Facebook Earnings: Posts 26% Growth, Remains Significantly Undervalued

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Social networking and technology giant Facebook Inc (NASDAQ:FB) has just released its earnings report for the fourth quarter and full-year 2019 at market close today. Facebook's one of the more controversial technology companies around, with it and its Chief Executive Officer Mr. Mark Zuckerberg often coming under the press' scrutiny for privacy-related concerns. A handful of these have been covered by this humble scribe, and our Internet & Security department has been busy taking the ball to Mr. Zuckerberg's court.

The purpose of today's piece, however, isn't to lambast Facebook or its top executive for slacking with user data. Mark Zuckerberg and Co. have to deal with roughly one-fifth of the world's population in terms of Facebook's daily active users as of December 2019, and while this does not let them off the hook for any data breaches, it does put into scope the scale of Facebook's operations.

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Today, we're going to analyze Facebook's past performance and use some basic assumptions to see whether the company's current share price reflects what it actually is worth. At the time of writing, Facebook Inc. closed at $223.23 on the open market today. And as you read below, you'll see that this is below what the company is worth based on our assumptions.

Facebook Inc Has One Of The Strongest Free Cash Flows In Tech Industry

As we headed to Facebook's earnings for fourth-quarter 2019, Wall Street analysts expected the company to pull in $20.9 billion in revenue, up 15% sequentially and 20% year-over-year. Facebook has beaten these estimates by posting $21.082 billion in revenue, up 25% year-over-year. While this is strong revenue growth by any standard, Facebook's true strength is not in its revenues. Instead, the company is one of Wall Street's strongest performers when it comes to free cash flows, and we'll use this performance to speculate on what Facebook's true value needs to be in our opinion.

In its fiscal year 2018, excluding the impact of the Federal Trade Commission's $5 billion fine, Facebook had roughly $20 billion in free cash flows (the table below includes the impact of this fine). This marked for a growth of 16% over the previous year when Facebook had generated $17.4 billion in free cash flow. 2017 also marked for a roughly 50% growth in Facebook's free cash flow, as the company raked in roughly $5.9 billion more over the $11.6 billion that it generated in 2016.

Using Facebook's free cash flows and calculating the company's Weighted Average Cost of Capital lets us evaluate the company's value determined by modest growth rates. Facebook has a stock market beta of 1.06, the risk-free rate is taken as 10-year U.S. Treasury bill rate of 1.65% and the market risk premium is set at 5.60%. This results in a cost of equity of 7.59% for Facebook, which is also the weighted average cost of capital for the company since the social networking giant has zero debt on its balance sheet save for short and long term leases.

Year: Free Cash Flow ($B) Growth: Terminal Value: Present Value:
2017: 17.50 50.49% - -
2018: 15.40 -11.94% - -
2019: 20.66 34.20% - 20.660
2020: 25.62 24% - 23.811
2021: 30.74 20% - 26.558
2022: 35.97 17% - 28.880
2023: 41.00 14% - 30.601
2024: 44.28 8% - 30.718
2025: 45.61 3% 1024.44 689.883
Total Value: - - - 851.110
Debt: - - - 0
Equity Value: - - - 851.110
Shares Outstanding: - - - 2.874 Billion
Value/share: - - - 296.141
Current Share Price: - - - $223.23

 

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The growth rates that we've chosen above are quite modest when looking at Facebook's past performance. And while past performance is no indicator of future results, for tech behemoths such as Facebook, inertia itself often results in a strong performance. In its fiscal year 2019, the company has reported free cash flows of $20.66 billion as it looks to regain a positive trend in the area following the FTC fine in 2018.

Assuming that Facebook shows healthy cash flow growth in the future, it's evident that the company's market price of $223.23/share at today's close is below what it's actually worth. Assuming a 24% free cash flow growth rate for 2020, and taking this down step wise to 3% in 2025 results in a total discounted cash flow value of approximately $851 billion for the company. Dividing this by Facebook's shares outstanding results in a per-share-value of $296.141.

When you analyze the table above keep in mind that the more conservative you get with growth rates, the lower Facebook's per-share-price will turn out. And if you think that our estimates are optimistic, consider the company's revenues for 2019 that it shared today. For 2019, Facebook has posted $70.697 billion in revenues (unaudited, $69.655 billion audited), up by 26% (27% audited) over-the-year. Looking at its bottom line, the company paints a different picture. Facebook reports $18.485 billion in net income, down by 16% over-the-year.

The social networking giant's total costs have gone up in the year by a whopping $16 billion and have in turn obliterated its bottom line. These are due to fines levied by the Federal Trade Commission and if we remove their impact then Facebook would have demonstrated a healthy annual net income growth of 6% in line with the year-over-year net income growth of 7% that it exhibited in its fourth quarter of 2019.

Indicating a healthy balance sheet (and cautionary measures against future fines?), Facebook's Cash and Cash equivalents at December 31, 2019, stood at $19.279 billion. marking for a massive 90% growth over-the-year. 

For the fiscal and calendar year 2019, Facebook also reports 9% and 8% yearly increases in daily and monthly active users respectively. Following its earnings report, Facebook's shares have dropped by 6.63% in aftermarket trading.

Commenting on the results, Facebook C.E.O. Mr. Mark Zuckerberg stated:

"We had a good quarter and a strong end to the year as our community and business continue to grow. We remain focused on building services that help people stay connected to those they care about."

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