Facebook has been under scrutiny for a variety of reasons recently.
The company’s service went down for a massive 6-hour outage, preventing many users from using it. Whistle-blowers have also released internal documents reflecting harmful consequences on Facebook users, such as misinformation and violent content. Understandably, these incidents incited greater public scrutiny of the firm.
That being said, if you have been following Facebook regularly, you are aware that the company receives bad press almost every year. Remember the Whatsapp crisis from last year? Oh well, you may have forgotten.
The point I’m trying to make is that none of this is a huge deal for Facebook and that the media tends to exaggerate things. In the grand scheme of things, this will pass. In fact, if you had purchased Facebook stock during its ‘crisis’ last year, you would today be in the black.
Facebook’s woes
Nonetheless, there are several facts that may be concerning for the company’s future prospects.
The first is the revelation that Facebook is overcounting its monthly active users because some existing users created new accounts. This might have a significant impact on the company’s primary advertising business. Imagine that you’re a business owner who wants to promote your goods. Would you be okay if Facebook charged you twice for reaching two users, even if they were the same person? I seriously doubt it.
Another issue is Apple’s new iPhone privacy settings. Snapchat missed results on October 21, 2021, a week before Facebook published its earnings, providing insight into how Apple’s privacy policies have impacted the social media advertising business. As a result, Facebook lost 5% of its market capitalisation, as many expected the company to experience a similar problem. The stock dropped another 5% on Facebook’s earnings day.
This is undoubtedly better than the 20% loss in Snapchat shares, but the drop emphasised that the company is not doing as well as everyone may expect.
Facebook’s Latest Earnings
Let’s take a closer look at its third-quarter profits before moving on to the company’s outlook.
In September 2021, the average number of daily active users (DAUs) on Facebook was 1.93 billion. It had consistently achieved a 6% increase year over year.
Similarly, as of September 30, 2021, Facebook reports 2.91 billion monthly active users (MAUs), up 6% from the previous year. However, as previously stated, there may be some overcounting when a user logs into two accounts on the same day or in the same month. As a result, we should take this figure with a grain of salt.
The average revenue per user (ARPU) on Facebook would be a much better indicator to keep an eye on.
Even if there is duplicate counting of users, an increase in ARPU indicates that Facebook is growing. Comparing Q3 2021 to Q3 2020, ARPU increased by 28%, from $7.89 to $10. However, if we compared its Q3 2021 numbers to its Q2 2021 data, there is a 1.2% dip from $10.12 to $10, this is most likely due to Apple’s privacy settings.
In terms of revenue, Facebook generated $29 billion in the third quarter of 2021, a 35% increase from the previous year’s third quarter.
Nonetheless, if we take a deeper look at this chart, we will see that its revenue growth has flatlined. When comparing the second quarter and third quarter of 2021, we can even say it has declined a little.
Even though they reported a $29 billion gain in revenue, Facebook missed analyst expectations by $510 million. This may explain the dip in its stock price. Furthermore, the company’s revenue projection for Q4 2021 was not outstanding, with the company predicting revenue of $31.5 billion to $34 billion, a slowdown from last year’s growth.
In line with its revenue, Facebook’s net income has decreased from the prior quarter.
Facebook’s operating margin has also decreased from 43% to 36%.
While this isn’t a cause for concern, a persistent reduction in operating margin over the next few quarters could indicate that Facebook’s moat is eroding.
Facebook/ Meta Platforms’ Future Outlook
In addition to reporting its financial results, Facebook has also indicated that from Q4 2021 onwards, it would break out its Facebook Reality Labs as a separate reporting segment.
i) Emphasis on Facebook Reality Labs
This category will contain Facebook’s augmented and virtual reality products and services, which it is pursuing to develop the next generation of online social interactions. Segmenting it into a separate sector shows that Facebook believes this segment will make up a significant portion of its revenue in the future. This segment is one that investors should keep an eye on because it has a huge addressable market.
ii) Still a market leader
Indeed, while Facebook is facing some short-term headwinds that may cause revenue growth to stall, the company’s future remains bright. It’s important to remember that Apple’s IOS settings impact all social media platforms, not just Facebook. So it’s not as if Facebook’s customers are flocking to its rivals. In fact, given its sheer size, Facebook may have a better chance of survival compared to its competitors.
Furthermore, Apple only owns 15% of the smartphone market currently, which is a small slice of the pie. I am confident that it will be able to get around Apple’s privacy issue with the help of its talented team and continue on its growth trajectory.
iii) Impact of its rebranding
If you’ve been following the news lately, you’re also aware that Facebook has changed its name to Meta. This name change was made to reflect the company’s image better as it moves into the Metaverse.
Why am I bringing this up? Well, Facebook isn’t the first company to change its name. In fact, Google changed its name to Alphabet in 2015.
A name change may bring about some benefits that aren’t immediately apparent. To begin with, it has the potential to dispel some of the negative news surrounding Facebook. Studies have also demonstrated that changing a company’s name might positively impact its stock price.
Nevertheless, while Facebook’s growth is probable, there are several issues that I am concerned about.
Concerns
Losing Popularity
Many businesses compete for our attention in today’s digital world. Facebook is no exception. It has had to compete for users’ attention against other social media platforms like TikTok, which has gained popularity in recent years.
According to an eMarketer analysis, Instagram, which Facebook owns, had more users in 2020 than TikTok. But this is no longer the case as TikTok had overtaken Instagram in 2021.
I’m not sure about you, but while I still use Facebook regularly, many others my age don’t use it at all, which suggests that Facebook might be losing its moat.
Metaverse is a multi-year project
The concept of a metaverse has been around for a while, but Facebook’s announcement has piqued people’s interest. The Metaverse is a virtual realm where people can interact with one another. It’s a place where the real world meets augmented and virtual reality, allowing us to socialise, play games, exercise, and even work.
You can check out this video put out by Facebook that beautifully captures the Metaverse’s essence, from Facebook’s point of view. It’s well worth your time to watch. In fact, I’m sold on the concept of retiring in the Metaverse (hopefully, in 20 to 30 years, the Metaverse is already fully developed!)
While the addressable market is immense, we must keep in mind that this is a massive long-term undertaking for Facebook that is unlikely to be profitable anytime soon. Facebook has also stated that there are many aspects of the Metaverse about which it is still unaware. In addition to making a minimal profit from this segment, Facebook intends to spend roughly $10 billion per year on it. This represents nearly a quarter of the company’s profits, a significant sum that investors are unlikely to see anytime soon.
To keep things in context, this is undoubtedly the best course of action for Facebook. As the largest social networking platform, Facebook would probably be the best company to start a Metaverse.
However, investors are short-sighted and they will most likely focus on the short-term headwinds mentioned above. As a result, Facebook’s stock price may remain unchanged or drop lower in the short run.
FB is cheap
With the recent drop, how cheap or overvalued is Facebook now in terms of valuation?
Price to Sale (PS)
Facebook’s PS is currently 8.52, which is slightly lower than its average of 10. If Facebook’s current revenue is maintained, this might offer a 15% upside at the very least.
PEG ratio
The PEG ratio is calculated by dividing a company’s PE ratio by its growth rate. This ratio would take into consideration a company’s growth at a given price. Compared to the Internet Service industry’s PEG ratio of 4.48, Facebook currently has a PEG ratio of 1.10. This could indicate that Facebook is currently undervalued.
Discounted Cashflow analysis
Using the Finbox discounted cash flow model with a 5-year CAGR of 20%, we obtained a fair value of $464.46 per share, representing a 40% upside compared to the current stock price. That being said, if we observe Facebook’s 5-year revenue growth, we will see that it has been dropping, with its latest year coming in at 21.6%. Considering IOS update and its metaverse investment, a 20% CAGR may seem impossible in the near term.
Parting thought
Facebook has long been the subject of negative press. While I am not here to debate whether Facebook is a morally good or bad company, we can be certain it is here to stay. Online advertising still accounts for the majority, if not all, of Facebook’s revenue, and it has been decreasing due to headwinds such as Apple’s privacy settings and the pandemic.
In the medium term, it’s probable that Facebook’s stock will continue to fall until it proves that it can withstand these headwinds. That said, if investors can see the long term prospect of the company, Facebook seems to be an appealing company to invest in right now.
Disclaimer: At the moment of writing, I am holding onto Facebook shares.