Facebook, Inc (FB) is an American online social media and social networking service company. It is based in Menlo Park, California. It was founded by Mark Zuckerberg, along with fellow Harvard College students and roommates Eduardo Saverin, Andrew McCollum, Dustin Moskovitz, and Chris Hughes.
Nature of Business
Mark Zuckerberg founded Facebook Inc., while he was studying psychology at Harvard University. He was a keen computer programmer who had developed a number of social-networking websites such as “Coursematch” and “Facemash.”
In February 2004 Mr. Zuckerberg launched “The Facebook” or Facebook, Inc., it engaged in building products to create a utility for users, developers, and advertisers. People use Facebook to stay connected with their friends and family, to discover what is going on in the world around them, and to share and express what matters to them to the people they care about.
Developers use the Facebook Platform to build applications and Websites that integrate with Facebook to reach its global network of users and to build personalized and social products. The site’s features have continued to develop during 2007. Users can now give gifts to friends, post free classified advertisements and even develop their own applications – graffiti and Scrabble are particularly popular. Currently, the company continues to grow and give people the power to share and make the world more open and connected.
How do they make money?
Facebook Inc., generate substantially all of their revenue from advertising and from fees associated with their payments infrastructure that enables users to purchase virtual and digital goods from its company’s developers with applications on the Facebook website.
Advertising revenue is generated by displaying ad products on Facebook properties, including company’s mobile applications and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies, based on the number of clicks made by users, the number of actions taken by users, or the number of impressions delivered.
Facebook, recognize revenue from the delivery of click-based ads in the period in which a user clicks on the content and action-based ads in the period in which a user takes the action the marketer contracted. They recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users.
FB also generates its income from payment and other fees from its users when they purchase virtual and digital goods from its developers with an application on the company’s websites. Users can transact and make payments on the Facebook website by using debit and credit cards, PayPal, mobile phone payments, gift cards or other methods. The company will then receive a fee from developers when users make purchases in these applications using its Payments infrastructure.
FB recognizes revenue, net of amounts remitted to their developers. They have mandated the use of their payments infrastructure for game applications on Facebook, and fees related to payments are generated almost exclusively from games. Facebook, Inc other fee revenue, which has not been significant in recent periods, consists primarily of user-paid services and its ad serving and measurement products.
Who is running the business and what is their background?
Mr. Mark Zuckerberg is the Founder of Facebook, Inc., and has been its Chief Executive Officer since July 2004. He is responsible for setting the overall direction and product strategy of Facebook. He leads the design of Facebook’s service and development of its core technology and infrastructure. Mr. Zuckerberg has been the Chairman and Director of Facebook Inc., since January 2012 and July 2004 respectively. He serves as a Member of the Investment Committee at FB Fund, L.P. Mr. Zuckerberg attended Harvard University, where he studied computer science.
Mr. David M. Wernher serves as Chief Financial Officer, Vice President – Corporate Finance and Business Planning of Facebook Inc, effective June 1, 2014. Mr. Wehner has served as Facebook’s Vice President, Corporate Finance, and Business Planning since November 2012. From August 2010 through November 2012, He also serves as Chief Financial Officer of Zynga Inc. From February 2001 to July 2010, Mr. Wehner was employed at Allen & Company, an investment bank focused on media and technology where he served as a Managing Director from November 2006 to July 2010, and a director from December 2005 to November 2006. He also served as an Analyst at JP Morgan Chase & Co, Research Division.
In his career, he worked as a Consultant with the global strategy consulting firm Monitor Company, where he advised clients in a range of industries both in the United States and Asia. Mr. Wehner joined the New York investment banking firm Allen & Company, LLC in 2001, where his responsibilities include principal investing, corporate finance and mergers & acquisitions advisory. Mr. Wehner holds a B.S. in Chemistry from Georgetown University, and an M.S. in Applied Physics from Stanford University, where he was a National Science Foundation fellow.
Do you trust these people and are they competent?
Facebook Inc., hires and retain people who can contribute to developing its strategy, quickly innovate and build new products. CEO and CFO of the company are highly talented and able to show its competency, as well as demonstrated strong leadership. Therefore, my confidence and trust are absolutely positive as they both shows good management capabilities.
If you want to invest in a company, you need to know not only the nature of business, background and the people behind the success of the firm but most of all to know the financial standing of the company. And this could be found on the balance sheet, income statement and cash flow statement for the given period.
Shown in the table below would determine how liquid the company Facebook is through calculations of data from 2010 to 2013.
Current ratio average in the past four years from 2010 to 2013 was 8.37, with the latest quarter of 12.81 times. This is the very high current ratio, while the quick ratio average was also 8.06 and the latest quarter was 12.48, which means the company has very high current resources. Looking at its details, cash is the number one contributor of this very high current ratio and quick ratio, which is 60, 62, 64 and 64 percent of total assets.
Their debt to equity ratio is minimal at an average of 0.13 while the solvency ratio is 86 percent average.
By looking at the above data, Facebook is financially healthy and stable. They are very liquid with high current resources. Their debt to equity is only 13 percent and the solvency ratio of 86 percent so above the general rule of thumb which is 20 percent.
The table below is the efficiency ratios of Facebook Inc., wherein it is used to analyze how well a company uses its assets and liabilities internally. Efficiency ratios can calculate the turnover of receivables, the repayment of liabilities, the quantity and usage of equity and the general use of inventory and machinery.
Accounts receivable turnover can be used to determine whether the company is having trouble collecting on sales where they provide customers on credit. Facebook Inc., shows an increasing trend from 2010 to 2013 with TTM of 10.19 times which is a good sign. Converting this into Days sales outstanding which are computed as 365 days over accounts receivable turnover. The result is amazing with the declining trend from 69 days to 42 days and TTM of 36 days.
Days payable or payables period shows likewise a declining trend with TTM of 19 days. This means Facebook pays their payables in the short term within 22 to 15 days.
Fixed asset turnover measures the company’s effectiveness in generating sales from its investments in plant, property, and equipment. It has an up and down trend with a TTM of 3.39 times or 108 days.
Asset turnover measures the ability of a company to use its assets to efficiently generate sales. Facebook asset turnover has been slightly up in 2011 and down in 2012 and 2013 with a TTM of 0.55 times or 664 days. This means they don’t usually generate sales from their total asset.
Their cash conversion cycle (CCC) measures how long they will be deprived of cash if it increases its investment in resources in order to expand customer sales. This show that Facebook has a declining cash conversion cycle from 2010 to 2013 with a TTM of 16.8 days.
Efficiency ratios are important because an improvement in the ratios usually translates to improved profitability. Knowing its cash conversion cycle so they can utilize well their cash from sales more efficiently in more investments as well as its asset base – efficiently to generate sales and that is a very good thing.
Revenue is the amount of money that is brought into a company by its business activity. It is the “top line” or “gross income” figure from which costs are subtracted to determine net income.
The table below shows the detailed income of Facebook from 2010 to 2013 and the latest five quarters:
As observed in the above table the trend of revenue and gross income per annual data was yearly increasing which means it is getting higher and higher year after year. While the operation and net income of Facebook have a similar trend which declined in 2012 by 69 and 95 percent respectively.
Meanwhile, quarterly data shows that revenue, gross profit, and operating income were consistently going up in the first three-quarters, but slightly down in quarter 2014-03 however, it recovered in the quarter ending June 2014. Net income shows getting higher and higher every quarter.
It refers to the percentage results of gross income, operating income and net income over total revenue.
Annual data showed that Facebook Inc., average gross margin was 77 percent, operating margin 37 percent and net margin was 19 percent. However, quarterly data shows the net margin of the company was getting higher and higher every quarter from 2013-06 to 2014-06 with the following percentage: 18, 21, 20, 26 and 27. This means a good profitability for the company recovering after the 2012 crisis.
It is an expression which breaks return on equity (ROE) into three parts. And this tells us how much profit the company generated for each dollar of total assets. Return on equity using the DuPont Method as computed by a Net profit margin x Asset turnover x Equity multiplier.
Facebook Inc., has the following data in TTM: Net profit margin = 24; Asset turnover = 0.55 and Equity multiplier = 1.13. Therefore, ROE equals 15 percent; which Facebook Inc., could return such profit for every dollar of equity. This is the portion of the return on equity earned on the debt at work in the business.
Cash Flow Statement
FB cash flow data from 2010 to 2013 are shown per the table below:
Operating activities are transactions which include the cash inflows associated with sales interest and dividend revenues and cash outflows associated with operating expenses, interest and taxes. FB’s operating cash flow from 2010 to 2013 was positive and increasing yearly. It shows that the company is doing good and continue progressing. It has an average of $2,578M.
The company’s investing cash flow shows a negative balance from 2010 to 2013, with an average of $-3,418M. It indicates that cash outflows are greater than inflows on this category. The company was expanding through the purchase of investments yearly.
And financing cash flow, the balance were positive except in 2012 which is -667. Through looking back at its details the company retired the debt of $1,891M in 2012, so cash outflow exceeds cash inflow.
Free Cash flow
It is the cash left over after deducting capital expenditures from the operating cash flow.
The table below shows the free cash flow balance of Facebook from 2010 to 2013.
FB’s free cash flow shows a positive balance, with an average of 1,559 and trailing twelve months of $3,208 from 2010 to 2013 operation. It shows that the company is capable of expanding its business wider.
In this investment valuation, the company’s historical financial records such as the balance sheet, income statement and cash flow statement are our basis aside from the key ratios. It is Totem’s philosophy to buy wisely when prices are down and to sell when prices rise a great deal. And doing this valuation is the heart of any investment decision.
Totem Investment uses this method. The financial calculator is our main instrument in computing the equity selection. The result data as seen below:
Yield 0 %
Value of Appreciation $ 94.29
Value of Dividend 0
Total Value $ 94.29
Price investor is willing to pay $363.52
Facebook Inc., has a company growth of 47% as a computed base from their book value. They had an average P/E ratio of 50 and a dividend yield of 0%. In computing the value appreciation it is the average ROE with the return of book value, price, and the average P/E all in 5 years. Therefore, the result of the present value after the margin of safety of 40% equals $94.29. And the value dividend is $0 resulted from dividend divided by interest rate of 15%, which is constant.So, the total of the two value appreciation and value dividend equals $94.29 as their total value. Comparing the total value of $94.29 with the current price per share of $77.43 dated September 10, 2014. This means the company stock is trading at an undervalued price of 17.9%. But the price investor is willing to pay amounting $363.52 as computed by multiplying historical P/E with expected earnings for five years.
Aside from these let us compare market values of the stock with the fundamentals, their earnings, book value, growth multiples and other metrics as shown in the table below:
The book value per share showed an increasing trend of 129, 396, and 507 percent from 2009 to 2013 with TTM of $7.06 and an average of $3.58 per share. This is used to calculate the per share value of a company based on its equity available to common shareholders and just one of the methods for comparison in valuing of a company.
Its historical price to earnings has trended up and down ratio of 1666.7and 92.6 percent from 2012 to 2013 with TTM of 84 and an average of 879. P/E ratio is an equity valuation multiple. It is defined as market price per share divided by annual earnings per share.
Earnings per share have a growth ratio of – 0.98 and 0.59 with an average of 0.35 and TTM of 0.92 per share. It is the monetary value of earnings per each outstanding share of a company’s common stock.
Their return on equity (ROE) showed an up and down trend of -0.05, -0.98, and 2638 percent with an average of $14.75 and TTM of 15.44. ROE measures the rate of return on the ownership interest (shareholders’ equity) of the common stock owners. It is a gauge of a firm’s efficiency at generating profits from every unit of shareholders’ equity (also known as net assets or assets minus liabilities). This shows how well a company uses investment funds to generate earnings growth. ROE’s between 15% and 20% are generally considered good.
Totem Investment is looking for companies with a strong balance sheet or those with little debt, above average profit margin and ample of cash flow. So, as undervalued whose stock price is temporarily down, but whose fundamentals are sound in the long run.Facebook Inc., passed these criteria. Current market price is down at $77.48 per share dated September 12, 2014. So, compared to its total value of $94.29, the company is undervalued and still merits a buy.
Researched and Written by Nelly, Rio, and Meriam
Edited by Cris