Advertising Market And Potential Saturation
It’s difficult to say whether you have been a good stock picker in tech when the whole sector is in such a strong bullish trend. Many tech stocks have been overhyped and posted huge rallies even if they continued to report growing losses and no significant improvements in their fundamentals. Facebook (FB) is not one of them. In a market environment full of excitement and where many Wall Street darlings are trading at extreme valuations based on what those companies are supposed to earn in 2025, Facebook is one of the few specimens that still combines solid fundamentals and strong growth prospects with a reasonable valuation.
While the huge free cash flows, the lack of debt on the balance sheet, and the strong competitive advantages don’t give much room to question Facebook’s extremely solid fundamentals, I have read some skeptical views about Facebook’s potential growth prospects and its current valuation.
For example, Brian Wieser from Pivotal is skeptical about growth prospects in the digital advertising industry, which is dominated by Facebook and Alphabet (NASDAQ:GOOG), because he sees the duopoly “gradually approaching the point of saturating available digital budgets,” and adds:
Growth rates are remarkable, Tradebuddy.online…] but also highlight risks around digital media owners – and Facebook and Google in particular – saturating digital media budgets in years ahead, and reinforce our cautious views on stocks in the sector at current levels.”
According to the analyst, the potential growth for these two companies is constrained by the ad buyers’ budgets, which will inevitably lead to a situation of saturation for digital advertising. It makes sense. There will be a point in time when share gains will stop and growth in the digital advertising segment will be more or less the same of the whole advertising industry. The point that is not addressed is when the saturation in the digital advertising industry will be reached in markets with very different socio-economic characteristics and underlying trends and how much the digital advertising segment can drive the whole industry higher. But above all, focusing too much on the digital advertising trend makes us underestimate Facebook’s idiosyncratic monetization potential, potential market share gains, and the consequent growth optionality.
Organic Growth and Monetization in Emerging Markets
The fact that the advertising market’s growth may be constrained by the overall economic growth doesn’t prevent Facebook from gaining further market share as more and more people use the core Facebook platform. The chart below is taken from the last 10-Q and shows how the number of MAUs (monthly active users) has evolved in the various geographies in the past three years.
Source: Last quarter’s 10-Q
There are two things that are very important to highlight:
- All the regions are still growing at a nice rate quarter after quarter, even North America and Europe, which are supposed to be much more mature markets. Both markets are still showing Y/Y at mid-single digit growth rates.
- Asia/Pacific and the rest of the world are growing MAUs at a 26.2% and a 15% rate, respectively. These fast-growing markets are also the most important ones in terms of the total number of monthly active users as they account for 71% of total monthly active users. Considering that these emerging markets are often the fastest-growing ones, it’s not difficult to see where the future growth is going to come from for the core Facebook platform.
These numbers shouldn’t be underestimated. We are talking about a 26.2% growth in MAUs in Asia/Pacific, which already accounts for almost 40% of MAUs and is by far the fastest-growing region in the world. With users growing so fast, I think it’s reasonable to expect more advertising dollars shifting to Facebook from other media platforms. ARPU in North America is more than nine times higher than in Asia Pacific, which is a good indication of how much room for further monetization there is in the less developed markets. The point is not just how much the digital advertising space will grow but also how much Facebook as a standalone platform will grow within the advertising industry, especially in markets where penetration is still low, such as in many emerging economies.
Growth And Monetization Opportunities
Assessing FB’s attractiveness based on how much money we expect the core Facebook platform to generate can make us underestimate the whole company’s potential growth. Platforms such as Instagram and Whatsapp, which are leaders in the respective segments and still grow at very good rates, offer excellent monetization opportunities. In the management’s own words:
We do think that there are opportunities to continue to grow the business in the U.S. on a lot of different fronts. So we can continue to grow engagement on core Facebook as well as there’s opportunities with Instagram and the other services that we have that are not monetizing significantly today. So there’s opportunities there. But most importantly, kind of I would go back to the fact that we’re getting better at – on the ad product side of being able to optimize our inventory for the advertisers in a way that will, we think, drive good pricing in the system for us and good outcomes for the advertisers. So we do think that, that will lead to the potential for additional revenue growth in the U.S.
Source: Q3 Conference Call, Sentieo.com
While Instagram’s share of advertising revenue is not disclosed, eMarketer estimated that the share of Facebook’s advertising revenue generated by Instagram was around 14% in 2017 and has tripled since 2015. In the same period, the number of users has doubled, which means monetization has improved by 50%, showing a very positive trend. On the other hand, Whatsapp’s monetization opportunities are even more obscure after the app became free in 2016, but the growth trend in the number of users is massive as well. The number of users more than doubled in the past three years and is now above 1.3 billion. With this kind of growth trends, it’s not difficult to see the source of future growth for the company as a whole.
Facebook has recently announced some changes in the frequency and the way users will see posts, videos, and photos in the news feed. Content from friends and family will get a privileged treatment compared to posts from companies and publishers, which, according to the CEO, will make the experience more personal for users.
The market hasn’t welcomed the news that Facebook will change the newsfeed algorithm to show more posts from family and friends and less public content from businesses or publishers. Although it’s true that the company admitted this move will have a negative effect on the time people will spend on the platform, I think the market is overreacting once again to some news that I consider neutral at worst and positive at best. In a long post on Facebook, Zuckerberg explains why the company decided to implement these changes. In summary:
The research shows that when we use social media to connect with people we care about, it can be good for our well-being. We can feel more connected and less lonely, and that correlates with long term measures of happiness and health.
Please don’t think that I am a bad person if I am a bit skeptical about the possibility that a company like Facebook is willing to damage itself in order to help people have more meaningful relationships and emphasize the personal aspect of the platform because “relationships make us happier”. If it could damage the company, the changes wouldn’t have been implemented. And it’s easy to understand why those changes won’t have a negative effect on the company. By limiting the amount of public content from businesses or publishers, Facebook will have more bargaining power over advertisers. It’s basically telling advertisers they will have to pay if they want good visibility on the platform. This can either increase the amount of advertised content or, more likely, increase Facebook’s pricing power as more advertisers will compete for the same space on Facebook.
Maybe I am wrong and the real reason is that Facebook cares more about making the world better than growing and making more money. Or maybe it simply found a good way to make more money and at the same time improve the platform and the way it can help people “live better”. I couldn’t care less. I think I spend less than 10 minutes per week on Facebook, Instagram and most of the social network crap out there. To improve my relationships I usually go out and spend time with the people I care about. Facebook doesn’t help much with that. What I see as an investor is another way for this giant to take even more money from advertisers and limit the number of “free riders” that can promote their content at zero costs. I don’t see how this can be a negative for Facebook unless we assume that the increase in ads will be more than offset by a decline in usage. Again, maybe I am too mean-minded to think it won’t do something that can hurt itself like this if it doesn’t see profits.
A valuation at 30x full-year EPS and 26x next year’s expected EPS is not excessive for a company in secular growth and a with a huge competitive advantage based on the strongest network effect I can think of. We have seen that there are many drivers of growth despite the skepticism from some analysts and investors. MAUs are still growing even in the markets that are considered mature. ARPU still has a huge room to grow in most of the market where Facebook operates. Monetization of valuable and growing assets such as Instagram and Whatsapp still offer growth optionality, while the recent changes in the newsfeed will probably drive even more advertising dollars as many companies and publishers won’t be able to free ride anymore and will have to pay if they want some good exposure to potential customers. I think there is basically no negative news here and the market is definitely getting this wrong. I maintain my long with a good conviction, as FB is still one of the few wide-moat growth stocks still trading at reasonable valuations.
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Disclosure: I am/we are long FB.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.