A few weeks ago, my good friend Saurabh Madaan (a former Googler who now works at Markel with Tom Gayner) invited me to come to Richmond to chat about a few investing ideas with Mr. Gayner and a few other “Markelers” (if there are Googlers, why can’t there be Markelers?)
We talked about some of the large cap tech companies here in the US (specifically Google and Facebook) as well as a few of the large cap Chinese tech companies (specifically JD.com and Tencent).
Here are the slides from my talk: Discussion at Markel. (Note: some of these slides were from previous work I’ve done, and thus a few slides have some outdated numbers, as the main point of what I wanted to convey was more conceptual).
Matt and I have discussed all four of these companies, and I happen to own all four. This week, Tencent announced earnings, and because of market conditions and partly due to the news that Naspers is selling a small chunk (relatively small considering their stake, but $10 billion is still $10 billion!), the stock dropped a significant amount. I thought the earnings were solid, although I don’t put much weight on quarterly results. I also think the fact that Naspers wants to sell a small portion of their stake is completely irrelevant (it has nothing to do with the intrinsic value of Tencent). They reduced their stake from 33% to around 31%, probably due to the desire to raise cash to support some of their other venture investments or possible new investments. But regardless, it has nothing to do with Tencent, and yet the stock dropped 10% and erased around $50 billion of market value. I added a small amount to my position on Thursday.
Facebook was certainly the most widely talked about company this week, and some of the regulatory risks that the company faces have come to the forefront. I’ve spent a lot of time in the past week really observing behavior on the site, and among users. My general thought is that if you get outside of the media world and the finance world, the vast majority of people not only don’t really care, but don’t even know about the situation that unfolded this week. I’d venture a guess that if you surveyed 20 people at a random Kroger in Peoria, Illinois (or any other location that’s outside of NYC or SF), 19 of them would have no idea what Cambridge Analytica is.
Now, this doesn’t mean they haven’t heard some news about privacy concerns, and certainly lots of users are aware of the Russian trolls, but in general, I don’t think most users generally care too much. I have heard a lot of people talking about how they have felt manipulated by various advertisements and fake news, but I have yet to have any user explain to me specifically how their data has been used against them. I think the Russians certainly achieved their objective in sowing discord, but I’m not sure how much damage was done with respect to data breaches. I think much of this is manufactured anger over the election of Trump, and Facebook has been an easy scapegoat. The stock price would indicate otherwise, and there have been some that have #deletedfacebook, but again, I think they are very few and far between. In fact, I’ve seen numerous comments about deleting Facebook on the actual platform itself, (some in the comment sections of Zuckerberg’s or Sandberg’s posts this week), but I notice these same commenters still happen to be posting on the platform days later on other topics. A network effect is very powerful, and it’s one thing for Elon Musk to delete his SpaceX page (that he apparently didn’t know existed). It’s another for a common user to delete his or her page, knowing that they’ll be missing all of the engagement from their other friends and family (who likely haven’t deleted their pages).
Matt has used this analogy in a discussion with me, and I think it’s a good one: Facebook itself is in some ways like TV. No one wants to admit they watch 4 hours a day, but yet the average time spent watching TV is four hours a day. Facebook has gotten to where many people don’t want to admit being on it for an hour a day, but yet they still spend that time on the platform. I’m not sure if this is ideal though (you’d rather have users want to admit that they spend time on the platform). However, I think Instagram has a much more positive feel, and users seem much more positive about their own time spent on that platform, which is growing in both MAU’s and revenue. And of course, WhatsApp has over a billion users, and Facebook hasn’t yet begun to monetize that network.
In short, I think the fear that users will flee the platform is overblown.
However, I do think there are risks to Facebook. I own the stock, and it’s a small position (but I am considering adding to it this week). I think the biggest risk is that ad regulation (or Facebook’s own self-regulation) increases privacy by reducing the data that is shared with advertisers, but in the process lowers the ability of the advertisers to target users with the same precision. If the ads aren’t as effective, they’ll earn lower ROI’s. And if they earn lower ROI’s, then obviously they are worth less and Facebook’s pricing power will decline (along with its revenue growth).
I think this is a real risk. But I also think the market is pricing a lot of this in. It’s hard to be specific about this, but I think the stock is incredibly cheap for a business that has a 57% operating margin and grew its bottom line profits by over 60% last year. Facebook will earn somewhere between $7 and $8 per share this year, and so the P/E multiple on this year’s earnings has fallen all the way to near 20. Facebook also has $15 of net cash on the balance sheet. The stock has never been as cheap as it is now in terms of price relative to earnings. A simple glance at the historical valuation relative to Facebook’s history was put together by Barron’s this weekend:
A 5% earnings yield does seem really cheap for a business that still is growing fast, especially when you consider the average high-quality blue chip company in the S&P 500 that has a similar valuation but has far slower growth, worse returns on capital, and likely a lesser moat as well.
But, there is another risk in addition to lower ad effectiveness. In addition to potentially slower top-line growth from advertisers who become more cautious, there is potential margin pressure as Facebook beefs up its security and investments in user protection and other safeguards. Zuckerberg mentioned hiring 15,000 additional employees for security alone. That is a quite shocking amount of people for a company that has 25,000 employees in total. But on the other hand, it also means he’s serious about the issues at hand. In general, this is another reason I like the company so much. I think Zuckerberg, despite the awkward interviews, is very sharp, and very much focused on the long-term. I also believe that he genuinely cares about the users, and about the integrity and long-term viability of the platform. They’ve made some mistakes, but I think they have proven to be a management team that is flexible, and will adapt and pivot when need be.
Overall, I think the risk reward is really interesting at this price, and I think the company is likely undervalued, potentially by a wide margin.
I already have a small position, but I am considering buying more (I’m weighing it against other positions already in the portfolio, as well as some other ideas that I’m working on that could become interesting should the general market continue to fall).
Have a great week!
John Huber is the portfolio manager of Saber Capital Management, LLC, an investment firm that manages separate accounts for clients. Saber employs a value investing strategy with a primary goal of patiently compounding capital for the long-term.
John can be reached at email@example.com.