Facebook's 10-Step Evaluation

David Meier January 21, 2013

Facebook (Nasdaq: FB)

1

•  Owns the largest social networking pla?orm •  DisrupAng on-‐line adverAsing •  Young but talented company, led by purpose-‐driven management team

•  InvesAng heavily in people and new products

•  Buy Around $35

2

Investment Summary

•  Facebook is an online social network.

•  Purpose: To make the world more open and connected

•  How: To build a pla?orm and tools that change the way people share informaAon

3

Step 1 – Define the business

4

Step 1 – Define the business

Facebook Users Customers

Data Eyeballs Products Analytics Advertisers Developers

Users Customers Internal External Agencies Users Businesses

How the Facebook platform creates connections

• Mark Zuckerberg, co-‐founder and Chairman –  Sets the vision and nurtures the culture – Owns 57.6% of the voAng rights (per prospectus) – DusAn Moskovitz owns 8.5% of voAng rights

•  Sheryl Sandberg, COO –  Focused on execuAon – Owns 0.8% of shares outstanding; negligible voAng rights

5

Step 2 -‐ Meet the managers

•  Zuckerberg dreams; Sandberg executes •  Facebook’s culture

–  The Hacker Way –  Speed; test and learn; conAnuous improvement –  Collaborate so the best ideas emerge

6

Step 2 – Meet the managers

•  Total addressable market – Overall adverAsing market was $588B in 2010 –  $55 billion addressable ad market, according to Sheryl Sandberg

– Hard to give a concise figure as Facebook is creaAng a new adverAsing opAon • TradiAonal (print, radio, tv) • Search adverAsing (Google, Yahoo!, Bing) • Social adverAsing (Facebook, LinkedIn, Google)

7

Step 3 – Market analysis

•  CompeAAon – Google –  Twider – Amazon.com – Angie’s List –  Yahoo! – Microsoe –  Yelp

8


• Market direcAon – Depends on the perspecAve – Ad market is mature but subject to disrupAon –  Social ad market is sAll being defined

•  Facebook is changing how the game is played – Huge, growing network of people –  CreaAng an alternate pool of adverAsees – Wants to take share away from other models

9


•  PosiAons –  Huge membership base –  Network effect

•  Fosters connecAons between users for lock-‐in •  Creates opportuniAes for targeted communicaAons

–  Scalable infrastructure •  CapabiliAes

–  Data collecAon and analysis –  Hacker culture

•  Data-‐driven, test-‐and-‐learn culture •  BMW engineers turn physics into an experience; Facebook engineers turn code into an experience

10

Step 4 – IdenHfy compeHHve advantage

11


Facebook

Customers Advertisers

Local Businesses Developers

Gaming users

Suppliers Users (data)

Hardware/infrastructure Programmers/Hackers

Developers

Complements Internet Desktop

Mobile device

Substitutes Google

Traditional ads Twitter

Facebook’s Value Net

•  Facebook gives users a free pla?orm to share informaAon

•  Facebook collects user data •  Facebook sells adverAsers access to targeted users based on the data collected

•  Facebook has found a criAcal mass of users that conAnues to grow and the right amount of interjecAon from adverAsers

12


•  Sustainable? –  ImitaAon – few –  SubsAtuAon – plenty – Hold up – Yes, if users see ads as intrusions –  Slack – yes; not every idea will payoff

•  EsAmate its compeAAve advantage period –  EsAmaAng 3-‐5 years – Will adjust over Ame with new info

13


•  Does the data back up the hypothesis? –  Limited financial data –  Current ROIC would show no advantage

•  Investments in SG&A (sales) and R&D reduces current net income

• Excellent cash flow gives cash-‐on-‐cash value of 18.7%

14


• Where is the business today? – AdverAsing

• ~85% of revenue • 36% growth during Q32012

–  Payments: • ~15% of revenue • 13% growth during Q32012

15

Step 5 – Look to the future

16


• Where can it go tomorrow? – User growth

• Number of users; average Ame spent; acAvity – More and more for mobile

• 375 million to 600 million mobile users in 3Q2012 • 14% of Q32012 revenue came from mobile; 0% before

– New experiences for users • The “Want” budon; Graph Search (Jan 15, 2013)

– New products for adverAsers •  Just over 26% of sales go to R&D

17


18


•  New products and services –  Rebuilt the Facebook mobile applicaAon –  Mobile App-‐Install

•  For developers to Ae into FB’s Social Graph –  Facebook Ad Exchange

•  Purchase targeted impressions –  Custom Audiences

•  TargeAng –  Gies

•  E-‐commerce –  Offers

•  PromoAons to adract and keep customers –  Promoted Posts

•  Turn Page Posts into ads

19


•  Business drivers –  Users in network

• Measurable adverAsing results –  Developers accessing network –  Engagement

•  Like, Want, Page Posts •  Business profiles •  In-‐app purchases • Graph Search

•  It all starts with the ability to collect and analyze the data

20


• What opAons might Facebook have? – More products to help improve targeAng –  Improved analyAcs to measure the ad results – More e-‐commerce opportuniAes

• Create an exchange between businesses and users • Graph Search could create purchasing opportuniAes

– Networks within the network • Rolled out idea to compete with LinkedIn

21


•  Confidence level –  The company has the data to experiment with new products and to adjust current products to improve adverAsing ROIs

– As targeAng and ROI improves, prices adverAsers are willing to pay can increase • 27% increase in the number of ads delivered in Q32012 • 7% increase in price per ad (GOOG seeing falling prices)

– Very confident in Facebook’s future

22


23

Step 6 – Margin analysis

24


25


•  Gross margins should fladen out over Ame –  Should stay relaAvely flat over Ame

•  OperaAng margins to remain volaAle –  Considerable spending in SG&A and R&D

•  Cash flow margins are outstanding –  Low working capital requirements

26


•  Source, uses, and needs –  Sources: Ad and fee revenue – Uses: R&D, staff, compuAng infrastructure, and future acquisiAons

– Needs: Very lidle right now; cash rich following IPO

•  Facebook has plenty of capital to invest in its future in order to generate more capital

27

Step 7 – Cash flow analysis

•  Capital intensity – Medium: CAPEX is ~25% of sales –  Focused on compuAng infrastructure, including developing new technologies to handle the incredible amount of data it processes

•  Quality of earnings –  Excellent: generates lots of cash

28

Step 7 – Cash flow analysis

29

Step 8 – Context

• Most recent earnings release, conference call – Management is clearly bullish –  Talked about current and future opportuniAes –  Stressed mobile

• Most recent investor presentaAon – No investor presentaAon given – Gives slides during conference calls

30

Step 8 – Context

•  Analyst senAment –  Analysts are moving from negaAve to posiAve –  Bulls outnumber bears

• What’s in the news? –  NegaAve arAcles saying Facebook is “overrated” –  Launched Graph Search on January 15, 2013

•  A business we’d be proud to own? –  Yes; creaAng a new technology pla?orm

31

Step 8 – Context

32

Step 8 – Context

•  QualitaAve –  Live by network effects, die by network effects –  People lose interest –  People do not want to be bombarded with ads –  Cannot create new products that spur growth

•  QuanAtaAve –  Cannot balance growth and returns – Doesn’t grow as fast as expected

33

Step 9 – Risks

34

Step 10 -‐ AWracHveness

2012 2017 CAGR Sales $4,984 $15,904 26% EBITDA $2,774 $8,659 26% EV/EBITDA 39 15 - 25 Price $30 $49 - $79 10% - 21%

EBITDA excludes stock-based compensation

Analysts estimates from S&P CapIQ

•  Risk/reward –  100% -‐ 150% upside vs. 20% downside in 5 years – Does not include opAons for future products

• OpAons could add 50 pts – 100 pts of addiAonal return

•  Odds of success –  2 to 1 –  Facebook has a compeAAve advantage –  Facebook will invest heavily in future growth

35

Step 10 – AWracHveness

•  Largest social network •  Huge, growing membership base •  Developing new products and services to increase ad and payment revenue

•  ConAnuous reinvestment in the business to improve user and customer experience

•  Buy below $35

36

Summary

Facebook's 10-Step Evaluation

Documents

Transcript of Facebook's 10-Step Evaluation