Monday, February 24, 2014

Facebook to Pay $19 Billion for WhatsApp- 02/26/2014


  1. Sources: Company 10K and 10Q, seeking alpha,
    Reference items: Rev 7.9 B, OCF 4.2 B, FCF 2.9 B.
    3 main operating segments,
    Text& display Ads 88.7%, generated from third party advertising, Transactions of virtual goods 10.2%, generated from end users, social commerce, 1.07% This segment enables retailers to sell products directly on FB.

    Rev by user geography US& Canada 47%, Europe 28%, 13%,
    Total daily active users 757 M, 25% annual growth rate over the past two years: US& Canada 19%, Europe 26%, Asia 26%, Rest of world 29%. DAUS is about 60% of MAUS, so MAUs are 1228 M.
    Avg Rev per users: World wide $2.14, Highest in US& Canada ($6.03), lowest in Asia and rest of world ($.95& $.84).
    TWTR Rev/User $1.01, LNKD Rev/User $1.97. Forward P/E ratio FB 39x, TWTR 252x, LNKD 82x.
    Expenses as a % of Rev,SG&A 21% Cost of Rev 19%, R&D 16%, Operating margin 44% in Q4'13
    In summary, FB has higher total rev, rev and profitability ratio than its competitors, and it is trading at a discount based on relative valuation.

    FCF was 2.9 B in FY 2013,
    1. FB didn't pay out dividends
    2. Debt/ total Capital was .3%, FB didn't pay off debt either.
    3. Spent 1.4 B, 48% of FCF in purchases of PPE.
    4. 368 M, 13% in acquisition of business.
    5. Reinvest in growth initiatives

    Risks with Rev
    - The size and composition of FB user base and the engagement of FB users: Competition from full-featured products such as Google+, and regional social networks, (such as Mixi in Japan, vKnotakta and Odnoklassniki in Russia). Companies that develop applications to engage users and traditional and online business that provide markets services to marketers.
    - Regulations: some countries' regulation might restrict FB, and changes in privacy laws could limit FB's potential gain on users increasing engagement.

    Risks with NI and FCF
    - Cost are growing, broadening the user bases and selling ADs to them are becoming increasing costly; net income will be adversely impacted. And as users increase the number of connections and amount of data they share, FB has to invest in infrastructure to keep up with users' needs. Increases in CapEx will decrease FCF.

    Acquisition of Whatsapp
    - FB acquired a popular messaging platform Whatsapp at 19 B. Currently, Whatsapp processes more than 50 B msgs per day and its user base is 450 M. FB paid $42 per user to acquire the company, and Whatsapp generates nominal cash flows of $1 a user per year. (Not all 450 pays this fee, the subscription starts after 1 year of use, and Whatsapp didn't disclose that information). Whatsapp grows very fast; it adds 1 million new users each day.
    - Whatsapp has a high penetration in emerging markets such as China and India. This acquisitions added new users from which FB has low market shares.

  2. --Segments:
    Ads: 89% of revenue
    Payment and other fees: 11%
    --Geographic segments
    US&Canada: 47%, Europe: 28%, Asia: 13%, Rest of world: 12%

    --Market share: global internet advertising rev in 2013:
    Google: 50%, Facebook: 7%, Yahoo: 5%

    Gross margin: 76%, Operating margin: 36%, Net profit margin: 19%
    Gross margin industry avg: 67%, Yelp: 93%, Yahoo: 89%, Linkedin: 87%, Google: 57%, Baidu: 71%

    11% in 2013, 0.4% in 2012, Industry avg: 20%, GOOG: 16%, Linkedin: 2%, Baidu: 36%

    36% in 2013, 7% in 2012, 25% in 2011
    68% in 2013, 23% in 2012, 61% in 2011
    --Use of FCF:
    No dividend and share repurchase
    CapEx: 1.24 billion (43% of FCF) related to the purchase of servers, network infrastructure, and the construction of data centers
    Acquisition: 911 million (32% of FCF) for the acquisition of businesses and other assets, such as patents.
    Payback debt: 1500 million (52% of FCF)

    Marketers and advertisers
    Users to purchase virtual and digital goods from developers with applications on the Facebook website
    (FB had 757 million daily active users (DAUs) on average in December 2013 , an increase of 22% compared to December 2012 . MAU: 1.2 billion, increase 16% from 2012)

    --What could go wrong?
    Rev: If the user growth rate decline or users decline and advertisers on FB decrease, their revenues may get threatened.
    (According to a Princeton study, Facebook will lose 80% of its users by 2017.)
    FCF: spend large amount of cash on acquisition.

    WhatsApp deal: 19 billion includes: 4 billion in cash, about USD 12 billion worth of Facebook shares. The whatsapp's founders and employees will be granted restricted stock worth $3 billion that will vest over four years after the deal closes.
    Whatsapp has 450 million monthly users, 70 percent of whom use it every day and more than one million new registered users per day.
    Facebook is paying $42 per WhatsApp user in the deal.

  3. Sources:
    - 2013 10-K
    - Bloomberg terminal
    - Seekingalpha
    - Morningstar
    Business Overview:
    Facebook is an online social networking service that helps in creating and fostering social networks through its web-based portal. It has two revenue segments:
    - Advertising: 89% of annual revenue in 2013.
    - Payments and other fees: 11% of annual revenue in 2013
    Largest segment: Advertising: revenue is generated by displaying ad products on the Facebook website or mobile application and third-party affiliated websites or mobile applications. Marketers pay for ad products based on the number of clicks made by users, the number of actions taken by users or the number of impressions delivered.
    - Desktop advertising revenue: 55% of total advertising revenue in 2013 V.S. 89% in 2012
    - Mobile advertising revenue : 45% of total advertising revenue in 2013 V.S. 11% in 2012

    - Main customers that contribute most to the revenue are marketers, including brand marketers, direct marketers, small and medium-sized businesses, and developers, who purchase ads from Facebook to market themselves.
    - Developers who use Facebook Payments infrastructure to sell virtual and digital goods

    Financial Overview:
    - FCF: 2.86 billion in 2013. Increased from 2008 to 2011, dropped in 2012 because of a reduction of $451 million of income tax refundable from income tax loss carrybacks, which was refunded in 2013.
    • FCF % of Rev: 36.33% in 2013; 7.41% in 2012, 25.41% in 2011, 20.52% in 2010
    • FCF % of OCF: 68% in 2013, 23% in 2012, 61% in 2011,58% in 2010
    • Use of Cash:
    o No Dividends and share repurchase
    o Debt repayment: 66% of FCF, increased significantly from 2010
    o Merge & Acquisition: 13% of FCF, 9 M&A activities in 2013
    o Capital Expenditure: 48% of FCF, Facebook intend to retain any future earnings to finance the operation and expansion of our business
    - Margin: 76% compared to industry profit margin of 67%. Maintained its gross margin over 71% in the last 5 years
    - ROE: 11% vs. industry average 20%, ROA: 9% vs. industry average 13%. Decreased from 2011 because of increase in assets and total equity.
    - D/E: 0.02, dropped from 0.17 in 2012

    What can go wrong?
    - Revenue:
    • Rev growth rate decrease as size of active user base increase
    • Increasing competition may shrink Facebook’s revenue and market share. Major Desktop ad revenue competitor: Google; major mobile ad rev competitor: Twitter.
    • Regulation in international market (China) limit its revenue growth
    - Expenses:
    • Expanses may increase faster than rev as user base increases. Expenses increase will be in particular for servers, storage, power, and data centers, to support anticipated future growth.
    • Expenses may increase as Fb want to retain employees from acquired companies
    • May incur large expenses to handle privacy issues in the future
    • Patent lawsuits, other intellectual property rights claims and numerous class action lawsuits and other litigation matters may result in huge expenses
    - FCF: ambitious acquisition may put pressure on FCF and increase its debt position accordingly

    Facebook Acquire WhatsApp deal
    - Announced to acquire WhatsApp for $16B, including $4B in cash and $12B of Facebook stock
    - Strengthen its mobile messaging service, highlighted focus of Facebook and closer to its core mission of connecting the world

  4. Facebook Annual Report 2013
    Seeking Alpha
    S&P Capital
    Morning Star

    2 Business Segments (Revenue % Revenue Growth%) Fiscal year 2013
    Advertising (89% of 2013 revenues, 63%)
    Payments and other Fees (11%, 9%)

    CORE BUSINESS - Advertising
    - FY 2013, Advertising revenue increased 63% including Desktop and Mobile Advertising
    - For the year ended December 31, 2013, revenue increased 55% to $7.8 billion.
    - Increasing the ad load for the News Feed was an important driver of Facebook’s ad revenue growth in 2013
    - For Advertising Segment: The main customers are companies who post ads on Facebook
    - For Payment and other fees segment: It is the register users who downloading app, upgrade accounts, etc.
    - MAU & DAU:
    Free Cash Flow: Strong balance sheet and generates significant cash flow
    - FCF in FY 2013 $2 .8 billion increase 6 times from 2012
    - FCF/OCF 68% in 2013 there are 44% decrease from 2012
    - FCF/Revenue 36% in 2013 there are 29% iccrease from 2012
    - Use of FCF:
    1. M&A (12%): The company spent $363.0 million on acquisitions in 2013.
    2. Reinvestment (21%): Invest in expanding and enhancing its technologies and offerings, network infrastructure, and the construction of data centers
    3. Pay down debt (50%): pay down its $1.5 billion for repayment of debt

    Operating Margin: 35.62% (2013) 47% (2011)
    Net profit Margin: 18.94% (2013) 18% (2011)
    - ROE: 10%; ROA: 9%. Significant increase from 2012

    - Strong global brands, substantial user bases, high levels of engagement
    - Software developments
    - Growth opportunities from increasing online and mobile advertising spending
    - Strategic Acquisitions
    - Strong balance sheet and cash flow
    CON (What could go wrong)
    - Fatigue particularly among teenagers
    - Low Internet penetration rate in emerging market
    - Increasing scrutiny by regulators
    - Total expenses are expected to increase app
    - High capital expenditure/ M&A and high revenue volatility
    Acquisition of WhatsApp Adds
    - Focus Messaging
    - Gain user bases: WhatsApp has over 450M MAUs and ~70% are active daily. WhatsApp (19B+ messages/day)