FB: All You Need is Like
Our bull case for FB is straightforward. 1. Ad spending will shift toward digital more quickly and more completely than consensus expects, with TV, print and radio all likely to cede share. 2. The ongoing swing toward mobile platforms inherently drives the concentration of usage, and thus, ad sales. 3. FB, with reach to 1.6B global MAUs, unmatched mobile user engagement, compelling ad formats, and a trove of user targeting data, is likely to add to its share of the mobile ad pie, particularly if it commits more fully to the strategy of breaking the monolithic newsfeed into more focused apps, as it did with Messenger. In this context, we believe consensus forecasts for 34.4% annual sales growth and 34.9% eps growth through 2018 materially underestimate FB’s likely trajectory. With a Forward PEG ratio of 1.1x, we also see considerable room for future appreciation. Still, we do have longer term concerns, as FB’s steadfast focus on connecting and engaging an ever larger global community closes off significant opportunities (hosting, enterprise software, e-commerce, transport, media distribution, etc.) for which we believe FB could compete and where its chief rivals, GOOGL and AMZN, have already established meaningful leadership. Meanwhile, we are concerned that FB’s attention toward driving marginal MAU growth via messaging and pushing virtual reality as a broad based interface standard could prove disappointing.
- Ad shift to digital will be more pronounced than expected. US digital ad spending will pass TV in 2016, accelerating share gains in the post-election/Olympics 2017 and beyond. The audience for traditional TV continues to shrink, even accounting for rampant time-shifting, which seriously degrades the effectiveness of advertising. An unusually vigorous campaign spending cycle and the rise of fantasy sports betting as a new category of advertiser have propped up TV ad demand, which will have the further benefit of the time zone friendly Rio Olympics. We expect sharp TV ad sales declines in 2017, along with further deterioration in both print and radio, with digital platforms the overwhelming beneficiaries.
- All the digital growth will be mobile, and then some. In the US, mobile accounts for 65% of time spent on digital media, with total minutes up 78% in just two years, while desktop use has been static. Mobile ad spending is catching up, accounting for over 60% of US digital ads in 2015, up 64.9% YoY. Overseas, the opportunity may even bigger – mobile is 17.3% of the $195 total US measured media advertising market, but just 10.8% of the $375B spent in the rest of the world.
- FB’s share of mobile ads will keep growing – The mobile app model exacerbates the natural on-line tendency toward market concentration. The typical smartphone user spends 90%+ of their time with their 6 favorite apps, with FB far and away the most used app worldwide. Just 27 apps can claim as many as 20M unique monthly US visitors (FB has 200M), vs. 93 sites on the mobile web. FB’s share of US mobile ad spending is already over 19%, second only to GOOGL (33%) and far ahead of #3 TWTR (4%), and it is growing its mobile sales at 82% YoY. FB’s mobile advertising strength is a product of its extraordinary reach (1.5B MAUs), strong engagement (46 min/day/MAU), valuable user data profiles, compelling ad formats and excellent targeting/analytic tools. With this growing demand, we believe that FB can continue increasing ad density across its services, particularly in mobile, with improving pricing.
- Monetizing Messaging – WhatsApp and Messenger have been successful on penetration, but it is not clear that the strategy for monetizing the messaging apps – selling paid messages from organizations to users who have previously interacted with them – will be well accepted by either users or advertisers. In particular, WhatsApp, founded with a strict “no ads ever” policy and catering to low income market segments, faces considerable challenges in monetization. We think the answer for both messaging platforms may be in facilitating m-commerce, a la WeChat. In retrospect, we believe that paying 10% of FB for WhatsApp will prove to have been ill advised, and have some concern that the M&A process may lack appropriate discipline.
- Is Oculus more than a gaming platform? – FB CEO Mark Zuckerberg has been enthusiastic in speculating broad future uses for virtual reality (VR) – distance learning, massive online events, even as the primary interface for desktop computing. We are concerned that latency limitations (>10ms can cause serious nausea, making cloud delivered apps impractical), the fully immersive nature, the high cost of content development and the lack of standards will limit VR to relatively narrow applications, such as high end gaming, that will prove disappointing to FB and its investors.
- Upside opportunities need more attention – While we see significant upside to expectations in FB’s core business, we are concerned that it may be missing significant future opportunities. 1. Building the archipelago – Cleaving specialized apps (streaming media, news, scrapbooking, photo management, etc) from its cluttered and heavily filtered main app, as it did with Messenger, could increase engagement, reinvigorate social sharing and provide a more focused context for advertisers. 2. Getting m-commerce right – previous e-commerce initiatives have been disappointing, focused more on attracting ads than in adding value to consumers or merchants. If FB is going to play against AMZN or GOOGL, it needs to articulate a vision for drawing shoppers with a differentiated experience and facilitating transactions for retailers, although with former PayPal CEO David Marcus on board, this may be forthcoming. 3. Thinking outside the box – FB has the data center infrastructure and engineering chops to play in the emerging opportunities being explored by rivals like AMZN and GOOGL – e.g. enterprise IaaS hosting and SaaS analytics, streaming media, payments/fin tech, transportation, etc.
- Get while the getting’s good – FB’s stick to the knitting strategy may prove a bit shortsighted in 5 years, but it plays well now, concentrating investment on driving mobile ad sales growth. We believe the core business will drive a further cycle of sales/earnings surprises and upward revisions throughout 2016. FB’s 18x ttm sales multiple may seem rich, but the 27.4x forward P/E makes for a modest 1.1x PEG ratio against conservative 5-year consensus earnings growth. We continue to hold FB as one of the 15 stocks in our large cap model portfolio.