Facebook – Middle age spread

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An opportunity lurks under the image of a maturing company. 

  • Facebook continues to show all the hallmarks of becoming a maturing company but I suspect that there is another leg of very rapid growth just waiting to happen.
  • In addition to a difficult set of results, where Facebook admitted that its growth was going to slow down meaningfully in 2017 (see here), Facebook has announced in an SEC filing that it will buy back up to $6bn worth of its shares.
  • This is a classic move that all companies make when they begin to transition from rapid growth into middle age.
  • It is a sign that the company does not know how to invest the money that it has generated to earn a good return for shareholders and so it decides to return the money to them instead.
  • However, there is a big difference between buying back shares and actually returning that money to shareholders.
  • I have long believed that to return money to shareholders a company must also cancel the shares that it purchases.
  • It is only as the total number of diluted shares declines and EPS is enhanced can the money be deemed to have been returned to the shareholder.
  • Most companies in the technology sector do not do this and instead use the shares that they have bought back to cover options programs and restricted stock unit awards.
  • Consequently, although they claim that they are returning cash to shareholders, very few of them actually do and I suspect that Facebook will be just the same.
  • Even, Microsoft, which aggressively buys back shares every quarter, only manages to return around 66% of the money to shareholders with the other 34% being used for share compensation programs.
  • Global leader in this area is Samsung which has promised to cancel every single share that it buys back thereby ensuring 100% of the money goes back to its shareholders.
  • Although this is a classic sign of a maturing company, I think that Facebook still has a trick or two up its sleeve.
  • Today, I calculate that Facebook monetises just 35% of the Digital Life pie but if I include the ecosystem that it is building, I could take this figure to 80%.
  • The problem is that the other assets, and the ecosystem itself, are not yet mature enough to start generating revenue and this is why I see a period of much more modest expansion.
  • Once these assets are mature, then I think Facebook will begin to grow quickly once again creating an opportunity to own the shares once all the bulls have given up hope.
  • Hence, I am keeping a very close eye on Facebook as depending on how its assets develop, there may be a great opportunity to get in during 2017 or 2018.
  • In meantime, I see continued disappointment as straight-line obsessed analysts continue to reduce their short-term (and by default long-term) estimates and rue the end of rapid growth.
  • While I wait, Tencent, Microsoft and Baidu look like good places to camp out.

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