Image Source: Esther Vargas
By Kris Rosemann
Best Ideas Newsletter portfolio holding Facebook (FB) continues to report incredible growth across its business, while remaining in the heart of the buzz surrounding the future of the Internet. We added the company to the Best Ideas Newsletter portfolio January 29, and we maintain our view that we haven’t seen anything yet. Facebook meshes with society so well that the company may eventually turn into the “next Internet” if humankind lets it.
Let’s talk numbers because that’s what matters. Total revenue leapt nearly 60% in Facebook’s second quarter of 2016 on a year-over-year basis, while diluted earnings per share nearly tripled. The firm’s mobile growth continues to be nothing short of impressive in terms of users–mobile daily active users were up 22% in the quarter to 1.03 billion–as well as in advertising revenue, which grew to 84% of total advertising revenue in the quarter (well over $5.2 billion) from 76% in the year-ago period. Facebook is not missing out on the transition of the Internet to mobile. Facebook is mobile; mobile is Facebook.
The social media giant is also not missing out on the Internet’s growing obsession with video consumption. CEO Mark Zuckerberg was “pleased with (its) progress in video as (it) move towards a world where video is at the heart of all (its) services.” The shift of visual consumption on the Internet to video is in full swing, and Facebook is helping lead the charge. The firm is making substantial investments in its infrastructure and network to enable its services to handle the increased burden massive amounts of video content will put on it. Facebook will win in this area, too.
The company is not a debt-heavy, dilutive-equity-issuance catastrophe by any stretch. In fact, the opposite is true. We absolutely love the firm’s cash balance of nearly $23.3 billion compared to its holding no debt on the balance sheet. Free cash flow generation has been spectacular as well, growing more than 60% to over $4 billion through the first six months of 2016 despite capital spending jumping nearly 38%. Cash is king, but perhaps the most impressive statistic at the end of the second quarter of 2016 was Facebook’s monthly active user balance of 1.71 billion. That’s nearly one-quarter (over 23%) of the global population (assuming world population of 7.4 billion)!
Facebook stands to continue to benefit from the growing global middle-class, as the expanding number of consumers with access to a computer or device ultimately means more opportunities; approximately half of the firm’s total revenue came from the US and Canada in the second quarter of 2016. Though a significant gap exists in average revenue per user in the US and Canada and the rest of the world, management is confident that as the mobile advertising market picks up around the world in coming years this gap should tighten. Look for the social media giant to find ways to establish growth in up-and-coming regions.
Facebook is also spending a significant amount on research and development efforts. The 23% of revenue it spent on R&D in the most recent quarter was on the low side of its R&D spending as a percentage of revenue over the past year or so. The fact that the firm is able to pour so much of would-be earnings into potentially needle-moving innovations while continuing to grow its bottom-line at a tremendous rate is impressive and will be a major reason why Facebook is able to stay relevant so much longer than any social media network we’ve seen before. The company can’t be stopped. It hits at the core of human nature, “Facebook: It’s All About the Vanity of the User (April 2016).”
Facebook, through its impressive R&D spending and capital investments, is investing in new platforms to enhance the user experience. In addition to its investments in video, virtual reality is something the firm has been adamant about; its Oculus virtual reality technology recently hit one million monthly users. Augmented reality has also been an area of focus for the company, as have its usual improvements and iterations of more mainstream services such as its Messenger app or WhatsApp, both of which have a community of more than 1 billion users. Artificial intelligence initiatives such as a deep learning based engine that will show people more of what they want to see on Facebook’s platform is also in its research efforts. The company also has made the first successful flight of Aquila, its solar powered aircraft that will beam Internet into places that have never been connected. How about that?
While we give Facebook a huge thumbs up, social-network rival Twitter (TWTR) continues to flounder. The firm reported its slowest revenue growth since going public in the second quarter of 2016, and the midpoint of its top-line guidance for the current period represents even slower growth. The company continues to lose money on a GAAP basis, and its user growth has not been nearly as strong as the immensely more-established Facebook. Twitter’s monthly active users were up a mere 3% in the second quarter on a year-over-year basis to 313 million. It seems the biggest obstacle to expansion is that users can’t find each other. Twitter seems to be more “news” than “social.”
Twitter is also losing in all the places where Facebook is winning. Stiff competition has made generating advertising revenues difficult for Twitter, and the firm has indicated that video advertising revenues, which many were expecting to provide a boost to revenue growth, are still a way away from being ready for action. The company has been unable to build the technology video advertisers need in order to accurately generate and execute marketing strategies on the social platform, an indication that tapping its true monetization potential may be more difficult than originally anticipated.
Not all social media platforms are created equal; from where we stand, Twitter and Facebook are polar opposites. One is working to deliver Internet connection to remote parts of the world via a solar powered aircraft, for example, while the other is struggling to get its video platform in working order. We expect Facebook to continue to be at the forefront of the revolution of the Internet and the way people consume content, and we will continue to hold shares of Facebook in the Best Ideas Newsletter portfolio. The company’s shares have some ground to cover before reaching our current fair value estimate of $142, but it’s likely the high end of our fair value range is also quite achievable.
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