Breaking Down Facebook's Fundamentals Following F8

  • Facebook revealed a lot of promising technologies at the F8 Conference.
  • But given the backdrop of conflicting data points on user engagement, the event was unable to lift the stock price.
  • Furthermore, some of the technologies demonstrated are not going to be monetized by Facebook.

The F8 Conference was full of information, and while I can’t capture everything that Facebook (NASDAQ:FB) presented at the conference - I’ll break down the good, bad and ugly from the conference. Furthermore, the lack of positive investor sentiment following the event can also be explained as well.

4-16-16 FB pic 1Source: Freestockcharts

Like I have mentioned in the past, by no means am I a technical analyst nor do I advocate short-term trading. However, it’s worth noting that following the F8 event on April 12th and 13th, the Facebook stock has declined. The stock is hovering above the 50-day moving average, which provides some technical support. I anticipate that Facebook will pivot from the 50-day moving average and will continue to trend higher going into the earnings announcement on April 22nd 2016.

However, there are concerns with recent data points published by DigiDay, which point to a 20% decline in engagement for Facebook Instant Articles over Q1’16. It’s not yet clear if this data is simply isolated to Instant Articles or if it’s website wide. However, the most recent rationale for why comScore data was weak is that it was due to reporting changes.

Furthermore, Q1 tends to result in some drop-off in web metrics across many publishers, so sustaining sequential growth in engagement is difficult between Q4 and Q1 of any given fiscal year (even if that website is Facebook). Therefore, the drop off in Instant Articles traffic may be tied to seasonality, as web impressions across a lot of media publishers tend to decline in the first quarter of any given fiscal year. Facebook has historically generated sequential user growth despite seasonal factors. It's also worth mentioning that usage growth for mobile internet has slowed with top publishers like Facebook and YouTube slightly outperforming.

Given the weak backdrop of data, the F8 Conference failed to lift the stock price.

Here’s what went well at the F8 Conference

4-16-16 FB pic 2

The company broke down its multi-year roadmap where they plan to develop an application ecosystem around the core FB application. Basically, open up the API (application programmable interface) and encourage further development from third-party programmers to design apps that integrate with Facebook or run natively from the Facebook application. That’s the three-year timeline and is the main priority for the company.

From there you move onto the five-year roadmap, which focuses on application development for adjacent properties like Groups, Messenger, Instagram and WhatsApp. The next five-years remain crucial as investor expectations are heightened, which implies that Facebook needs to have a series of earnings beats to sustain the current valuation.

In a prior article, I provide a forecast on FB Messenger revenue/valuation. I stand by my earlier forecast, as the company disclosed a compelling strategy for monetizing Facebook Messenger and also broke down their vision for Virtual Reality. Facebook’s strategy for monetizing FB Messenger revolves heavily around a new feature/service referred to as “Chat Bots for Messenger.” Facebook uses an advanced AI algorithm that allows developers to integrate customer service, point of sales or mobile applications via a conversational algorithm within FB messenger. Facebook earns a take-rate against transactions via the Bots platform and increases the amount of engagement for 3rd party applications that don’t have conventional sales conversions (service based applications).

Chat Bots integrates with media applications (like CNN), which creates a third-party marketplace for applications without prospective FB users needing to download a separate application. My guess is that Facebook will have two forms of monetization, one for direct sales conversions and a usage based monetization scheme where third-party applications pay Facebook directly for each usage instance via the Messenger Bots platform.

Usage instances make sense because chats bots effectively replace the customer relationship management software thus lowering the cost of servicing customers. So, reducing cost implies more of a platform as a service model (PaaS) as opposed to the conventional ad-monetization scheme that Facebook has built its business around. Chat Bots isn’t only a sales conversion funnel, so the other half of monetization comes from hosting applications messenger platform, which strongly suggests a usage monetization model (similar to Amazon Web Services) or subscription licensing revenue. Since the platform itself revolves around Facebook’s ever evolving AI technologies, I can only imagine Facebook furthering its competitive advantage. As such, this is the single most important takeaway for investors coming out of the event.

The bad stuff from F8

VR was one of the most hotly anticipated technologies, and Facebook tried to pitch the idea of a mainstream experience that brings users into a virtual environment that's more contextual and conversant.

While the current technology is superior to whatever else exists it has yet to hit the critical threshold for becoming a proxy for human communication in a virtual environment. The company mentioned in the Day 2 of its press event that advanced algorithms for recognizing subconscious human gestures are yet to be developed, which reduces the effectiveness of non-verbal communication via VR. The development of inputs that accurately render human movement is a five to ten-year project, so the product is tied to a niche of enthusiast gamers. Furthermore, graphics rendering capabilities

Furthermore, graphics rendering capabilities don't match the output capabilities of  VR headsets. Photorealistic graphics will require a one million times perf/watt improvement according to AMD’s Capsaicin event at GDC this year. With Moore’s law slowing over the past several years we can anticipate VR headsets reaching that key inflection point of photorealism in 10 to 15 years, which diminishes mass market adoption.

The really ugly stuff from F8

F8 excluded any meaningful update on WhatsApp, so we have no way of anticipating the monetization scheme for the "other" messenger application. Facebook already abandoned the annual subscription model. Furthermore, there hasn’t been any new rumblings of advertising API integration into WhatsApp, so we’re left clueless on WhatsApp monetization.

Furthermore, Facebook mentioned that they had developed a lot of new technologies for emerging markets connectivity. The Facebook Lite application was good. But, the development of cutting edge drones that beam down internet via a mobile base station is pretty darn innovative. Why Facebook intends to give this away for free, so telecoms can use the technology “free of charge” is simply absurd. Facebook spent significantly on R&D this year, and if it wanted to buy low-band spectrum in Africa and Asia, it could have done so. So, the over-emphasis on unlicensed spectrum was the ugliest part of the conference as FB could easily become a licensed spectrum operator.

If Facebook has a commercially viable product for becoming an internet service provider (ISP), it should simply become an ISP.  The incremental revenue opportunity is too lucrative to ignore, and since shareholders are footing the bill for R&D, they should get higher returns from this activity rather than the residual effects of more internet users on Facebook branded applications.

Final thoughts

Facebook remains a high conviction buy going into earnings, and I continue to reiterate my $163.21 price target. F8 didn’t contribute to the valuation this year, but that was due to hazy data points not pertaining to the event. I'm optimistic on the positive tailwind effects of various products and services that were announced, as the numerous open field opportunities rapidly expand TAM (total addressable market) assumptions, thus reasserting high growth rates in investor/analyst models.

Alex Cho Alex Cho   on Amigobulls :
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