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Facebook's 10-Step Evaluation
- 1. Facebook (Nasdaq: FB) David Meier January 21, 2013 1
- 2. Investment Summary • Owns the largest social networking pla?orm • DisrupAng on-‐line adverAsing • Young but talented company, led by purpose-‐ driven management team • InvesAng heavily in people and new products • Buy Around $35 2
- 3. Step 1 – Define the business • Facebook is an online social network. • Purpose: To make the world more open and connected • How: To build a pla?orm and tools that change the way people share informaAon 3
- 4. Step 1 – Define the business How the Facebook platform creates connections Users Facebook Customers Data Eyeballs Products Analytics Advertisers Developers Users Customers Internal External Agencies Users Businesses 4
- 5. Step 2 -‐ Meet the managers • Mark Zuckerberg, co-‐founder and Chairman – Sets the vision and nurtures the culture – Owns 57.6% of the voAng rights (per prospectus) – DusAn Moskovitz owns 8.5% of voAng rights • Sheryl Sandberg, COO – Focused on execuAon – Owns 0.8% of shares outstanding; negligible voAng rights 5
- 6. Step 2 – Meet the managers • Zuckerberg dreams; Sandberg executes • Facebook’s culture – The Hacker Way – Speed; test and learn; conAnuous improvement – Collaborate so the best ideas emerge 6
- 7. Step 3 – Market analysis • Total addressable market – Overall adverAsing market was $588B in 2010 – $55 billion addressable ad market, according to Sheryl Sandberg – Hard to give a concise figure as Facebook is creaAng a new adverAsing opAon • TradiAonal (print, radio, tv) • Search adverAsing (Google, Yahoo!, Bing) • Social adverAsing (Facebook, LinkedIn, Google) 7
- 8. Step 3 – Market analysis • CompeAAon – Google – Twider – Amazon.com – Angie’s List – Yahoo! – Microsoe – Yelp 8
- 9. Step 3 – Market analysis • Market direcAon – Depends on the perspecAve – Ad market is mature but subject to disrupAon – Social ad market is sAll being defined • Facebook is changing how the game is played – Huge, growing network of people – CreaAng an alternate pool of adverAsees – Wants to take share away from other models 9
- 10. Step 4 – IdenHfy compeHHve advantage • PosiAons – Huge membership base – Network effect • Fosters connecAons between users for lock-‐in • Creates opportuniAes for targeted communicaAons – Scalable infrastructure • CapabiliAes – Data collecAon and analysis – Hacker culture • Data-‐driven, test-‐and-‐learn culture • BMW engineers turn physics into an experience; Facebook engineers turn code into an experience 10
- 11. Step 4 – IdenHfy compeHHve advantage Facebook’s Value Net Customers Advertisers Local Businesses Developers Gaming users Complements Facebook Substitutes Internet Google Desktop Traditional ads Mobile device Suppliers Twitter Users (data) Hardware/infrastructure Programmers/Hackers Developers 11
- 12. Step 4 – IdenHfy compeHHve advantage • Facebook gives users a free pla?orm to share informaAon • Facebook collects user data • Facebook sells adverAsers access to targeted users based on the data collected • Facebook has found a criAcal mass of users that conAnues to grow and the right amount of interjecAon from adverAsers 12
- 13. Step 4 – IdenHfy compeHHve advantage • Sustainable? – ImitaAon – few – SubsAtuAon – plenty – Hold up – Yes, if users see ads as intrusions – Slack – yes; not every idea will payoff • EsAmate its compeAAve advantage period – EsAmaAng 3-‐5 years – Will adjust over Ame with new info 13
- 14. Step 4 – IdenHfy compeHHve advantage • Does the data back up the hypothesis? – Limited financial data – Current ROIC would show no advantage • Investments in SG&A (sales) and R&D reduces current net income • Excellent cash flow gives cash-‐on-‐cash value of 18.7% 14
- 15. Step 5 – Look to the future • Where is the business today? – AdverAsing • ~85% of revenue • 36% growth during Q32012 – Payments: • ~15% of revenue • 13% growth during Q32012 15
- 16. Step 5 – Look to the future 16
- 17. Step 5 – Look to the future • Where can it go tomorrow? – User growth • Number of users; average Ame spent; acAvity – More and more for mobile • 375 million to 600 million mobile users in 3Q2012 • 14% of Q32012 revenue came from mobile; 0% before – New experiences for users • The “Want” budon; Graph Search (Jan 15, 2013) – New products for adverAsers • Just over 26% of sales go to R&D 17
- 18. Step 5 – Look to the future 18
- 19. Step 5 – Look to the future • New products and services – Rebuilt the Facebook mobile applicaAon – Mobile App-‐Install • For developers to Ae into FB’s Social Graph – Facebook Ad Exchange • Purchase targeted impressions – Custom Audiences • TargeAng – Gies • E-‐commerce – Offers • PromoAons to adract and keep customers – Promoted Posts • Turn Page Posts into ads 19
- 20. Step 5 – Look to the future • Business drivers – Users in network • Measurable adverAsing results – Developers accessing network – Engagement • Like, Want, Page Posts • Business profiles • In-‐app purchases • Graph Search • It all starts with the ability to collect and analyze the data 20
- 21. Step 5 – Look to the future • What opAons might Facebook have? – More products to help improve targeAng – Improved analyAcs to measure the ad results – More e-‐commerce opportuniAes • Create an exchange between businesses and users • Graph Search could create purchasing opportuniAes – Networks within the network • Rolled out idea to compete with LinkedIn 21
- 22. Step 5 – Look to the future • Confidence level – The company has the data to experiment with new products and to adjust current products to improve adverAsing ROIs – As targeAng and ROI improves, prices adverAsers are willing to pay can increase • 27% increase in the number of ads delivered in Q32012 • 7% increase in price per ad (GOOG seeing falling prices) – Very confident in Facebook’s future 22
- 23. Step 6 – Margin analysis 23
- 24. Step 6 – Margin analysis 24
- 25. Step 6 – Margin analysis 25
- 26. Step 6 – Margin analysis • Gross margins should fladen out over Ame – Should stay relaAvely flat over Ame • OperaAng margins to remain volaAle – Considerable spending in SG&A and R&D • Cash flow margins are outstanding – Low working capital requirements 26
- 27. Step 7 – Cash flow analysis • Source, uses, and needs – Sources: Ad and fee revenue – Uses: R&D, staff, compuAng infrastructure, and future acquisiAons – Needs: Very lidle right now; cash rich following IPO • Facebook has plenty of capital to invest in its future in order to generate more capital 27
- 28. Step 7 – Cash flow analysis • Capital intensity – Medium: CAPEX is ~25% of sales – Focused on compuAng infrastructure, including developing new technologies to handle the incredible amount of data it processes • Quality of earnings – Excellent: generates lots of cash 28
- 29. Step 8 – Context 29
- 30. Step 8 – Context • Most recent earnings release, conference call – Management is clearly bullish – Talked about current and future opportuniAes – Stressed mobile • Most recent investor presentaAon – No investor presentaAon given – Gives slides during conference calls 30
- 31. Step 8 – Context • Analyst senAment – Analysts are moving from negaAve to posiAve – Bulls outnumber bears • What’s in the news? – NegaAve arAcles saying Facebook is “overrated” – Launched Graph Search on January 15, 2013 • A business we’d be proud to own? – Yes; creaAng a new technology pla?orm 31
- 32. Step 8 – Context 32
- 33. Step 9 – Risks • QualitaAve – Live by network effects, die by network effects – People lose interest – People do not want to be bombarded with ads – Cannot create new products that spur growth • QuanAtaAve – Cannot balance growth and returns – Doesn’t grow as fast as expected 33
- 34. Step 10 -‐ AWracHveness Analysts estimates from S&P CapIQ 2012 2017 CAGR Sales $4,984 $15,904 26% EBITDA $2,774 $8,659 26% EV/EBITDA 39 15 - 25 Price $30 $49 - $79 10% - 21% EBITDA excludes stock-based compensation 34
- 35. Step 10 – AWracHveness • Risk/reward – 100% -‐ 150% upside vs. 20% downside in 5 years – Does not include opAons for future products • OpAons could add 50 pts – 100 pts of addiAonal return • Odds of success – 2 to 1 – Facebook has a compeAAve advantage – Facebook will invest heavily in future growth 35
- 36. Summary • Largest social network • Huge, growing membership base • Developing new products and services to increase ad and payment revenue • ConAnuous reinvestment in the business to improve user and customer experience • Buy below $35 36