion. Realistically, over time, we should expect Facebook’s compounded annual growth rate (CAGR) to hover at roughly 21-24%, which is somewhat similar to that of Alphabet (GOOGL) – although for now, despite having similar growth rates and similar exposure to the advertising space, Facebook is trading at a discount to Alphabet.
Incidentally, compared with Snap (SNAP), a company which continuously burning through cash, Facebook comes across as an unrealistic bargain opportunity.
For now, investors are concerned about the impact of regulation and privacy, as well as whether user numbers can grow further or even remain stable. I argue that while this type of discussion makes for great dinner time conversation, the fact of the matter is that while we discuss the minutiae, Facebook continues to generate strong free cash flows, which the market will be sure to reward over time.
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Disclosure: I am/we are long FB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.