Facebook - Fantastic product. Fearsome Industry

High level summary
Facebook is a company that most people are intricately familiar with. Prominently among the US tech FANG stocks, it has exhibited the ability to generate profits (mainly from marketing revenue) that sets it aside from its peers. Currently the market darling for growth and momentum investors, every slight dip (unfavourable news regarding slipping profit growth and Cambridge analytica related privacy lawsuits) will be greedily gobbled up by welcoming investors as they seek to participate in this fantastic growth story.

I have spent some time to read through the 2017 annual report. IMHO, Facebook commands a fantastic product base (whats-app, Facebook, messenger, Instagram) in an immensely difficult industry. From a client experience perspective, I personally utilize Facebook to keep in touch with people I met and is interested to keep in touch with. Whatsapp has virtually led to the near obsolescence of the traditional telcos sms and mms businesses, with FOC services and superior experience delivered. Instagram, I am not so familiar with. However, my female colleagues and cousins swear by it and use it exclusively for their overseas travel shots and daily picture shots, where they use it as exclusive photo album storage. Photoshop is now literally considered old school and a thing of the past. The network externalities generated indirectly led to the further growth of new users, as they seek to use these platforms for business advertising and communication, as well for for personal usage (since everyone is on it)

Facebook is laser focused on core product development rather than diwosifying into multiple areas to artificially inflate balance sheet via intangible assets or seek inorganic growth. Facebook is also currently rolling out the virtual reality headset which is beyond my circle of competence. I shall try to explore the industry from a past, present and future perspective.

Past
The technology company is simply littered with the corpses of has been  in the technology industry. I have been through the short lived era of Friendster and Myspace whereby my secondary school mates joined those platforms because other popular classmates were already on it. Friendster, Zanga, WordPress and  Blogger were the hotshots of then. Now, there are you-tube videos documenting their demise and how it happened. Snapchat was promising to those whom subscribed to the IPO, and Skype / lync did see corporate use although I am unsure of the future outlook. IMHO, client experience is a very fickle minded affair and people can easily move in and out of this business. 



Present

If you simply look at the present, it can simply do no wrong. There is almost complete dominance in the Facebook social media sharing platform and it's assorted functions, Despite conventional corporate beliefs about product cannibalism, Facebook embraces it and tries to simplify and implement brands within its specialised apps despite similar core functions. It is especially diligent with un cluttering the functions and simplifying the aesthetics.

Lines of businesses

Messenger and whatsapp 

The no ads no clutter, simple messaging services provided by Facebook messenger, whatsapp respectively, is prevalent among the American users. Facebook is employing a 'branding 'strategy on its specialised products and services. This is sharply in contrast with apps touted by rival tech companies. We chat and weixin is touted by Ten cent as the ultimate and only app, where one can do everything with it. Grab and uber and Didi chuxin is closely mirroring it and jumping from the bandwagon. As a common user and observer, I am unable to come to a conclusion about what method is superior. I will simply use what comes free and suits my needs. Fantastic product, Yes! Fantastic outlook, that remains to be seen.

Facebook

Facebook is not beyond monetising it's products and services whatsapp for corporate usage. Business pages from Facebook can be set up and advertisements based in select themes can be put up on Facebook. This is a far cry from Myspace, in the pursuit of maximising profits for shareholders, compromised the features and user experience for a fast buck (advertising revenue). The reliability of the continual growth of non GAAP metric MAU (monthly active users) does not seem to be very consistent and very much driven by consumer sentiment. 

From a quantitative  standpoint, it indeed seems like the model company. It is difficult to not fall in love with its rosy prospects. The financial numbers are more impressive! It has the aesthetically pleasing image of a young and visionary CEO, the face of youth and optimism. When you dive in to its financials,  it has incredible figures that is the envy of many . Nonetheless, some of its unsavoury practices with regards to loose data protection caught up to it, and certain companies has announced boycotting of its services. 

Future outlook and moat of business.

Projecting to the murky future for the fast moving technology industry is no mean feat. From a quick glance at Facebook annual report, the future is indeed bewildering and almost impossible to forecast. Based on my understanding, not only must Mark Zuckerberg be able to continually innovate and produce new content / features, it must also get the timing of the content release right to compete effectively in the technology industry. There is also the possibility that consumers may not have a positive reception of the new products and jump ship to other platforms.



Regarding its financial results, to borrow a Chinese analogy, Facebook is the model company, with an angelic image with killer figures.  (天使般的脸,魔鬼的身材) . Its revenue, ROE and numbers are aesthetically pleasing and it appears to do no wrong. However, regulation and public perception pays a huge part to this companies success. When a business is too successful, everyone will want a share of this pie, and  with the recent Cambridge analytica and Presidential election scandals, there is no assurance whether this profitable trend will continue. Tightened regulation could also have a great impact on its viability and operating profit margin.

Facebook is also moving to the oculus virtual reality hardware business, which is also largely untested and unproven. Dealing with inventory, sales of physical assets, amortisation and depreciation expense and creating a distribution channel is vastly different from this electronic platform based company.







Important Snipperts of 2017 Annual report Page 5 to 24
https://s21.q4cdn.com/399680738/files/doc_financials/annual_reports/FB_AR_2017_FINAL.pdf

 Porter 5 forces
Competitive rivalry
Plenty

Bargaining power of suppliers.
Regulators and Retail clients.
Free to tweak privacy settings and information flow which could reduce the viability of this data driven business model.

Bargaining power of customers.
Corporate clients and retail users.Free to walk away if its cannot sustain network externalities.

Threat of new entrants
Zero barriers of entry. No entrenched ecosystem

Threat of substitute products or services
Plenty. One may be springing up in the dorm room of the incoming Mark Zuckerberg.

Conclusion.
The moat of this fast moving industry is not as robust as I initially envisioned and I believe it is impossible for the average investor to correctly know the future direction of the company. From a growth story standpoint, Facebook looks like it has a huge available market share / blue ocean that was not yet captured. The quantitative approach seems to give a definite thumbs up with the growth story of the company. From a PE, cash flow and debt structure perspective, it is reasonably valued compared to its growth potential.

Nonetheless, from a value standpoint, the margin of safety and moat of the business is patchy at best. From my understanding, the moat of the business is to thrive in continual change and new content revision. As I do not work in the fast moving technology industry, I am not in a position to make intelligent guesses about the outlook of the company.

As the US and China stock market is relatively overvalued at present and my orientation is to tend towards cash accumulation, I will NOT be buying this stock in the meantime. Nonetheless, if it falls to more attractive valuation levels and I have certain insights that the price weakness is only temporary, I can consider a small size position into this growth prospect. Not vested currently but staying tuned!



Links
https://www.businessinsider.com/facebook-explains-why-it-needs-instagram-whatsapp-and-messenger-2015-3/?IR=T
https://www.wsj.com/articles/facebook-to-banks-give-us-your-data-well-give-you-our-users-1533564049
https://quotes.wsj.com/FB/financials