Growth Opportunities Lie Ahead For Facebook (NASDAQ: FB): Wedgewood

Missouri-based Wedgewood Partners presented its thoughts on Facebook (NASDAQ: FB) in its Q4 investor letter – you can download a copy here. The investment firm loves Facebook because the social network has a “vastly superior profitability metrics relative to its peers in the media and advertising industry” and the company’s “social platforms serve as very low-cost forms of user traffic and content.” The investor believes that Facebook has “plenty of room for growth in the years ahead” with “strong advertiser demand and healthy ROI along with” its ability to increase ads pricing. Here are Wedgewood’s comments about the social networking giant:

2018 was annus horribilis for Facebook. After seemingly surviving the public relations nightmare of the Cambridge Analytica scandal this past spring, the Company’s reputation and stock have been shredded since the summer. It’s hard to recall a greater circular firing squad fusillade aimed squarely at Facebook’s C-suite, board of directors and business model from consumer outrage over security and privacy breaches, government regulatory threats, and media exposés, plus spiking expense growth, lowered operating guidance, and hard-to-measure platform transitions. Yet, the Company’s monopoly-like business model remains remarkably intact.

Facebook’s scale across its platforms, including Instagram and WhatsApp, continues to drive a “virtuous cycle” of user engagement and therefore incredibly low-cost content creation. Some recent monthly active user (MAU) stats include 2.27 billion users on Facebook, as well as 1.50 billion daily active users (DAUs), as of September 30, 2018. Additionally, there are 1.5 billion users on WhatsApp as of January 2018, and Instagram MAUs cross the billion-user mark as well. Watch (the Company’s new video offering) has already grown to 75 million DAUs and 400 million MAUs. In addition, Facebook continues to report stable user engagement (as measured by DAU and MAU) at 71%.

Facebook continues to exhibit vastly superior profitability metrics relative to its peers in the media and advertising industry. Facebook’s value proposition remains unique and defensible relative to peers, which we expect will enable the Company to generate industry leading returns on invested assets for years to come. This value proposition is focused on providing advertising customers with highly attractive, triple-digit returns on advertising spend (ROI). While many of Facebook’s peers offer a value proposition that entails better ROI, it is often via an inflexible, expensive, or monolithic solution. In contrast, the Company’s low-cost value chain, especially its multibillion user social platforms, and an arsenal of ad measurement tools, both acquired and internally developed over the past several years, provide advertisers with multiple avenues to drive successful ROI.

Facebook’s social platforms serve as very low-cost forms of user traffic and content. Many of Facebook’s competitors pay a substantial portion of their ad revenues in the form of traffic acquisition (sometimes referred to as “customer acquisition”) and/or content costs. For example, television advertising platforms are dominated by telecommunication and multiservice-offering conglomerates. The advertising businesses of these platforms are often carved out from subscriber economics, with the cost of content typically being the largest expense, by far, in running the ad platform. Even digital competitors such as Microsoft Bing, do not spend quite as much on content, but spend a substantial portion of revenue on traffic acquisition.

The Company vows to make further changes, which include conducting audits, improving its privacy policy, and banning third-party data services from its ad targeting platform. These actions continue to increase Company expenses (CAPEX/revenues 16%-21%), however we do not believe there will be any significant impact to the Company’s revenue growth as we believe there are few channels available that can match Facebook’s return on ad spend. We believe strong advertiser demand and healthy ROI, along with Facebook’s ability to increase pricing on their ads, leaves the Company with plenty of room for growth in the years ahead.

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That said, we do have concerns that we are watching closely. Specifically, in 2017, Facebook created Stories as a Snapchat-like offering. Facebook Stories is another kind of News Feed, but it is visual rather than written media. Stories posts, similar to Snapchat, only remain viewable for 24 hours, plus Stories posts don’t appear in the News Feed or Timeline by default. The challenge is to successfully embed advertising into an impermanent medium of personal experiences. Stories ads, particularly video ads, take advertisers more time to create. In addition, the transition from News Feed ads to Stories looks to be a significantly different transition as compared to desktop ads to mobile ads. The Company has acknowledged the challenge to monetize Stories at a level and pace of News feed. All told, Facebook has approximately 150 million Facebook Stories daily users, 70 million in Messenger Stories, 400 million in Instagram Stories and 450 million in WhatsApp Stories (called Status).

The stock is currently valued at just 16X consensus 2020 earnings. The stock is cheaper still when you consider the $41 billion in cash the Company has on its no-debt balance sheet. The Company recently increased its stock buyback by 60% to $15 billion.

2018 was a worse year for Facebook on the share market. The company ended the last year in the bear market, with the share price plunging over 27% for the year. However, the stock is up 23.33% since the start of the year, as the company posted better-than-expected fourth-quarter earnings. On Monday, FB closed at $165.79. Analysts polled by FactSet has a consensus price target of $195.77 on the stock and a consensus rating of ‘OVERWEIGHT’.

Facebook (NASDAQ: FB) is a popular stock among hedge funds tracked by Insider Monkey. According to our database, hedge funds’ interest in the social network declined during the third quarter. As of the end of the third quarter, 164 funds held FB in their portfolios, compared to 193 funds at the end of the second quarter.

Disclosure: none