• 1Q23 revenue and earnings modestly beat expectations on higher Ad sales. 1Q23 revenue/PATMI at 23%/20% of our FY23e forecasts.
• Investments in AI driving improvements in ad tech, with Reels user engagement and monetization starting to ramp up.
• Optimistic outlook with 2Q23e revenue guidance of 7% YoY growth at the midpoint (11% YoY top-end), while reducing FY23e total expense growth by 5%. Expectations for a final wave of headcount cuts in May 23.
• We increase our FY23e revenue estimates by 3%, and our FY23e PATMI/EBITDA estimates by 11% to reflect better-than-expected improvements in cost savings. We maintain NEUTRAL due to recent stock price performance, with a raised DCF target price of US$235.00 (prev. US$200.00), a WACC of 7.1%, and a terminal growth rate of 3.5%.

The Positives

+ 1Q23 results beat on both top and bottom line. META issued 1Q23 revenue of US$28.6bn, 3% YoY (6% YoY in constant currency), beating estimates by about 3%, and the top end of its own 1Q23e revenue guidance (US$28.5bn). This outperformance was led by a 26% YoY increase in ad impressions, and strong spend from Chinese advertisers’ outbound spending. E-commerce and Healthcare were the 2 leading contributors to YoY ad revenue growth. 1Q23 EPS of US$2.20 also beat estimates by ~10% as the company continued to show improvements in cost efficiencies as expense growth slowed to 11% YoY (4Q22: 22% YoY) – Sales & Marketing expenses were down 8% YoY.

+ AI continues to drive improvement in ad tech. Investments in AI capabilities continue to be the backbone driving product improvements. AI recommendations drove >24% increase in user time spent on IG, with Reels monetisation efficiency up >30% on IG, and >40% on FB. With the help of AI, we do expect the gap between Reels monetization vs Feed/Stories to continue narrowing, with META mentioning that this could reach neutrality by early 2024.

+ 2Q23e guidance of 7% YoY revenue growth showing potential pickup in growth trends. META issued optimistic revenue guidance for 2Q23e, with a range of US$29.5bn-32bn indicating a 7% YoY growth taking the midpoint, and a 11% YoY growth taking the high end of the range – implying some acceleration in revenue trends, with FX expected to also be less of a headwind moving forward.

The Negative

- Profit declined YoY, though less than prior quarters. META announced 1Q23 PATMI of US$5.7bn, -24% YoY, as expenses continued to grow faster than revenue (10% YoY vs 3% YoY), and a slightly higher tax rate of 22% vs 16% in 1Q22. However, YoY decline in PATMI was significantly better than prior quarters (3Q22: -52% YoY, 4Q22: -55% YoY), with a resumption in earnings growth on the horizon due to significant cost efficiencies and FX headwinds neutralising.

• META recently announced another round of job cuts, laying off ~10,000 (~12% of current workforce), and further removing ~5,000 vacant positions. META’s plans include removing multiple layers of management, and automating more functions to improve efficiency.
• We reduce FY23e OPEX by ~3% as a result of the planned job cuts. As a result, FY23e EBITDA/PATMI is increased by 3%/4% respectively. We maintain ACCUMULATE with a raised DCF target price of US$200.00 (prev. US$182.00), a WACC of 7.1%, and a terminal growth rate of 3.5%.

Update

Job cuts should help to further contain expenses growth. META announced that it would be laying off ~10,000 people (~12% of current workforce), and will also be eliminating another ~5,000 vacant job positions as it continues to streamline its workforce and contain its expenses. YoY headcount growth has been declining over the last 3 quarters – as YoY revenue has begun to contract, and we do expect this to drop drastically for 1Q23e as the job cuts take into effect, especially compared with 1Q22 when hiring was still rampant with headcount growth around 27%. OPEX growth is expected to drop as well, although not as significant given the anticipation of sizeable severance-related charges. META incurred restructuring charges of US$4.2bn in 4Q22 after it performed similar cost-cutting initiatives – US$3.2bn from the consolidation of facilities and restructuring of data centre assets, and US$1bn in severance-related charges.

Maintain NEUTRAL with a raised target price of US$200.00.

As a result of the planned job cuts, we reduce FY23e OPEX by ~3% to be roughly in line with FY22 levels. FY23e EBITDA margins are increased by 120bps to 37.0% due to the reduction in OPEX, offset slightly by expected severance-related charges, with net margin also increased by 100bps to 22.8%. We maintain NEUTRAL with a raised DCF target price of US$200.00 (prev. US$182.00), a WACC of 7.1%, and a terminal growth rate of 3.5%.

•  4Q22 revenue beat expectations by 3%, with adj. earnings (excl. US$4.2bn restructuring charges) beating by 58%. FY22 revenue/adj. PATMI at 101%/114% of our FY22e forecasts.
•  Committed to streamlining costs moving forward, and focusing on improving efficiencies with AI. FY23e total expense guidance reduced by US$5bn, 5% YoY growth.
• Digital advertising outlook weak, Meta guided 1Q23e revenue contraction of -2% YoY.
• We downgrade to NEUTRAL with a raised DCF target price of US$182.00 (prev. US$113.00) to account for an expected 9% increase in EBITDA margins over the next 2 years due to a sharp reduction in expenses. We cut FY23e revenue by 13% on continued uncertainty in digital advertising demand, but also reduce FY23e CAPEX by 15%, and total expenses by 9% to reflect a slowdown in expenses. As a result, FY23e net margin is reduced to 22% (FY22: 20%). We reduce our WACC to 7.1% to account for an increase in debt in relation to equity, and maintain our terminal growth rate of 3.5%.

The Positives

+ Revenue beat expectations on higher holiday ad sales, continued user growth. 4Q22 revenue came in at US$32.2bn, 3% above our forecasts, but still representing a decline of 4% YoY. Revenue was driven by a 23% increase in ad impressions, and strong YoY growth in the travel and healthcare verticals. Active users on Meta’s family of apps continued to grow steadily, increasing 4% YoY to 3.74bn.

+ Laser focused on controlling expenses moving forward. As mentioned during its previous 3Q22 earnings call, Meta remains fully committed to streamlining costs moving forward as it transitions from a phase of hyper growth into a phase of maturation and efficiency. The company plans on: 1) reducing CAPEX by improving its data centre architecture to be more flexible and cost effective; 2) slowing headcount growth as it looks to lean out its management layers; and 3) leveraging AI to increase efficiency and monetization of its products. The expected reduction in expenses should provide an immediate respite to the company’s shrinking margins. 4Q22 total expenses was US$26bn, a 22% YoY increase. Guidance for FY23e total expenses was reduced by 5% to a range of US$89bn-95bn, with FY23e CAPEX reduced by 12% to US$30bn-33bn.

The Negative

- Near-term digital advertising demand expected to remain weak. Meta guided 1Q23e revenue to be in the range of US$26bn-28.5bn – approx. -2% YoY contraction, indicating continued expected weakness in digital advertising demand. FX is also expected to be about a 2% YoY headwind. However, we do expect growth to expand throughout the year as Reels monetization and advertising performance continues to improve.

• 3Q22 revenue in line with expectations, earnings miss by 12%. 9M22 revenue/PATMI at 68%/60% of our FY22e forecasts.
• Earnings hurt by 19% rise in expenses; Reality Labs segment continuing losses; guided to another quarter of negative revenue growth.
• We cut our FY22e revenue/PATMI forecast by 7%/23% to account for slowing revenue growth, higher-than-expected total expenses and increasing FX headwinds. We also increased our total expenses forecast for FY23e. We downgrade to an ACCUMULATE recommendation with a lowered DCF target price of US$113.00 (prev. US$221.00).

The Positive

+ Reels engagement seeing continued momentum. Meta continues to gain time spent share on competitors like TikTok, with Reels seeing more than 140bn daily plays – 50% increase from 6M ago, and driving incremental time spent on Meta’s family of apps. Reels growth presents near term headwinds since it does not monetize as quickly as feed or stories, but is expected to even out over the next couple of years as monetization improves. LTM revenue run rate for Reels was around US$3bn in 3Q22, 3x more than 2Q22.

The Negative

- Earnings cut in half due to jump in expenses. Meta announced EPS of US$1.64 for 3Q22, almost 50% lower than a year before. The main reasons were YoY revenue contraction of about 5%, and a 19% YoY increase in total expenses. R&D saw a 45% YoY increase as Meta continued hiring technical roles to support its Family of Apps segment. However, the company did mention that they expect overall headcount to remain roughly the same until the end of FY23e, which should help to ease YoY growth in total expenses.

- Reality Labs segment running deeper into the red. Revenue from Reality Labs was down 49% YoY as a result of slowing Quest 2 sales – VR headset. Expenses remained high, with the operating loss for the segment at US$3.7bn for 3Q22, up 40% YoY. Operating loss YTD was US$9.4bn, an increase of 37% YoY. Continued losses from Reality Labs is concerning given the uncertainty surrounding its timeline to profitability, and a growth stagnation in Meta’s core digital advertising revenue.

- Guidance for another quarter of negative revenue growth. Meta guided to 4Q22 revenue range of US$30bn-32.5bn, representing a 7% YoY contraction taking the midpoint, with an approximate FX headwind of 7%. The sluggish guidance reflects continued weakening trends in digital advertising, and an uncertain macroeconomic environment.

• 2Q22 revenue in line with expectations, with earnings missing target slightly. 1H22 revenue/PATMI at 43/42% of our FY22e forecasts.
• Reels driving positive user growth across all metrics for 2Q22, with 15% YoY increase in ad impressions. Business messaging potential additional revenue driver because of its growing popularity amongst SME business owners.
• Soft revenue guidance for 3Q22 from slowing advertising demand and 600 basis points YoY revenue headwind from strengthening US dollar.
• We lower our FY22e revenue/PATMI forecast by 5/10% to account for slower revenue growth, slightly higher-than-expected R&D expenses, and increasing FX headwinds. We maintain a BUY recommendation with a lowered DCF target price of US$221.00 (prev. US$231.00).

The Positive

+ Reels driving positive user growth, increasing ad impressions. META recorded 3.65bn Family Monthly Active People (MAP) for 2Q22, increasing 4% YoY, with ad impressions also increasing 15% YoY. User growth and engagement continues to be driven by strong 30% QoQ Reels growth, particularly in the APAC and Rest of World regions. This is good news for META especially as it shifts its focus into short-form video formats like Reels.

+ Business messaging a potential lever of revenue growth. Once clicked, Click-to-Message opens a chat between the user and a business, connecting both parties instantly, and is proving to be particularly popular amongst SMEs in Brazil and Mexico. Business messaging products like Click-to-Message are already a multi-billion dollar business for the company – with strong double-digit YoY growth and more than 1bn users, which we believe should unlock an additional lever of revenue growth for META moving forward.

The Negatives

- Earnings miss due to higher than expected expenses. META recorded 2Q22 EPS of US$2.46, missing estimates of US$2.61, largely due to higher-than-expected expenses, which increased 22% YoY. Headcount increased by 32% YoY, mainly in tech functions, above expectations. However, META also mentioned that it expects headcount growth to slow for the rest of the year as they reduce hiring.

- Soft 3Q22 revenue guidance due to continuing weakness in advertising, and 6% FX headwinds. META issued very soft revenue guidance for 3Q22, in the range of US$26bn-28.5bn – representing a 6% YoY decline. Broader macroeconomic uncertainty, softening demand for advertising, and an approximate 6% YoY headwind from a strengthening US dollar, were cited as the main reasons for the expected weakness.

Outlook

META guided 3Q22 revenue to be US$26bn-28.5bn, a 6% YoY decline, and relatively flat compared with 2Q22, with this guidance reflecting weakening revenue trends that are expected to continue. Meta also lowered its FY22e guidance on total expenses from US$87bn-92bn, to US$85bn-88bn, as it slows hiring and overall expenses to account for a more challenging macro environment.

META’s transition from Feed/Stories to Reels seems to be ahead of schedule, with management seemingly optimistic about its results so far. As advertisers shift more spending on Reels, average price per ad declined 14% YoY. In the long-run, this should be a positive for META as it continues to compete with other short-form video players like TikTok for advertising dollars.

Management reiterated its focus on investing more into its Artificial Intelligence (AI) and Machine Learning capabilities to drive better user experiences on its platforms and grow video monetization. The increasing capabilities in AI will also help to deliver better personalized ads using less data, helping to combat the negative effects from Apple’s third-party privacy changes.

META is no doubt in a transition period, with margins contracting and revenue slowing in the near-term. However, we believe in its ability to get through this transition period, especially with its long-term investments in AI. Free Cash Flow (FCF) for the quarter was US$4.5bn, with the company also repurchasing US$5.1bn of shares.

We reduce our FY22e revenue/PATMI forecasts by 5/10% on the back of slowing revenue growth as a result of weakness in consumer advertising, and increasing FX headwinds.

• 1Q22 earnings in line with expectations. 1Q22 revenue/PATMI at 21/22% of our FY21e forecasts. EPS beat consensus estimates of by 6% as a result of lower than expected total expenses.
• Positive user growth across all metrics for 1Q22, with Facebook DAU rebounding from negative QoQ growth in 4Q21.
• Continued negative impact on revenue from suspending operations in Russia, and from strengthening US dollar.
• We maintain a BUY recommendation with a DCF target price of US$312.00 (WACC 6.6%, g 3.5%).

The Positive

+ User growth across all metrics a positive sign. Meta recorded 3.64bn Family Monthly Active People (MAP) for 1Q22, increasing 6% YoY, and slightly over 1% QoQ. Specifically for its Facebook platform, Monthly Active Users (MAU) grew 1% QoQ and 3% YoY to 2.94bn, with Daily Active Users (DAU) rebounding from a negative QoQ growth in 4Q21 to a 2% QoQ growth. Overall, across platforms, growth was driven by the APAC region, with most other regions either flat or slightly contracting.

+ Earnings beat consensus estimates of US$2.56, with lower than expected total expenditure. Meta’s EPS of US$2.72 for the quarter beat consensus estimates of US$2.56, partially due to a lower than expected total expenditure for the quarter, indicating that the company’s slowdown in earnings was not as bad as analysts feared. Operating Income was US$8.5bn, with operating margins of 31%, compared with 43% in 1Q21. Meta also conducted share buybacks of US$9.4bn for the quarter.

The Negatives

- Continued revenue headwinds for 2Q22 due to strengthening USD, negative impact from Russia/Ukraine conflict, and Apple’s ATT* changes. Revenue headwinds continue in Russia, where its services are totally suspended. Also, the company estimates a 3% headwind to YoY growth in revenue for 2Q22 as a result of a strengthening US dollar. Apple’s ATT changes continue to pose a headwind for Meta, with its changes decreasing the effectiveness and the tracking capabilities of Meta’s targeted ads. The company said that overcoming these challenges using AI and machine learning will continue to be a long term challenge that it is focused on.

*App Tracking Transparency (ATT) – Changes by Apple during its iOS 14 update that allows users the ability to choose what kind of data, and to whom they wish to give their data to (privacy safeguard)

Outlook

Meta guided 2Q22 revenue to be in the range of US$28bn-30bn, a 1-7% QoQ increase compared with 1Q22, with this guidance reflecting revenue trends that are expected to continue. This guidance is also in line with our estimates. Taking the midpoint guidance of US$29bn (0% YoY growth), 1H22e revenue will work out to be around 43% of our FY22e revenue estimates.

Meta also lowered its FY22e guidance on total expenses from US$90bn-95bn, to US$87bn-92bn, but still expected the majority of expense growth to come from the Family of Apps segment, as it increases Data Centre capacity, and invests heavily in Artificial Intelligence to improve overall efficiency.

Regulatory legislation continues to be an overhang for the company, with Meta working together with the EU to finalize the wordings of the newly created EU Digital Markets Act, which was primarily created to be a “gatekeeper” for big tech companies, and prevent them from indulging in monopolistic practices.

Maintain BUY with an unchanged target price of US$312.00

We maintain a BUY rating with an unchanged target price of US$312.00, with a WACC of 6.6%, and a terminal growth rate of 3.5%.

• 4Q21 earnings in line with expectations. FY21 revenue/PATMI at 102/105% of our FY21e forecasts
• Apple iOS 14 privacy changes decreases the accuracy of FB’s targeted ads, making it increasingly tougher to track and measure the outcomes of these ad campaigns
• The company guided weak 1Q22 revenue growth of 3-11% and FY22e expenses to rise at least 26% to US$90bn-95bn. FB is also undertaking major capital expenditure of US$29bn-34bn to beef up its IT infrastructure.
• We maintain a BUY recommendation with a reduced DCF target price from US$424.00 to US$312.00 (WACC 6.6%, g 3.5%). Our target price is lowered due to growth pressures from increased competition and reduced earnings of 24% due to increased expenditures.

The Positive

+ Revenue growth still positive for the quarter. FB reported 20% YoY revenue growth for 4Q21, and 37% YoY revenue growth for FY21. This was supported by a 9% YoY increase in user growth, 6% YoY increase in prices of digital ads, and 13% YoY increase in ad impressions.

The Negatives

- Reduced effectiveness of targeted advertising due to Apple iOS 14 privacy changes. Apple’s iOS 14 privacy changes continue to affect FB’s core advertising business, decreasing the accuracy of its targeted ads, and making it tougher for the company to track and measure the outcomes of these ad campaigns. As a result, advertisers have begun reallocating portions of their ad budget away from FB, and towards competitors like GOOGL and AMZN.

- Increasing competition from TikTok and other social media companies. The emergence and growth in popularity of short-form video apps like TikTok continue to be a threat to FB, particularly with its younger users. User growth has begun to slow down, with only 0.3% QoQ for 4Q21. As a result, FB has begun transitioning its own services towards more short-form video like Reels, in an effort to better serve its younger audiences. They have also scaled up hiring in this area, leading to higher total expenses and lowered margins - by almost 10%. This shift in format could be accompanied by near term pressures on impression growth, as well as slower monetization rates.

- Weak 1Q22 and FY22e guidance of increased expenses. FB guided weak 1Q22 revenue growth of just 3-11%, impacted by headwinds in both ad impressions and prices. It also expects FY22e total expenditure to rise at least 26% to US$90bn-95bn on the back of increasing CAPEX by at least 56%, as it scales up investments in tech talent and IT infrastructure to better compete with its competitors.

• 3Q21 results in line with expectations. YTD FY21 revenue/PATMI at 73/78% of our FY21e forecasts. EPS beat consensus estimates largely due to share repurchases in the quarter.
• Monthly Active People (MAP) growth for the quarter above our full-year estimates, with Family Average Revenue per Person (ARPP) growth in line.
• Limited guidance on 4Q21 due to the continued uncertainty of Apple’s iOS 14 privacy changes, and other macro headwinds.
• We maintain our BUY recommendation and unchanged DCF target price (WACC 6.7%) of US$424.00.

The Positives

+ Continued growth in Monthly Active People (MAP). FB recorded strong growth in MAP for Q321, adding about 70mn users QoQ (2%), and growing 11.5% YoY. We view this as an endorsement of the company’s network effect, as well as its ability to continuously add users onto its family of platforms even in the face of publicity headwinds.

+ Sustained investments in improving IT infrastructure. CAPEX grew at a YoY rate of 23.1%, to US$4.5bn this quarter. Reaffirming FB’s commitment to bolstering its IT infrastructure through strategic and continued investments. We should see this trend continuing as FB has already guided for FY22e CAPEX to be in the US$29-34bn range, on the back of proposed investments in AI and Machine Learning capabilities.

+ Share buybacks boosting EPS. FB spent almost US$14bn repurchasing shares in 3Q21, almost twice the repurchase amount from 2Q21. The sheer amount of buybacks contributed to EPS reaching US$3.22, narrowly beating consensus estimates of US$3.17. FB also announced an additional US$50bn authorization for buybacks moving forward.

The Negatives

- Lower than expected revenue due to privacy headwinds. FB recorded negative QoQ revenue and ARPP growth, attributing Apple’s iOS 14 privacy changes as causes for the slowdown in growth for the quarter. Other factors for lackluster revenue numbers were moderated growth in e-commerce, supply chain disruptions amongst businesses, and reduced economic activity in APAC region due to the resurgence of Covid-19.

Monthly Active People (MAP) is defined by FB as a person that has registered or logged in to its family of platforms in the last 30 days

Family Average Revenue Per Person (ARPP) is the total revenue during a given quarter divided by the average number of MAP at the beginning and end of the quarter

• PATMI is expected to grow CAGR 19% till FY22e, supported by growth in Family Monthly Active People and Family Average Revenue per Person.
• Expanding outside advertising into commerce and AR/VR verticals, payments & others category driven by commerce activity and VR device sales.
• Initiate coverage with a BUY recommendation and DCF target price (WACC 6.7%) of US$424.00.

Company Background

Founded in 2004, Facebook (FB) is the largest social-media company in the world, serving more than 3bn users and about 10m advertisers. Its portfolio includes Facebook, Instagram, Messenger, WhatsApp and Facebook Reality Labs (VR). FY20 revenue was a record US$86bn, with PATMI of US$29.1bn. Almost all FB’s US$86bn revenue in FY20 came from advertising, at 98% or US$84.2bn. Payments and Others made up 2%. Geographically, North America contributed 49% to revenue, Europe 24%, Asia-Pac 18% and the Rest of The World 9%.

Investment Merits

1. Expanding user base and value to advertisers. FB’s Family Monthly Active People (MAP) was up 14% YoY in FY20, from 2.9bn to 3.3bn people. Family Average Revenue per Person (ARPP) was also up by 17% YoY, due to increases in digital ad spending. Worldwide digital ad spend as a percentage of total media ad spend is projected to increase from 58% in FY20 to 68% by FY24e, with dollar spend also projected to almost double from $378bn to $646bn in the same period. The strong growth in MAP and ARPP reflects FB’s ability to attract, retain and commercialise users on its platforms. We expect FB’s MAP growth rate to dip slightly in the later years, to around 8-10% YoY. In view of: 1) strong competition from other social-media platforms; and 2) FB’s already large share of active Internet users around the world. We expect ARPP to increase 22% YoY in FY21e, on the back of tailwinds from a recovering advertising market.

2. Capitalising on commerce, AR/VR. FB plans to develop Shops into an all-in-one touch point for users to browse and transact without third-party diversions, similar to other e-commerce platforms. More than 200m small businesses around the world are currently estimated to be tapping FB’s technological reach and tools to promote their businesses – with this number growing each day. We view this as a huge opportunity for FB to develop a new revenue stream to complement its main advertising business. Revenue from payments & others was up 146% YoY Q1 FY21, and we expect continued growth on the back of increased commerce activity and usage of WhatsApp Pay. FB is also doubling down on AR/VR, touting its future potential as being more immersive products than current web browsers. Worldwide AR/VR market is projected to expand 10x over the next four years – from US$30bn to US$300bn, providing FB another large market opportunity to capture.

3. High margins, high cash generation model. FB recorded net margins of 34% in FY20 - slightly below its 5-year average of 35%. Net margins backed by gross margins of 80% and low operating expenses on infrastructure, content & traffic costs. Largest cost item is R&D at 21% of revenue. FCF has been growing at a CAGR of 14% over the past three years despite the huge capital expenditure programmes.

We Initiate coverage with a BUY rating and target price of US$424.00 based on DCF valuation, with a WACC of 6.7% and terminal growth of 4%.

REVENUE

The bulk of FB’s US$86bn revenue in FY20 came from advertising, at 98% or US$84.2bn. Payments & others made up 2% or US$1.8bn. FB’s advertising revenue is generated from selling ad placements to marketers using an open bid system, allowing marketers to purchase ads at a price determined by supply and demand, with the added option for marketers to place these ads on any of FB’s family of platforms.

Geographically, North America contributed 49% to revenue, Europe 24%, Asia-Pac 18% and Rest of The World 9%. Even as growth rates of monthly average people in developed regions like North America and Europe start to slow down, we expect ad revenue from these two regions to increase 40+% YoY. This would be largely led by increased digital ad-spending in these regions.

We see the potential for growth from the monetisation of FB’s e-commerce products, Shops. Shops is a product to bring businesses and consumers together. It allows businesses to create a free to use an online store to display and sell merchandise to FB users, leveraging on connectivity tools such as Messenger and WhatsApp as support functions. FB is expected to use these products to generate additional revenue from 1) transactional fees; and/or 2) increased ad impressions and higher advertising prices associated with shopping directly on its platforms.

FB has also been actively developing a secondary revenue stream in the payment sector. It launched WhatsApp Pay in developing countries like India and Brazil in Q4 FY20, where its combined user base exceeds 500mn people. It wants to: 1) monetise it’s largely untapped free-to-use platform; and 2) develop its existing payment platform for future integration with its family of platforms. Revenue from payments & others was up 146% YoY Q1 FY21. Thanks to the company’s global user reach and a strong emphasis on growth in this revenue stream, we expect YoY growth to be maintained around 65% moving forward.

FB recorded gross profits of $69.2bn in FY20, with PATMI of $29.1bn. Revenue is expected to hit US$138bn by end-FY22e, largely due to increases in MAP. MAP is a key metric for FB as it leverages its user base to generate advertising revenue. FB recorded MAP of 3.3 billion people in FY20, and is expected to grow at a CAGR of 8% to 3.9 billion by FY22e. ARPP was US$27.51 for FY20, an 8% YoY growth, and is forecasted to hit US$37 by FY22e – CAGR 10%, on the back of increased worldwide ad spending. Worldwide digital ad-spending is expected to trend upwards as a result of behavioural shifts in advertising and marketing spending, which would benefit FB.

EXPENSES

Cost of sales grew at a 34.5% CAGR from FY16 to FY20, above revenue CAGR of 25.5%. Operating expenses include research and development (21.5% of revenue), sales and marketing (13.5%), and general and administrative (7.6%). Expenses have remained fairly stable over the last 5 years, except for general and administrative expense in FY19 which hit 14.8% of revenue – due to US$5bn FTC settlement. Depreciation and amortization for FY20 was US$6.9bn (8% of revenue), a 19.5% YoY increase from FY19. D&A expenses are expected to increase significantly over the next 2 years on the back of increased capital expenditure in tech infrastructure.

MARGINS

Gross margins hit 80% in FY20, slightly below the 5-year average of 84%. The high margins are attributed to its minimal overhead costs, mostly spent on facility and server depreciation, salaries and content & traffic acquisition costs.

Net margins in FY20 were 34%, up from 26% the previous year. Led by 37%/36% YoY drops in G&A expenses and tax. G&A expense decreased from US$10.5bn to US$6.60bn given the absence of a US$5bn Federal Trade Commission settlement in 2019. Cost of revenue, R&D expenses and G&A expenses are expected to increase due to business expansion, but net margins should remain stable at 32-33% due to increased revenue.

BALANCE SHEET

Assets: Cash, cash equivalents and marketable securities increased by about US$7bn YoY in FY20, largely due to increased purchases of marketable securities. Equity Investments increased US$6.1bn, following a US$5.8bn investment in Jio Platforms – a holding company for India’s largest mobile network provider. Plant Property Equipment & Intangible Assets rose US$10bn, reflecting continued capex on buildings and network equipment. We expect cash & cash equivalents to increase in FY21e from US$17.5bn to US$29.5bn, from operational cash flows and lower net marketable securities and purchases of equity investments. We also expect PPE & IA to increase significantly, in line with increased capex of US$20bn, up US$5bn YoY.

RISKS

1. Antitrust battle with the US Federal Trade Commission. The FTC and 46 other states in the US filed a court complaint against FB in December 2020, for creating a social-media monopoly through its acquisition of Instagram, WhatsApp and smaller start-ups. The FTC’s ultimate goal is to force FB to unwind these acquisitions. The case is still ongoing.
2. User data and privacy concerns. Concerns over data misuse by FB surfaced in 2018 when the company allegedly sold user data it obtained on its platform to a third-party data analytics firm, Cambridge Analytica, without consent from its users. When the dust settled in 2019, FB had to pay a record US$5bn settlement to the FTC.
3. Changes in third-party privacy settings. In 2Q FY21, Apple rolled out a new feature on its iOS 14 aptly named “App Tracking Transparency”. With this feature, Apple users – many of whom regularly use FB, are given more control and transparency over who they provide their data to and what kind of data is provided. This could be a hurdle for FB as users would be able to restrict significant amounts of data provided to FB – reducing the effectiveness of its targeted advertisement campaigns. To counter this, FB plans to re-engineer algorithms used in its targeted ads to be more efficient using fewer data points.
4. Biden’s corporate tax plan. Another risk for FB is President Biden’s proposed corporate tax rate hike from 21% to 28%. The President is also considering imposing a minimum tax rate of 15% on book income and a minimum 21% tax rate on companies’ foreign earnings to ensure profits in tax havens are taxed appropriately.

VALUATION

We initiate coverage on Facebook Inc. with a BUY rating and a price target of US$424.00. Our valuation is based on DCF valuation, using a 6.7% WACC and 4% terminal growth rate.