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Morningstar | Another Negative Story Has again Hit Facebook Shares; Our Long-Term View on Facebook Remains Bullish

Despite the ongoing negative news that continues to surround Facebook and its handling of data privacy, we remain confident about the firm’s ability to maintain its long-term competitive advantage and remain one of the top players in the digital advertising space. We are maintaining our $186 fair value estimate per share on wide-moat Facebook. Based on the firm’s user and user engagement figures throughout 2018, the potential for further Instagram monetization, and Facebook’s efforts to address data privacy and security issues, we think the stock remains an attractive investment as this wide-moat name is now trading at a 28% discount to our fair value estimate . We must also note that in early December, the company’s board also upped its share buyback program by $9 billion, displaying confidence in the firm’s future, in our opinion. Facebook has already repurchased $9.4 billion of its shares during the first three quarters of 2018.

On Dec. 18, The New York Times published an article stating that Facebook had shared user data with a variety of large and well-known firms, including Microsoft, Amazon, Spotify, Yahoo, Netflix, and Huawei. Facebook responded by saying that the firm’s agreements or partnerships with other companies did not include sharing user information without user consent. In addition, the company did not sell user data to any of the other firms. Rather, the goal of the programs was to provide ease of use for its users with the integration of the app with different devices, as well as usage of Facebook login. While Facebook could have been more transparent to its users regarding where, how, when, and by whom their data would be utilized, we believe the firm has taken those steps to improve transparency this year. Looking ahead, we still believe that Facebook's reputation will overcome these reported transgressions.

As one example, The New York Times itself continues to provide the Facebook login option to its online subscribers. This option simplifies the entire login process for users. In addition, the user information to which companies such as The New York Times may have access can be controlled by Facebook users. Within the “Apps and Websites” section of Facebook’s settings, users can indicate what level data each third-party for which a Facebook login is used can have access to.

We also agree with Facebook that when it comes to providing platforms that enable user interactions initiated on Facebook to continue elsewhere, all parties benefit, including not only the apps/websites but also Facebook users. Spotify (which was mentioned in the article) is a good example, in our view. Discussions on Facebook about various types of music or songs could initiate traffic to the Spotify app or website, on which the same users and friends can continue their discussions (which began on Facebook) while listening to and sharing the music.

We believe a more important question is whether the agreements or partnerships mentioned in The New York Times article possibly indicate a violation of the settlement that Facebook and the Federal Trade Commission reached in August 2012. On this one, we also agree with Facebook--we do not think that the firm has violated its agreement with the FTC. When the third party, user, and Facebook agree to enable most (if not all) Facebook features on other devices or platforms, with restrictions of data sharing or usage imposed by Facebook and its users remaining intact, we think Facebook would still be in compliance with the FTC settlement.

While such news regarding Facebook, and data privacy and security issues continues to make the headlines, we note that its impact on the stock has been very significant mainly because of the current political environment, where both the right and the left of the political spectrum continue to criticize Facebook and other social platforms. Politically motivated legal actions against the firm may also take place, which we do not see impacting Facebook significantly.

In terms of the firm’s operations, we think the business, which includes Facebook significantly increasing investments in data privacy and security, along with content, remains intact. Facebook still has over 2.25 billion users, and while it may have reached saturation in terms of user growth, its user engagement or interaction remains around 66%. On average, according to SimilarWeb, users continue to spend nearly an hour per day on Facebook, higher than any of its competitors. Such engagement explains why advertisers are allocating more ad dollars to Facebook and Instagram, as indicated by the strong growth in average revenue per user, or ARPU, which was 20% in third quarter of this year. During the last five years Facebook’s ARPUs have grown at an average annual rate of 31%. Going forward, while we expect a slowdown in ARPU growth, we still think ARPUs will increase at around 10% per year through 2022, likely to be driven by more Instagram ad inventories sold. All of this reinforces our confidence that this wide-moat name’s network effect moat source remains intact.

Our fair value estimate of Facebook remains at $186 per share, representing a 2019 enterprise value/adjusted EBITDA multiple of 14 times. We modeled double-digit top-line growth and through 2022, assuming slight impact from the data issues on user count and ARPU. As the firm plans to further invest in R&D and content creation, in addition to data security, we see average operating margin declining during the next five years. Our projections represent a five-year compound annual growth rate of 23% for total revenue and a five-year average operating margin of 38%.