Weekly Equity Idea Highlight - 2020 02 10
Market expectations are for FB's current doldrums to continue in perpetuity. The market is expecting UAFRS-based (Uniform) ROA (ROA′) to fade from 66% in 2017 to 20%-25% in 2023, with Uniform Asset growth slowing from 50%+ a year to 15% a year going forward.The market's concerns about declining profitability and top-line growth rates accelerated after the Q2 2018 call. FB's ROA′ declined for the first time in seven years in 2018, and is forecast to drop to 27% levels, highlighting management's concerns.
However, management continues to have multiple levers to pull to drive strong growth and ROA′ expansion, thanks to their strong brands. As such, market expectations, which appear to be solely focused on regulatory and cost downside, appear too pessimistic, spelling potential for equity upside.
FB's management 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.
Also, management has shown building confidence in the past two calls about their outlook. In Q3, management showed confidence in driving user engagement, DAU rates, the strength of their mobile ad platform, and the potential for their investments. All these point to management gaining more control of the business, and successfully improving profitability.
In Q4 they continued these markers, with confidence on increased user engagement and monetization, new products, reducing costs, and around new innovation.
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 inflection in confidence, 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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