I was going to write this article about Facebook (FB) a couple days after the biggest lock up expiration on November 14th. Lockup expirations allow early employees and investors to sell their shares on the open market. The plan was that since Facebook stock had gone down during the last lockup expirations, it was going to go down again as new shares flooded the market. I would be able to scoop up the shares at my intended target price of between $15-$20.
However, a funny thing happened. On November 14th, instead of the stock crashing like I had hoped, the stock shot up from below $20 to above $22 and I was not able to buy shares. Two weeks after the expiration the stock has gone up a staggering 30% to close above $26 yesterday. Although I have no plans to buy the stock at this price, I wanted to share why I like Facebook as an investment under $20.
I agree that Facebook is expensive by all metrics. However, at $20 it is not that expensive. At $20, its market capitalization is around $40 billion. About $10 billion of that is in cash from the botched IPO. Its cash flow is more than a $1 billion+ a year and that is growing over 20% a year. If you back out the cash, you are talking about a PE of 30. It is not unreasonable for such a great company.
Facebook will be able to generate a couple billion more in cash flow over the next coming years. If it does, at $20, you are talking about an inexpensive stock.
Here are some of the reasons that will enable it to generate more cash in the future:
According, to a great article by the business insider, “there are an estimated 6 billion mobile handsets in the world, and only about 1/5th of them are smartphones. Over the next several years, most of these handsets will be replaced by smartphones.”
The smartphone revolution will give a big boost to the already 1 billion+ subscriber base. Although, these users will have lower average revenue per user because they will be poorer, it should increase Facebook’s overall cash flow. Also, it should increase the engagement from users as the world is more connected.
Although, there are challenges to advertising on the mobile platform, Facebook proved last quarter that it will be able generate revenue through advertising.
“Facebook Open Graph is an attempt to map all the complex interactions existing between you, your friends and the content you all like.” Although, this sounds complicated, it is not. Facebook is mapping the real world on Facebook. When you like an article on HypeZero or share a song on Spotify, it captures that information and is able to build a better profile about who you are.
The obvious implication is that it and its partners are able to target advertise directly towards you taste. As a result, you are more likely to click on an advertisement.
Obviously, Facebook advertisements are not as powerful as Google’s where you are actually searching for something, but it will be possible for Facebook to compete with Google on search because of Open Graph. As Facebook maps the real world, it will not only be able to make search more personalized to your taste, but it will be an alternative to Google’s PageRank Algorithm.
Facebook is still a young company, and there will be many unthought of avenues for revenue growth. Although revenue from Facebook credit revenue has gone down due to Zynga’s demise, the company has recently come out with Facebook Gifts that allows users to send gifts to their friends with just a few clicks by partnering with companies such as Fab.com. Although, this may not prove successful, there will be plenty opportunities like this and if any of them succeed, you are talking about millions of dollars in additional revenue due to the large number of users.
For example, it is possible that Facebook could have a premium service for users or businesses. If say 10% pay $1/month for such a service, it amounts to a billion dollars in additional revenue. The point being that it is not unimaginable for Facebook to generate billions in revenue from other sources than just advertising.
As Warren Buffett once stated, “it is better to pay for a great company at a fair price, than a fair company at a great price.” I think Facebook is a great company that has numerous opportunities for revenue growth. And at the right price, it is a great investment.
Disclosure: I do not own Facebook.