Once a leader in the widely followed FANG group, social media giant Facebook (NASDAQ:FB) has fallen on tough times recently, causing Facebook stock to become the group’s laggard. First, there was the Cambridge Analytica scandal. Then, there was the company’s awful second-quarter results. Since then, regulators haven’t eased their scrutiny of the company.
Facebook stock has been weighed down by fundamental headwinds recently. Today FB stock trades at $155. At the start of the year, it was a $180 stock. At its peak in July, Facebook stock reached $220.
In other words, Facebook stock has been a loser. Bulls continue to believe that, over the long-term, this company will be a necessary and huge component of the growing digital advertising industry. But that thesis hasn’t propelled Facebook stock higher because regulation and slowing growth trends cloud the outlook for continued robust digital advertising growth.
Thus, FB needs to find a new angle in order to spark a rebound in Facebook stock.
It looks like Facebook may have found that new angle. According to The Information, Facebook is looking to buy a cybersecurity company, has held talks with several security companies about an acquisition, and is stepping up its efforts to make such a deal amid the recent data protection backlash against it. Moreover, according to The Information, one person familiar with the matter said a deal could happen by the end of the year.
That is great news for FB and Facebook stock. Purchasing a cybersecurity firm could be the golden ticket which changes everything for Facebook, from usage trends to public image to growth trajectory to the performance of Facebook stock.
Buying a Cybersecurity Firm Would Be a Major Positive for Facebook Stock
Facebook has a lot of cash. There is roughly $42.3 billion in cash and cash equivalents sitting on the company’s balance sheet right now. The combined market caps of cybersecurity companies Palo Alto Networks (NYSE:PANW), Proofpoint (NASDAQ:PFPT), FireEye (NASDAQ:FEYE), and Fortinet (NASDAQ:FTNT) add up to less than $42.3 billion. The most expensive one, Palo Alto Networks, has a market cap of less than $20 billion.
Thus, Facebook could acquire a major cybersecurity company without doing much damage to its balance sheet. After all, Facebook’s free cash flow over the past twelve months was nearly $20 billion. Thus, FB generates enough free cash flow in one year to fund a major cybersecurity acquisition.
So buying a cybersecurity company would be very easy to do for Facebook. More importantly, it would be the right thing to do for two huge reasons.
First, buying a cybersecurity firm would be a positive, offensive move that would allow Facebook to gain exposure to the growing cybersecurity sector. The whole cybersecurity market is projected to grow at a 12%-15% clip over the next several years, and the revenue of many of the top security companies are growing at a 20%-plus rate. Additionally, the importance of cybersecurity is increasing, and demand for it won’t drop anytime soon. Furthermore, entering the cybersecurity market would enable FB to accomplish the necessary goal of becoming less dependent on digital advertising.
Second, buying a cybersecurity firm would be a positive defensive move for FB. Such a transaction would enable FB to enhance its data protection efforts, prevent further data leaks and hacks, and repair what has become a damaged reputation among regulators and consumers. These defensive moves are important because, if they are successful, FB could stabilize its usage trends, improve its advertising trends, and prevent regulators from taking action against it. By accomplishing those goals, FB would enable its digital advertising business to continue to grow.
And if that happens, Facebook stock would start to be valued like a growth stock again.
Facebook Stock Is Materially Undervalued, But Needs A Catalyst
Facebook is and has been undervalued for a long time. This is a company whose revenue jumped by over 40% last year, and yet FB stock trades with a forward multiple of just 20.
That makes no sense. Low-growth titans Coca-Cola (NYSE:KO), McDonald’s (NYSE:MCD), and Proctor & Gamble (NYSE:PG) all trade with forward multiples of 20, too. It simply makes no sense that rapidly growing digital advertising giant Facebook, with 40% revenue growth, trades at the same valuation as mature and stable consumer beverage giant Coca-Cola, whose revenue is increasing 5%.
But this disconnect between valuation and fundamentals has persisted for some time. The market is saying something here. It is going to take more than a beaten-up valuation to spark a recovery in Facebook stock.
From this perspective, a cybersecurity acquisition could be the golden ticket to a recovery by Facebook stock.
Bottom Line on FB Stock
There’s no way of hiding it. Facebook stock has been a big loser in 2018. But don’t throw in the towel just yet. This company is a growth giant that is simply one catalyst away from a huge turnaround. A major cybersecurity acquisition by the end of the year could be that big catalyst.
As of this writing, Luke Lango was long FB, PANW, FTNT, and MCD.