Date: 12/23/2018

Facebook, Inc. (NSDQ: FB)

$ 124.95

Data Overview Summary

Target Price $149.5  Facebook’s top line continues its upward trend during 2018 because of strong
Potential Upside/Downside 20%
advertising revenue, in particular, from mobile ads. In addition, average revenue
per user (“ARPU”) also increased during 2018, demonstrating the value that
52 Week High-Low $218.62 - $123.42
advertisers see in using Facebook’s advertising services.
Beta (5-year monthly) 0.65
Market Capitalization $359 billion  Despite the ongoing negative news that continues to surround Facebook and its
Dividend Yield N/A
handling of data privacy, we are confident about the firm’s ability to maintain its
long-term competitive advantage and remain one of the top players in the digital
Industry Online Services
advertising space
Price/Earnings (P/E) 16.9x
Price/Book (P/B) 4.5x  On the basis of user and user engagement figures throughout 2018 as well as ARPU
Price/Cash Flow (P/CF) 12.24x figures, the potential for further platforms monetization, and Facebook’s efforts
to address data privacy and security issues, we think the stock is an attractive
EV/EBITDA 11.20x
investment as it is now trading at nearly 20% discount to our baseline estimate
Earnings Yield 5.9%

Abbreviated Financials
Income Statement (USD MIL) FY2017 FY2016
Revenue 40,653 27,638
Gross Income 35,198 23,848
EBITDA 23,227 14,754
EBIT 20,202 12,412
Pretax Income 20,594 12,501
Net Income 15,934 10,200
Common Shares 2,905 2,887

Balance Sheet (USD MIL) FY2017 FY2016

Cash & Cash Equivalents 41,441 29,449
Fixed Assets 13,721 8,591
Total Assets 84,524 64,961
Current Liabilities 3,760 2,875
LT Debt 0 0
Total Liabilities 10,177 5,767
Total Shareholders’ Equity 74,347 59,194

Cash Flow Statement (USD MIL) FY2017 FY2016

Net Income 15,934 10,200
Cash From Operations 24,216 16,108
Capital Expenditures 6,855 4,614
Cash From Investments (20,038) (11,739)
Cash Dividends Paid - -
Cash From Financing (5,235) (310)

Consensus Recommendation Author

▼
██████████████████ Glen Borg
Sell Strong Buy Equity Research Analyst
# of Analysts: 50 Contact Number: +356 99747380
Upgrades Last 30 Days: 3 Email: [email protected]
Downgrades Last 30 Days: 0 LinkedIn: linkedin.com/in/glenborg/

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Company Overview
Facebook, Inc. (“Facebook”) is focused on building products that enable people to connect, share, discover and communicate with each other through multiple devices.
The company’s products include Facebook, Instagram, Messenger, WhatsApp and Oculus.

 Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are
a number of different ways to engage with people on Facebook, the most important of which is News Feed which displays an algorithmically-ranked series
of stories and advertisements personalized for each person.

 Instagram. Instagram is a community for sharing visual stories through photos, videos, and direct messages. Instagram is also a place for people to stay
connected with the interests and communities that they care about.

 Messenger. Messenger is a messaging application that makes it easy for people to connect with other people, groups and businesses across a variety of
platforms and devices.

 WhatsApp. WhatsApp is a fast, simple, and reliable messaging application that is used by people around the world to connect securely and privately.

 Oculus. The Oculus virtual reality technology and content platform power products that allow people to enter a completely immersive and interactive
environment to train, learn, play games, consume content, and connect with others.

Facebook generates the majority (approximately 95%) of its revenue from selling advertising placements to marketers which enables them to reach people based on
a variety of factors including age, gender, location, interests, and behaviors. Accordingly, marketers purchase ads that can appear in multiple places including Facebook,
Instagram, Messenger, as well as third-party applications and websites. The balance is generated from a circa 30% fee charge on the proceeds earned by developers
from the sale of in-game virtual and digital goods.

In 2017, Facebook generated $40.6 billion in revenue, an increase of 47.1% over the 2016 figure of $26.3 billion. Advertisement accounted for 98.3% of total revenue
with over 2.2 billion in monthly active users (“MAUs”).

Reasons to Buy
I. Potential turnaround. The continuously barrage of recent negative headlines combined with a major sell off in the stock market, set the stock to fall by
more than 40% from its all-time high in mid-2018. Consequently, the stock is likely to end the year with a negative return for the first time since the IPO.
In our view, once all this bad news is out of the way, we believe Facebook is in a position to recover and resume its growth trend, especially when it’s still
running the world’s most popular social platforms. As such, we remain confident about the firm’s ability to maintain its competitive advantage and to
remain one of the top players in the digital advertising space. Hence, we view the current situation as an attractive opportunity to invest in the stock.

II. Dominant position as a social platform. With more users and usage time than any other social network, Facebook provides the largest audience and the
most valuable data for online advertising. The company was able to gain a first mover advantage and was able to attain a high level of penetration in
developed economies. Despite the increasing competition from new social network startups, we believe that users are not likely to switch platforms or
rather, spend more time on other platforms since most users already belong to more than one social network. This durable competitive advantage supports
the relatively high profitability margins. In addition, continuous investment in connectivity infrastructure in developing economies, also known as the basic
initiative scheme should enable the company to sustain a healthy growth rate in total MAUs and generate additional revenue in the medium to long term.

III. Continuously finding opportunities on monetizing its platforms. Facebook is intensively working on monetizing its existing platforms. For instance, chatbots
and “conversational commerce” are likely to be the strategies for Messenger and WhatsApp that would enable businesses to extend customer service and
other transactions. In addition, Facebook is also working on digital advertising, such as online video advertising which generate higher ad revenues than
typical existing advertising. Accordingly, we believe that Facebook, through all its subsidiaries, has great opportunities to increase advertising through its
existing platforms.

IV. Investments in AR/VR. The application of Augmented Reality and Virtual Reality technology to Facebook’s various offerings, along with the launch of VR
products such as Oculus Rift, ought to increase user engagement, driving further growth in advertising revenue.

V. Strong fundamentals. With the large amount of cash and cash equivalents, along with no debt, Facebook is well positioned to make additional investments
in the form of acquisitions or more research and development. In this regard, we expect the firm to continue to make decisions in relation to capital
allocation that are beneficial for its social network users and its shareholders.

VI. Business advertising is becoming more popular. Facebook’s advertising revenue per user is growing, a clear indication of the value that advertisers see in
working with Facebook. Latest figures show that 90 million business use Facebook to reach customers for free and another 6 million businesses are actively
advertising across FB, Instagram and other services.

Reasons to Sell
I. Growth limitations. In light of high penetration in developed economies, further growth in users in these regions are to a certain degree, limited. On the
other hand, Facebook has significant growth opportunities in emerging economies, most especially in South-East Asia and Africa. Although Facebooks
intentions to develop and invest in connectivity infrastructure in these regions, low internet penetration in these regions may negatively affect its
expansion. In addition, while the social network platform can be accessed in Hong Kong, its usage is restricted in mainland China due to Government
restrictions. Moreover, despite the company being able to increase user growth in the developing economies, ARPU in these regions is significantly low
when compared to ARPU in developed economies.

II. Increase in costs. Recent headlines in relation to data scandals has significantly sqeezed profitability margins as the company embarked on a hirign spree
(total employees increased from approximately 25,105 at the beginning of 2018 to 33,606 as of 30 September 2018) largely because of safety and security
reasons.
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 III. Regulation uncertainties. Regulation could emerge that limit the application by means of collection of users data, and usage of user data, which in turn,
would have a material negative affect on the company’s financial performance.

IV. Other disruptive technologies. The likelihood of an new innovative technology luring away users from its social networking platforms remains a potential
risk. Having said that, we do not expect competition to be in the form of a substitute for Facebook, but rather another form of application which could
decrease user engagmenet in the form of usage hours per day. Consequently, this would reduce the return on investment for advertisers which would in
turn, have a negative impact on Facebook’s top and bottom line.

Ratio Analysis
Profitability Ratios Industry Median FY2016 FY2017 % Change
Gross Margin (Gross Profit/ Revenue) 79.7% 86.3% 86.6% 0.3%
EBITDA Margin (EBITDA/ Revenue) 15.2% 53.4% 57.1% 6.9%
Operating Margin (EBIT/ Revenue) 8.0% 44.9% 49.7% 10.7%
Net Margin (Net Income/ Revenue) 5.3% 36.9% 44.8% 21.4%
Return on Assets (Net Income/ Average Assets) 5.7% 17.8% 24.4% 37.1%
Return on Equity (Net Income/ Average Equity) 7.8% 19.7% 27.3% 38.6%
Asset Turnover Ratio (Revenue/ Total Assets) 0.64x 0.43x 0.48x 11.6%

Liquidity Ratios Industry Median FY2016 FY2017 % Change

2.7x 12.0x 12.9x 7.5%
Current Ratio (Current Assets/ Current Liabilities)
2.7x 12.0x 12.9x 7.5%
Quick Ratio ((Current Assets – Inventories )/ Current Liabilities)
- 10.2x 11.0x 7.8%
Cash Ratio (Cash & Cash Equivalents/ Current Liabilities)
- 801.7x 843.7x 5.2%
Defensive Interval Ratio ((Cash + Receivables)/Daily Cash Expense)

Solvency Ratios Industry Median FY2016 FY2017 % Change

2.8% 0.0% 0.0% -
Gearing Ratio (Total Debt/ (Total Debt + Total Equity))
0.0x 0.0x 0.0x -
Net Debt to EBITDA (Net Debt/ EBITDA)
2.7% 0.0x 0.0x -
Debt to Asset Ratio (Total Debt/ Total Assets)
1.5x 1.1x 1.1x -
Financial Leverage Ratio (Total Assets/ Total Equity)
- - - -
Interest Coverage Ratio (EBITDA/ Interest Expense)

Efficiency Ratios Industry Median FY2016 FY2017 % Change

Inventory Turnover Ratio (Cost of Sales/ Average Inventories) - - - -
Days of inventory on hand (DOH) - - - -
Receivables Turnover Ratio (Revenue/ Average Receivables) 8.3x 8.4x 8.3x -1.2%
Days of sales outstanding (DSO) 44.1x 43.4x 44.2x 1.8%
Payables Turnover Ratio (Cost of Sales/ Average Trade Payables) 3.5x 7.6x 8.0x 11.1%
Number of days of payables 105.0x 48.1x 45.4x 5.3%
Working Capital to Sales Growth (Working Capital/ Revenue Growth) 2.9% 4.3% 1.2%% -

Valuation Hypothesis
Our model baseline price stands at $149.5, 19.6% higher than the current price of $124.95 (as of 21 December 2018). The model price is calculated using a 10 year
Discounted Cash Flow approach using a weighted average cost of capital (WACC) of 5.63% increasing up to 8.4% by the end of year 10 and a terminal growth rate of
the Free Cash Flow to the Firm of 1.0%.

Our model assumes revenue to grow at a CAGR of 17.0% over the next 5 years, and marginally dropping down to 1.0% after year 10. In addition, operating margins
are expected to decline significantly over the next 5 years to 30%, reflecting higher costs as previously mentioned and to stabilize thereafter.

Revenue
The two main determining factors of revenue are MAUs and ARPU.

In terms of user growth, we expect MAUs to keep growing in all four regions, although on diverse scales.

 US & Canada - This region is highly saturated with MAUs as a percentage of population currently at 66.1%. We expect this to marginally increase to nearly
68.0% by the end of year 10. The main reason why we expect MAUs to increase marginally is largely because of demographic changes. (approximately 25
million new users over the next 10 years)

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  Europe – This region is also highly saturated. MAUs as a percentage of population currently at 50.7%. Accordingly, we see more room for growth in the
euro area when compared to the US & Canada region. Our baseline model incorporates MAUs as a percentage of population in Europe to reach up to
55.0% by the end of year 10. (approximately 30 million new users over the next 10 years)

 Asia-Pacific – This region is expected to record the highest level of MAU growth, however, growth is still limited due to the inability to enter into China due
to legal reasons. Presently, MAUs as a percentage of population stands at approximately 20.0% and we expect this to reach nearly 33.0% by the end of
year 10. (approximately 600 million new users over the next 10 years)

 Rest of the World - Growth in other countries is also expected to increase significantly as more individuals gain access to internet connection. However, we
expect growth in this region to be less than that in Asia-Pacific. Presently, MAUs as a percentage of population stands at approximately 29.5% and we
expect this to reach nearly 43.0% by the end of year 10. (approximately 440 million new users over the next 10 years)

ARPU has increased significantly at a CAGR of 29.5% over the past 5 years to $24.5. We are confident that Facebook can sustain further growth in ARPU because of
the durable competitive advantage it enjoys. Having said that, we expect ARPU growth rate to slow down considerably when compared to recent growth rates. This
is largely because the highest expected increase in users is in the Asia-Pacific and RoW regions, which both generate a lower level of ARPU when compared to the US
& Canada and Europe regions. Our baseline model assumes ARPU to grow at a CAGR of 10.0% over the next 5 years and to just below 2.0% over the remaining 5 year
period.

Operating Margins
In 2017, operating margins stood at 49.7%, an increase of 4.8% over the previous year (FY2016: 44.9%). The cause for this improvement is largely due to benefits of
economies of scale as top-line growth can be sustained with a relatively lower growth in costs. However, due to the major developments that occurred in 2018 in
relation to data protection, the company’s capital expenditure and costs related to safety, security, and transparency have materially increased during 2018 which in
turn, dented profitability margins.

Consequently, in 2018 we expect operating margins to decrease to 38.0%, from 49.7% in 2017. Going forward, we believe that operating margins will decline further
over the next 5 years to around 30%, largely reflecting additional related costs and to stabilize thereafter.

Tax Rate
We use an effective tax rate of 20% in year 1, further increasing to 25% by the end of year 10 as it converges to a global tax rate.

Valuation
The price estimate distribution illustrated below supports the substance of our buy recommendation. We run a Monte Carlo Simulation with 100,000 iterations to
generate potential future scenarios according to our assumptions (potential deviations from our baseline scenario). The current price of $124.95 is below our baseline
scenario price estimate of $149.50 by nearly 20%. Our baseline scenario is positioned approximately at the first quartile whilst the current price stand below the first
decile of all possible outcomes. Consequently, Facebook’s intrinsic value is likely to be above the current market price of $124.95 at a probability of 90%, given the
range of possibilities used in our assumptions. As a result we have a strong level of confidence to issue a buy recommendation on the stock.

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Disclosures
The analysts contributing to this report holds shares of this stock. The revenue and stock price forecasts are the Gorilla’s Investment Research (GIR) consensus estimates.
Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts' personal views as to the subject securities
and issuers. GIR certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed
by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from
sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not
be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to
be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. GIR may have a position long or short in the securities mentioned
and buy or sell the securities from time to time. GIR uses the following rating system for the securities it covers which results from a proprietary quantitative model
using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 24 months. The model assigns
each stock a rank from 1 through 5. GIR Rank 1 = Strong Buy. GIR Rank 2 = Buy. GIR Rank 3 = Hold. GIR Rank 4 = Sell. GIR Rank 5 = Strong Sell.