Weekly Equity Idea Highlight - 2018 08 01
Market expectations for FB are currently very pessimistic. The market is expectingUAFRS-based (Uniform) ROA (ROA') to fade from 65% in 2017 to 22% in 2022, with Uniform Asset growth slowing from 50%+ a year to 25% a year going forward. The market's concerns about declining profitability and top-line growth rates accelerated after the most recent Q2 call. However, FB's ROA' has improved for the past five years as similar concerns have intermittently cropped up, and management continue to have multiple levers to pull to drive strong growth and ROA' expansion, thanks to their strong brands. For context, even if the company did see margins decline at the rates they have communicated, ROA' would fall to 50% over the next several years, not 22%. As such, market expectations, which appear to solely be focused on regulatory and cost downside, appear too pessimistic, spelling potential for equity upside.
FB's management's compensation framework aligns them to focus on driving user growth and top-line growth in an investment-efficient manner, limiting the risk they will chase growth in a way that will compress ROA' going forward. This gives further confidence that current market expectations for ROA' are too pessimistic.
Furthermore, even while the stock was declining from the call, the Q2 2018 earnings call continued to confirm the positive signals seen since the Q3 2015 earnings call. Tellingly, management continues to show confidence in their ability to drive ad revenue growth, including accelerating ad revenue growth from Stories and the strength of Instagram. Management was also confident on their innovation spend, and about how they are not seeing negative impacts from GDPR, and in fact may be able to better monetize customers after GDPR. While management showed concerns about forex headwinds in the Q2 call, they did not show concerns the market is perceiving about massive ramps in cost and declining growth, and if anything, showed continued confidence in their ability to monetize their regulatory related investments.
Considering low market expectations, positive longer-term macro tailwinds, management's appropriate alignment, and strong positive fundamental momentum for the company based on management's communication, there appears to be material
near-term and long-term equity upside for FB.
Facebook is building and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality headsets, and in-home devices. The company's products include: Facebook, which enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers; Instagram, which is a place where people can express themselves through photos, videos, and private messaging, and explore their interests in businesses, creators and communities; Messenger and WhatsApp, which are messaging applications; and Oculus, which connects people through its Oculus virtual reality products.
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