Facebook (NASDAQ:FB) didn’t get left behind in the market’s 2019 rally. Year-to-date, investors are up 27% with the shares. Even though media is constantly reporting negative news on the company, FB stock’s discount to other social networking companies will need to come to an end as revenue re-accelerates and profits grow in the double digits in 2019.
There are three reasons Facebook shares will bounce back to $200 a share or over 25 times the estimated $7.58 EPS for the year.
#1: Costs on Beefing Up Privacy Grossly Exaggerated
The Cambridge Analytica scandal was a result of good privacy policies gone bad at Facebook. It wasn’t any gap in the company’s technology that failed to protect user privacy, it was bad behavior by an outside party. Now that the company is shifting its approach to user privacy, changes should benefit users and ultimately regain their trust.
To be sure, the media has doubts that Facebook has changed its DNA in the last year. BuzzFeed wrote that Facebook is managing the optics that it’s changing, and they may have a point since there’s still no obvious tool for a user to clear their history.
Performance-wise, though, at 19 times forward P/E, FB stock trades below Twitter (NYSE:TWTR) at 32x forward P/E. Snap (NYSE: SNAP) does not make any money so it’s valued infinitely more than either of the other two stocks. Markets clearly have discounted the risks of users leaving the Facebook site in light of concerns over privacy.
Fortunately, deactivating or deleting a Facebook account is easier said than done. The company also owns WhatsApp and Instagram, both of which are essential, if not “must have” apps for the younger generation. WhatsApp’s messenger keeps friends connected. Instagram is a source for following celebrities and users based on user interest.
These two apps lead to the second reason FB stock will rebound.
#2. Advertising Monetization Will Accelerate
Instagram use grew during the holiday season, with Feed and Stories drawing more users and user activity on the app. Once folks get familiar with Instagram, the discovery tool increases stickiness. And advertisers like that kind of user behavior. As monetization of Stories accelerates, Facebook will invest more in the advertising tools to draw more advertisers.
Currently, Facebook’s Feed on mobile is the biggest revenue generator. As the company looks for ways to diversify its revenue sources, Instagram is likely to add more to revenue this year.
Monetizing WhatsApp is still proving elusive. Fortunately, CEO Mark Zuckerberg is consolidating the security around all sites (including Instagram). The more it knows about its WhatsApp user and the user associated on Facebook, the more likely it will find a way to make a profit from the messaging app.
#3. Higher Spending is Temporary
Unifying the security among the apps and tightening up on security will not come cheap. Expense growth of 40-50% in 2019 is necessary to strengthen the back-end technologies that power Facebook. For the near-term, artificial intelligence could cut down on FTEs (headcount) for detecting fake news posts, terrorist-related content, and other objectionable material. Beyond 2019, spending levels will moderate.
Facebook continues to commit to the development of AR and VR. Though this fad is fading, the company needs to have research and development work in the gaming market. Whether it is connected to the console or smartphone device, the company cannot rely solely on advertising for its revenue.
FB Stock Still has Double-Digit Upside
Snap may have a large percentage of the teen market but Facebook’s ARPU from U.S. users is a solid $110. Near-term ARPU levels could fall as Facebook accepts lower revenue from Instagram Stories. Once users start engaging more actively with ads, FB stock could see EPS rise 23% this year. Gross margin will continue to trend higher as the company completes its security infrastructure overhaul over the next year.
According to stock sentiment engine Tipranks, 39 analysts cover Facebook and have an average price target of $193 a share, 16%+ higher than current levels. My target is seven bucks higher at $200.
To assess the risks, assume revenue won’t keep growing in the double-digit percentage rate. A 10-year DCF EBITDA Exit model (provided by finbox.io) would peg FB stock trading at around fair value. This takes into account revenue growth falling to the single-digit range in 7-10 years from now.
Facebook is not an expensive stock at these levels. Strong revenue from Instagram and continued strength in Facebook’s News Feed will lead to sustained revenue growth for 2019.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.