With all the focus on Facebook’s (FB) slowing user growth and calls for the end of its dominance, I finally gave in and decided to look into it myself. After all, from a personal perspective, I’m not the best person to evaluate user interaction with Facebook. I might look at my Facebook page a couple of times a week but it’s usually just to see if anyone sent me a message – it takes me all of 10 seconds to do that. I don’t scroll through my news feed to see what everyone had for breakfast this morning – because I really don’t care. Nor have I experienced the eerie feeling of seeing an ad pop up on my Facebook app shortly after having visited a related site on my home computer. At least Facebook knows I’m not its advertisers’ target market.
Based on Facebook’s definition of Daily Active Users (DAU) and Monthly Active Users (MAU) I would categorize myself as an MAU and the “A” is a stretch. Nonetheless, that’s one of the key stats investors look for when evaluating Facebook’s future potential to provide attractive shareholder returns.
After 2Q results were announced, I didn’t understand the rationale for what the bears were saying. 42% year of year revenue growth? That was slower than the previous quarter’s 50% growth, but still not too shabby. It’s a slowdown in growth mathematically, but the pessimism didn’t make sense.
The overall growth figures were driven by 47% growth in Europe and Asia Pacific, with 43% growth in the Rest of World.
Source: Facebook SEC Filings
A look at specific user data sheds light on some of the pessimistic forward views for the company. Both daily and monthly worldwide active users grew 11% year-over-year, but more importantly, the daily and monthly user base in the US and Canada grew by just 1% for daily active users and 2% for monthly active users year-over-year – growth also remained flat from the previous quarter. This slowdown in the company’s most lucrative market? Now I see what the bears might be talking about.
However, user growth is coming from other regions. Specifically, Asia-Pacific users were up 21% year-over-year and 3% sequentially from the prior quarter. There are now 546 million daily active users and 894 million monthly active users in Asia-Pacific. To put the opportunity in perspective, Asia-Pac now has almost four times as many users as the US and Canada.
Source: Facebook SEC Filings
With a population of 4.5 billion, however, that means Facebook has only penetrated 12% of the population in the region, compared to 32% in the US and Canada, 38% in Europe, and 28% in the rest of the world (see chart below). I’m not saying it will get to the same penetration levels in Asia-Pac as it has reached in other regions, but there’s room to grow.
Source: Facebook SEC Filings, World Bank
Revenue Per User
The second growth driver is the amount of revenue the company generates per active user. With overall active users growing at 11%, it’s obvious that the 42% growth in revenue came from higher revenue per active user. On a worldwide basis, revenue per daily and monthly active users were up 28% YoY and 9% sequentially from the previous quarter.
Source: Facebook SEC Filings, World Bank
Growth in revenue per user was highest in the more developed regions such as US/Canada and Europe, which grew revenue per daily active user by 36% and 43%, respectively. In these markets, there’s still apparent upside to what advertisers are willing to pay, but we’re probably reaching a limit.
But once again, I believe the user growth story is in Asia-Pac, where revenue per daily active user is just $4.21, compared to $33.17 for the US/Canada and $11.64 for Europe. Only the Rest of the World, which includes Africa, Latin America and Middle East has a lower revenue per daily active user, and this is not surprising considering the GDP per capita of the Rest of the World region is around $3,000. Despite revenue/user growth of just 22% on a year-over-year basis in Asia-Pac, however, the growth rate is accelerating.
In Asia-Pac, where GDP/capital is closer to $10,000, the potential revenue per user figure has much longer to run. In fact, the revenue/GDP per capita in Rest of World is 0.10% quarterly. In Asia-Pac, that figure is just 0.04%, higher than Europe but still less than in the US.
Even if Asia Pacific has no additional growth in users, an increase in revenue/GDP that’s more in line with that of the US will result in an additional $3.2 billion in revenues quarterly – that’s about 12% higher than current levels with no additional growth from any of the other regions. If we also increase penetration levels to just 20% – still below any of the other regions, the marginal increase in revenue from Asia-Pac alone could reach $5.3 billion!
And let’s not forget Europe. In Europe, we wouldn’t expect to have much more of an increase in penetration levels of daily active users. But the revenue per daily active user in Europe is just 0.03% of the GDP/capita of around $36k. With a boost to 0.06% – the same levels as those in the US – revenues would increase by $5.8 billion, all else equal.
These are two aggressive assumptions that would result in an additional $11.1 billion in quarterly revenues, and there are plenty of challenges that would prevent Facebook from reaching these revenue numbers – but the potential is there.
According to my calculations, Facebook could boost revenues by $9 billion with no user growth at all – so data showing slower user growth shouldn’t lead to the conclusion that growth isn’t possible.
If it could continue to increase revenue/user then the growth story is still compelling – and the data shows that in some regions, there’s upside pricing potential that could drive that growth. Any user growth would just be icing on the cake – and we know that penetration levels in some regions still show a big market opportunity.
New product launches like Watch, Watch Party, Stories, Ads Animator, Ads in Stories, IGTV, and others, can continue boosting revenue per user as well, even in the US, where revenue per user already is $33.17. And we haven’t even mentioned the potential upside of WhatsApp, Instagram, and Oculus.
From a valuation perspective, Facebook looks cheap. It currently trades at a price/free cash flow of 25.6. That’s well below the five-year average of 35.2.
Analyst price targets are at $204, which is a 35% gain from current levels. Free cash flow was $17.67B over the previous 12-month period on sales of $48B. If revenue increases by $9B whether with or without user growth, we could calculate an increase in free cash flow of about $3.31B, or $1.13 per share. At a more appropriate multiple of 30 (still below its recent five-year average), we arrive at a price target of $213.
The user growth story is wrong. Facebook is a strong buy.
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