Facebook's network of top-ranked social media networks, Facebook and Instagram, possesses deep network effects that benefit individuals, businesses, and creators alike. These three groups of users interact with each other, driving engagement that facilitates effective advertising campaigns and favourable business outcomes. Facebook is the ultimate beneficiary, who gushes cash from operations that are so lean, the company does not need to seek debt.
Facebook's core advertising business makes up almost all of the business's financials and is so strong, it can probably single handedly drive impressive growth at the company for many years. Shifting ad spend to digital forms and a naturally growing user base, as well as growth due to ecommerce and creator efforts, are catalysts that should catapult Facebook to new highs.
Facebook's investments in the creator economy and ecommerce are a bet on the new way of doing business and a way to exercise optionality within its own platform. Users want more convenient ways of purchasing products they see on content shared on Facebook and Instagram, and Facebook is making this a reality.
The metaverse is a new wave of computing that Facebook believes will be the next major computing platform after mobile. If Facebook emerges as the first mover and leader of the metaverse, it can unlock an unimaginably massive total addressable market that would dwarf the company's current growth rates.
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A set of metrics we constantly keep updated to monitor the investment thesis.
A user of Facebook's social networks benefits from the billions of users that interact with Facebook products on a daily basis. Facebook and Instagram have become part of our regular routines where we post about ourselves and our ideas, check in with friends and family, stay up to date with the news and the hottest trends, and connect with people thousands of miles away.
As these networks swell, Facebook's networks benefit individuals and businesses alike in the following ways:
More users mean more compelling content is posted across Facebook platforms on a more frequent basis for users to consume.
As more compelling content is consumed, the greater the time spent per day by each user, which feeds Facebook's ever-improving data algorithms to suggest even more relevant content, as well as relevant ads based on a user's unique behaviour, ultimately driving better engagement.
Marketers are attracted to platforms with active engagement - areas or media where users or consumers would notice an ad, consciously or subconsciously process the information on it, and finally make a purchase decision on it.
Although still in its infancy, Oculus will experience network effects to a similar degree. Facebook is offering VR hardware to the retail consumer at affordable prices, and they expect to keep it that way. Oculus is effectively a "razor and blades" model - Facebook's goal with Oculus is to get the hardware into as many hands as possible around the world, after which the digital economy inside of the hardware will compound at astounding rates. After all, Facebook knows what it takes to host a multi-billion-user network – it has done so once, and it will do it again.
Facebook effectively self-finances its own growth investments. The company gushes so much cash that it hardly relies on public equity and debt markets to raise capital to grow.
Facebook has zero debt on its balance sheet if we were to exclude operating lease obligations. Facebook's only "debt" would be its operating lease obligations, which we believe should be considered debt based on the substance and form of these lease payments mimicking traditional debt payments. The company has a net cash position, which means the value of Facebook's cash, cash equivalents, and short-term investments is greater than current and long-term debt and lease obligations.
Facebook is still growing revenues at rapid rates, meaning the company is far from maturity despite its market cap hovering around the $1 trillion mark. A net cash position implies there is significant room to reinvest idle cash into new opportunities, and Facebook can also issue debt to finance much larger projects should the need arise. In the absence of growth opportunities, Facebook can buy back large amounts of stock or make its operations more efficient.
All in all, Facebook shareholders can rest assured that the company is ready for any new competitors, products, or economic and political environments that may threaten Facebook, as long as its balance sheet remains this robust.
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Facebook's impenetrable network effects, bulletproof balance sheet, and self-financing profile enable it to explore monetization opportunities within its current network and in new verticals.
Facebook's daily active user ("DAU") base sits just under 2 billion people and counting. The strength of Facebook's core social media and ad business allows Facebook to be very active within the blue app and Instagram by expanding its services and ultimately, user engagement. It appears some of these services have been around forever, but many launched only recently and with little initial interest. For example:
Facebook Marketplace was introduced in 2016
Facebook Stories was launched in 2017
Facebook Watch was launched in 2018
Facebook Shops and Instagram Reels were launched in 2020
Facebook can dive headfirst into any emerging trend and spend billions of dollars in doing this to upkeep its ~2 billion DAU base. Today, Facebook is dialled in on video, which now accounts for almost half of all time spent on Facebook. Reels is also the largest current contributor to Instagram's engagement growth and Facebook Watch is growing faster than any other form of content found in Facebook's News Feed. E-commerce and the creator economy are two other major trends with seemingly unlimited growth opportunities that deserve a separate section and discussion later in this report (see "Creator Economy").
On the acquisitions front, Facebook has made a few monumental purchases that initially looked extremely expensive and attracted investor criticism:
Instagram was purchased in 2012 for $1 billion when it had only 50 million monthly active users ("MAU[s]").
WhatsApp was purchased in 2014 for $19 billion even though it was valued at $1.5 billion in private markets merely a year prior.
Oculus was purchased in 2014 for $2 billion to control VR products that were largely unheard of and had little use in our daily lives.
We know today that these investments have paid off handsomely – Instagram and WhatsApp host about 1 billion and 2 billion MAUs, respectively, and Oculus sales are taking off.
Facebook and Instagram are now places where people and organizations not only interact for pleasure, but also for business and content consumption. The number of potential use cases presented within Facebook and Instagram are sprouting in all directions right in front of our eyes, and Facebook is investing accordingly.
Facebook has been increasing its capital, acquisition, and research & development investments to enhance its moat. These investments have also been the key to Facebook's success and there is more coming. "Skin in the game" would be an understatement - Facebook is "all in" on growth.
In its current state, Facebook is an advertising company in virtually all respects. Although its products are still mainly used for online social interaction and the company is venturing into many exciting new fields, almost 100% of revenues are derived from advertising. The growing user bases of Facebook and Instagram in unison with ad budgets increasingly shifting to digital media provide enough "firepower" for Facebook to continue growing at above-average rates.
Facebook is now investing in the future of e-commerce and advertising that will pose even greater returns on advertising spend for marketers. Facebook recently introduced Live Breaks (i.e., in-stream video ads), Instagram Reels Ads, Shopping, and Checkout (Checkout is currently only available in the US), Facebook Shops, and Facebook Marketplace. With all these assets available on Facebook, advertisers will be able to reach wide audiences and help businesses and organizations convert eyeballs into consumers.
Facebook is working on creating a full e-commerce stack that begins with its world-class advertising tools and ends with payments. This should theoretically eliminate the inconvenience of landing on non-personalized external web pages after a consumer makes a purchasing decision following an interaction with a business, organization, influencer, content creator, or an artist on Instagram or Facebook. The effects of a full ecommerce stack within Facebook platforms are profound - consumers all over the world will eventually be able to purchase products right off Facebook Marketplace and Shops with Facebook Pay and off Instagram with Instagram Checkout within seconds and without ever leaving the Facebook ecosystem.
Despite the smartphone holding the throne as the dominant computing platform in our daily lives, Facebook believes the metaverse will be the new internet and AR / VR will be the next major computing platform. The metaverse can be thought of as a form of computing that blurs the line between reality and the virtual world. Facebook's Oculus ecosystem and metaverse plans could make the company a winner in what will eventually become the metaverse, with use cases across AR / VR advertising, real estate, gaming, e-sports, live events, social experiences, design, and many others.
The creator economy, ecommerce, and the metaverse - certainly the most speculative concept of the three listed - may be poorly executed and take far longer and much more expensive to build out than expected. In the case of the metaverse, it is possible that this virtual realm never truly materializes as something tangible, or customers may scrutinize the concept as something that has more risks than benefits to society, resulting in low customer uptake or heavy regulation from governments.
Apple's IDFA / iOS Changes
Earlier in 2021, Apple announced iOS 14.5, an update to Apple devices that would ask users to opt-in to Identifier for Advertisers ("IDFA") tracking if they would like advertisers, like Facebook, to use their online behavioural data to show relevant and personalized ads. This iOS update impairs Facebook's ability to show effective ads to iOS users, which may result in lower ROI on ads, dissatisfied advertisers, and lowered CPMs.
However, advertiser behaviour has been changing considering these changes - ad spend is decreasing on iOS, while Android ad spend is increasing, shielding platforms like Facebook from some of the IDFA impact. Further, Facebook's growing ecosystem could gather enough high-quality first-party data to provide immense value to marketers down the line.
Stronger regulatory oversight may limit growth opportunities and reach, and hinder current operations as they currently stand. Even if Facebook does not engage in anti-competitive practices, its association with Google, Amazon, and other large corporations that regularly face antitrust probes could direct regulatory and social scrutiny in the direction of Facebook.
Facebook sees more engagement from older demographics, while TikTok and Snapchat hold a large share of younger demographics, including Millennials and Gen Z. New registration interest in Facebook may wane as these newer social media platforms grow their user bases and establish strong network effects themselves. Facebook may not be able to purchase most of these social media apps due to their size and lack of alignment with Facebook's internal goals.