5 Reasons Why Facebook Is Finally A Buy

By
A A A
Share |

If you're like millions of investors, you've decided againstinvesting in Facebook (Nasdaq: FB) .

The company's hotly-anticipatedIPO in the spring of 2012 was a bust, and over subsequentquarters ,shares have been adrift at sea. Indeed, as the S&P 500 has tacked on additional robustgains thisyear , shares of Facebook have quietly sunk below the 100-daymoving average .

Of course, like many other investors, you've tucked thisstock away into the back of your mind, planning on giving it a fresh look when the current phase of malaise has passed.

Well, the time has come to give this broken IPO a fresh look. And when you do, you'll find abusiness model that is finally ripening, with many arrows in its quiver. Facebook's 2013sales andprofit trends may not seem overly impressive, but the seeds are now in place for a much better 2014 and 2015. 

Here are five key reasons why shares of Facebook should finally hold great appeal.

A Global Freight Train
At first glance, Facebook would seem to be a purely American phenomenon. The company's U.S user base of 207 million (as of May) is larger than its next four markets combined (Brazil, Indonesia, Mexico and the U.K). Yet the U.S.-centric nature of this business model is really a matter of timing, as the social-media network was launched here first and is only now showing solid growth in other less-penetrated markets.

For example, two-thirds of all Americans now have a Facebook account, according toinvestment firm Jefferies & Co. Across Europe, that figure stands at 50% in Europe, while in Japan and other key markets in Asia, that figure is closer to 25%. Notably, Facebook's penetration is rising at a faster rate outside the U.S. as the rest of the world plays catch-up. Simply focusing on the 600 million registered users in Facebook's 10 largest markets gives you a sense of the size of this company's captive audience. Those 10 markets account for half of the company's total user base.
Learning ToMonetize
The biggest concern around Facebook's IPO was an unproven ability to profit from that customer base. Management has been pilloried for moving slowly on that front, preferring to "build the base" before profiting from it.

Yet thanks to sharp rises in ad placements,revenue is finally starting to take off. Look for 30% revenue growth this year (to above $6.5 billion) and 25% annualized growth in coming years, setting the stage for $10 billion in revenue by 2015.
Aggressively Pursuing New Platforms
Investors may mistakenly think that Facebook is losing its grip on the young consumer. Even if that's the case, management is adeptly building (or buying) complementary user platforms to retain consumer interest. For example, the $1 billion purchase of Instagram in April 2012 now looks like a masterstroke, as some Facebook users now simply spend more time on Instagram instead. In the quarter that ended in March, the number of global Facebook users rose 5% sequentially, compared with a 25% increase in Instagram users.

In addition to Instagram, "Facebook has rolled out a series of mobile apps fundamentally niche mini-social networks) over the past 12 months," notedanalysts at BMOCapital Markets . "These include the Messenger, Camera, and Poke apps. We see these offerings not as an attempt to create the next blockbuster platform, but rather as specialized offerings for users focused on particular activities as opposed to the 'social utility' that is offered by Facebook." BMO 's analysts raised theirrating on the stock to "outperform" from "market perform " in late May, with a $33price target .

Other growth initiatives include:
  • Custom Audiences: Allows marketers to reach target audiences based on their own custom databases, whether a list of client email addresses, phone numbers or Facebook IDs.
  • Partner Categories: Enables marketers toleverage third-party data to deliver targeted ads.
  • Facebook Exchange (FBX): Provides for real-time-bidding for coveted ad slots.
  • Facebook Offers: This has a chance to exceed Groupon's deals platform, thanks to Facebook's massive reach.
  • Facebook gifts:Will allow users to send gifts for birthdays, anniversaries and other events.
  • Premium Services: This has been briefly mentioned by management with few details thus far.
As Google (Nasdaq: GOOG) will tell you, not all of these initiatives will succeed, but those that do should help sustain solid long-term revenue growth.
A Premier Player In Mobile Video
Sometime in the current quarter, look for Facebook to start serving video ads on its core site and on Instagram. And look for that effort to have a huge effect on theincome statement , as ad rates are far higher than static image-and-text ads.

Facebook is expected to take a "Super Bowl commercial" approach, selling coveted 24-hour slots, with hundreds of thousands of ads served, for a price between $1 million and $4 million. Details remain a bit sketchy, but when the service is rolled out, look for solid revenue forecasts from analysts.

For instance, analysts at Jefferies predict "video ads could be Facebook's next billion-dollar business." That outlook was a key reason why Jefferies upgraded shares from "hold" to "buy" in late May with a $32 price target.
Not As Expensive As You Think
Until now, Facebook has been seen as a "story stock" without a robust income statement to drive valuations. That is anissue that dogged Amazon.com (Nasdaq: AMZN) , Google and others as they patiently built out their businesses.

Yet Facebook's operating metrics are extremely strong. Margins onEBITDA (earnings before interest,taxes ,depreciation andamortization ) exceeded 55% in each of the past five quarters and should stay above 50% for the foreseeable future, even as the company heavily invests in headcount for new growth initiatives.

Equally important, shares trade for around 12 times consensus 2014 EBITDA, on anenterprise value basis (according toFactSet Research). Facebook's EBITDA is expected to grow at a 24% annual pace through 2016, according to Merrill Lynch, faster than most of its rivals .

Also,free cash flow was a bit disappointing in 2012 at just $379 million. However, free cash flow is expected to hit $2 billion by next year and approach $3 billion by 2015, according to consensus forecasts. For comparison, Google didn't reach $3 billion in free cash flow until 2010 -- six years after its IPO.

Risks to Consider: Facebook is enteringprime time interms of monetizing its user base, and any problems on that front will push shares to fresh lows.

Action to Take --> Thanks to the imminent launch of video ads, shares of Facebook may be reaching an inflection point. Though second-quarter results (which are due July 23) are unlikely to surprise on theupside , management's forward view should be quitebullish , leading many investors to give this moribund stock a fresh look.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks:

StreetAuthority

StreetAuthority

More from StreetAuthority:

Related Videos

Stocks

Referenced

Most Active by Volume

89,970,926
  • $16.15 ▲ 0.12%
77,131,582
  • $58.94 ▼ 1.31%
67,336,935
  • $26.56 ▲ 1.68%
48,814,124
  • $86.20 ▲ 0.02%
47,526,126
  • $23.21 ▲ 0.78%
44,660,424
  • $23.91 ▲ 6.36%
38,799,699
  • $4.289 ▲ 4.36%
36,199,890
  • $40.01 ▼ 0.97%
As of 4/17/2014, 04:07 PM