Management Matters: Facebook And Twitter! by Aswath Damodaran
I am not a big user on social media. I have a Facebook page, which I don’t visit often, never respond to pokes and don’t post on at all. I tweet, but my 820 lifetime tweets pale in comparison to prolific tweeters, who tweet that many times during a month. That said, I have been fascinated with, and have followed, both companies from just prior to their public offerings and not only have learned about the social media business but even more about my limitations in assessing their values. The paths that these companies have taken since their public offerings also offer illustrative examples of how markets assess and miss-assess these companies, why management matters, and the roller coaster ride that investors have to be willing to take, when they make bets on these companies.
In its brief life as a public company, Facebook has acquired a reputation of being a company that not only manages to make money while it grows but is also able to be visionary and pragmatic, at the same time. In its most recent earnings report on January 27, 2016, Facebook delivered its by-now familiar combination of high revenue growth, sky high margins and seeming endless capacity to add to its user base and more importantly, monetize those users:
The market’s reaction to this mostly positive report was positive, with the stock rising 14% in the after market.
[drizzle]I first valued Facebook a few weeks ahead of its IPO and again at the time of its IPO at about $27/share, laughably low, given that the stock is close to $100 today, but reflecting the concerns that I had on four fronts: whether it could keep user growth going, given that it was already at a billion users then, whether it could make the shift to mobile, as users shifted from computers to mobile phones and tablets, whether it could scale up its online advertising revenues and whether it could continue to earn its high margins in a business fraught with competition. The company, through the first four years of its existence has emphatically answered these questions. It has managed to increase its user base from huge to gargantuan, it has made a successful transition to mobile, perhaps even better than Google has, and it has been able to keep its unusual combination of revenue growth and sky-high margins. Prior to the prior year’s last earnings report, in November 2015, I was already seeing Facebook as potentially the winner in the online advertising battle with Google and capable of not only commanding a hundred billion in revenues in ten years but with even higher margins than Google. The value per share of almost $80/share, that I estimated for the company in November 2015, reflects the steady rise that I have reported in my intrinsic value estimates for the company over the last five years. If anything, the story is reinforced after the earnings report, with revenue growth coming in at about 44% and an operating margin of 51.36%.
The value per share that I get for the company, with this narrative, is about $95/share, just a little bit under the $102/share that the stock was trading at in February 2016. As with my other valuations in this series, I ran a simulation of Facebook’s value and the results are below:
At the prevailing price of $102/share, the stock was close to fairly priced on February 12, at least based on my inputs.
I am sure that there will be others who will put Facebook under a microscope to find its formula for success, but there are two actions that are illustrative of the company’s mindset. The first was its afore-mentioned conquest of the mobile market, where it badly lagged its competitors at the time of it IPO. Rather than find excuses for its poor performance, the company went back to the drawing board and created a mobile version which not only improved user experience but provided a platform for ad revenues. The second was the company’s acquisition of Whatsapp, an acquisition that cost the company more than $20 billion and provoked a great deal of head scratching among value minded people at time, since Whatsapp had little in revenues and no earnings at the time. I argued at the time that the acquisition made sense from a pricing perspective, since Facebook was buying 450 million Whatsapp users for about $40/user, when the market was pricing these users at $100/user. That acquisition may have been driven by pricing motivations but it has yielded a value windfall for the company, especially in Asia and Latin America, with more than 100 million Whatsapp users just in India.
It is true that Facebook’s latest venture in India, Free Basics, where it had partnered with an Indian telecom firms to offer free but restricted internet service, has been blocked by the Indian government, but it is more akin to a bump in the road than a major car wreck. At the risk of rushing in where others have been burned for their comments, I am cynical enough to see both sides of the action. Much as Facebook would like to claim altruistic motives for the proposal, the restriction that the free internet use would allow you access only to the portion of the online space controlled by Facebook makes me think otherwise. As for those who opposed Free Basics, likening Facebook’s plans to colonial expansion is an over reach. In my view, the problem with the Indian government for most of the last few decades is not that it’s actions are driven by knee jerk anti-colonialism, but that it behaves like a paternalistic, absentee father, insisting to its people that it will take care of necessities (roads, sewers, water, power and now, broadband), while being missing, when action is needed.
On a personal note, I was lucky to be able to buy Facebook a few months after it went public at $18, but before you ascribe market timing genius to me, I sold the stock at $45. At the time, Tom Gardner, co-founder of Motley Fool and a person that I have much respect for, commented on my valuation (on this blog) and suggested that I was under estimating both Facebook’s potential and its management. He was right, I was wrong, but I have no regrets!
If Facebook is evidence that you can convert a large social media base into a business platform to deliver advertising and more, Twitter is the cautionary note on the difficulties of doing so. Its most recent earnings report on February 10, 2016, continued a recent string of disappointing news stories about the company:
The market reacted badly to the stagnant user base (though 320 million users is still a large number) and Twitter’s stock price hit an all time low at $14.31, right after the