Company Overview: Facebook, Inc. is focused on building products that enable people to connect and share through mobile devices, personal computers and other surfaces. The Company's products include Facebook, Instagram, Messenger, WhatsApp and Oculus. Facebook enables people to connect, share, discover and communicate with each other on mobile devices and personal computers. Instagram enables people to take photos or videos, customize them with filter effects, and share them with friends and followers in a photo feed or send them directly to friends. Messenger allows communicating with people and businesses alike across a range of platforms and devices. WhatsApp Messenger is a messaging application that is used by people around the world and is available on a range of mobile platforms. Its Oculus virtual reality technology and content platform offers products that allow people to enter an interactive environment to play games, consume content and connect with others.


FB Details

Facebook Inc.’s (NASDAQ: FB), the giant tech sector group, is currently facing some headwinds and has flagged for organizational changes given the Chief Product Officer, Chris Cox’ resignation and change in strategy. However, the new strategy to have a privacy-focused social platform with other required changes and continued strong user base, strong engagement and monetization tools over the internet, will enable the group to mitigate the challenges at hand. The prevailing downtrend in share movement and bleak outlook are expected to be leading to short term challenges. However, fundamental strength in support of the margins better than the industry levels and return on investments expected from efforts related to platforms including Stories, Video and Messaging are expected to drive growth in the long term. Thus, the overall thesis still looks positive.
 

Financial Ratios (Source: Company Reports and Thomson Reuters)

The latest hurdles: Facebook’s stock plunged after the company’s chief product officer, Chris Cox resigned from the company. He has been with the company from the time Facebook had started and was considered an important part of the company. The company has also announced that vice president of the Facebook messaging app WhatsApp, Chris Daniels is also going to leave the company. Previously, key executives like Kevin Systrom and Mike Krieger, who were the co-founders of Instagram, that is the Facebook-owned photo-sharing app had left the company. There were many reasons for the slew of top executives leaving the company and others planning the same. The concern have aroused that more top executives could follow the footsteps of Cox and Chris Daniels. Further, the fear has increased among the investors that if all the important executives leave the company, then the management of the company will come under question. This with stock market downgrade in view of issues cited about the “negative network effects”, seem to be eroding the shareholders‘ value. The company has been under the wave of risks from the regulations’ standpoint and negative impact on the finance arising due to policy change of focusing on the private messaging in place of open posts on the News Feed. The recent coverage on the mass shooting in New Zealand has also tinted the scenario in a negative shade as the company could not block the same from being posted and circulated. On the other hand, FB aims to stabilize the network effect and prevent it to be falling in negative zone by combating the issues of top management turnover and the risk arising from the policy changes. It also believes in keeping its customer base strong with capital investments driven towards better growth profile.


Capital Investments In Millions (Source: Company Reports)

Policy changes: Facebook had told the investors that the company plans to move towards private communication, which has increased the concerns of the analysts and the investors regarding the profit of the company. The company gets significant profit from advertising, which may be affected if the users are not able to post publicly. Further, the company had earlier warned that it is getting affected due to rise in costs, fall in the margins and rise in capital expenditures, all of these problems will get triggered if the company goes for private communication. The investors are also concerned about three year growth of the company as the private communication has lower revenue attached to it. However, the market is bullish on the company’s plan to advertise in products like Stories and messaging, through which the company gets the opportunity to increase the revenue. Instagram projects 500 million daily active users in their Stories feature alone. Further, the company expects 2 million advertisers within Stories. As well as, the growth Stories product will give stiff competition to competitors like Snap. Meanwhile, Facebook is facing criticism and the analysts’ concern in the market after the spread of videos last week that showed the shooting at a mosque in New Zealand. The video was made available via FB's live feature, and it spread through the platform like a fire. The investors and the analysts’ were concerned as this may affect the brand image of the company, and the company could not block this video 100% technically; though FB had removed 1.5 million videos that had showed the attack in the first 24 hours after the incident happened.

Regulatory Concerns, investigation by State attorneys general: There are risks arising due to regulatory concerns, as some state attorneys general are considering to take action against the privacy practices of big tech companies like Facebook and Google. These companies have grown very big and powerful, and handling of data and protecting people’s information constitutes a big concern. Washington is already challenging FB’s practice of doing business in court. There has been a lot of discussion between Democrats & Republicans regarding the data issue, consumer protection and privacy policy, competition and the technological change. FTC will conduct the hearing for two days to listen on these major issues. FB was earlier facing lawsuits regarding the Cambridge Analytica issue.

Strong Fourth Quarter 2018 Performance: For the fourth quarter of FY 18, the company has posted better than expected results. The company during the fourth quarter has reported strong growth of 61% in net income to $6.88 billion. FB in the fourth quarter of FY 18 has reported the adjusted earnings per share of $2.38, beating the analysts’ estimates for the adjusted earnings per share of $2.19. The company had reported the adjusted revenue growth of 30.4 percent to $16.91 billion in the fourth quarter of FY 18, beating the analysts’ estimates for revenue of $16.39 billion. Daily active users during the fourth quarter grew 9 percent to 1.52 billion, which is in line with the market estimate of about 1.52 billion. Monthly active users also grew 9% during the quarter to 2.32 billion, which is in line with consensus expectations. Average revenue per user grew by 19% to $7.37 during Q4 FY 18, beating the market estimate of $7.11. Moreover, during the fourth quarter of 2018, with regard to growth in regional ad revenue, Asia-Pacific grew strongest by 34%, North America grew by 31% and Europe posted growth of 28%. Rest of World ad revenue has posted the growth of 24% despite the impact due to the currency weakness and macroeconomic challenges. During the fourth quarter, there was 42% growth in Payments & Other Fees revenue to $274 million. Additionally, during FY 18, the company incurred the capital expenditures of $13.9 billion, on the back of investments done for data centers, servers, network infrastructure, and office buildings. During the fourth quarter, the company  generated the free cash flow of  $3.3 billion and ended the year 2018 with cash and investments of approximately $41 billion. In addition, during the fourth quarter, FB bought back about $3.5 billion of the Class A common stock and had finished the prior repurchase authorization. In December, the company had authorized to repurchase an additional $9 billion of FB’s stock.


Fourth Quarter of FY 18 Financial Highlights (Source: Company Reports)

Future Outlook: For the first quarter of FY 19, FB expects the total revenue growth rate on a constant currency basis to decline by a mid-single digit percentage compared to the fourth quarter rate. The company also anticipates that the revenue growth rates will also decline sequentially throughout the FY 19 on a constant currency basis. For FY 19, the total expenses are expected to grow in the range of 40-50% compared to FY18. FY 19 capital expenditures are expected to be in the range of $18-$20 billion, on the back of major investment in building data centers. While the outlook is a bit weak; however, we believe that the company would take charge on growth drivers in the long run in order to witness better returns and expenses will be more driven towards the overall growth profile.


Expenses as a % of Revenue (Source: Company Reports)
 
Stock Recommendation: FB stock is trading at a price of $165.44, and has support at $144 level and resistance at $172. FB Stock has recently plunged driven by departure of top executives, policy changes, stock downgrade and news on investigation by State attorneys general. FB has put a lot of money to keep a check on security issues that earlier affected the company’s profitability. However, the opportunity for the products like Stories and messaging do hold potential. Instagram’s daily active users on Stories have touched over 500 million and over 2 million advertisers are using Stories. FB plans to come with the feature of payments on WhatsApp in more countries. The company also aims to lower the engagement in WhatsApp with regards to sharing of questionable pieces of information, and has lowered the number of viral videos on the platform. Moreover, the company has posted strong fourth quarter 2018 results despite various court cases and problems in 2018. With Forward 24 months EPS consensus target of over $9 and P/E in lower double digit, an upside of about single high digit to low double digit is expected in stock price. We have a “Buy” recommendation on the stock at the current price of $ 165.44 (up 2.4% as at March 20, 2019).

 
FB Daily Chart (Source: Thomson Reuters)

 
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