Facebook F8 – Cash crusade.

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Where the connection crusade goes, the cash machine will follow.

• Facebook made it very clear at its developer conference that it will stop at nothing to ensure that everyone is able to share anything with anyone.
• The net result of more connections, more sharing and more time spent with Facebook, will be a substantial increase in the revenue opportunity but of this, there was no mention.
• To date, Facebook has been ruthlessly efficient at making the most of its revenue opportunity and, with Sheryl Sandberg running the cash machine, I am confident that this will continue.
• RFM estimates that Facebook’s opportunity is currently around $24bn in annual revenues but if its strategies are successful, this should grow to more than $40bn.

At its developer conference Facebook did 3 things:

First: Demonstrated ecosystem understanding.

• In laying out the 10 year roadmap, Facebook clearly demonstrated that it has understood and embraced the importance of the ecosystem.
• Today, Facebook is effectively a two trick pony with social networking and instant messaging.
• All of its announcements from messaging bots to open source infrastructure and internet.org are squarely aimed at driving traffic to its servers.
• It has also realised that there is an exponential relationship between how much time users spend in within its servers and how much value it can derive from it.
• I think that the lack of integration between Messenger and WhatsApp is still a major problem because without it, Facebook is unlikely to really be able to monetise WhatsApp to its fullest extent.
• In addition to clearly moving to increase its coverage of the Digital Life pie, Facebook is also building all of the software infrastructure that is needed for its services to run completely independently.
• For emerging markets this is very important as Google is rapidly becoming its No.1 competitor and currently, most of Facebook’s apps are dependent on Google system services.
• Facebook cannot possibly keep this dependency and still expect to be able to maximise its opportunity in emerging markets.

Second: Declared war on hardware.

• Facebook clearly sees the cost of hardware as a hindrance in both bringing a large part of the 4.1bn offline people online for the first time and in driving usage.
• Consequently, it is on a mission to bring the cost of hardware down such that its services become accessible to many more users.
• This is why it has announced products in telco infrastructure, last mile access and a professional grade, high resolution 360 camera that shoots 3D at 60 frames per second with 8K to each eye.
• However, Facebook does not intend to make any of these products but instead will be open sourcing the designs and the software for anyone who wants them.
• Even if these products never make it to market, it will give telecom operators and content creators leverage when it comes to price negotiations.
• Facebook is hoping that some of these savings will be passed onto users in the form of lower tariffs, enabling more to get online with the result of more traffic arriving at its servers.
• Facebook has no need to do this in smartphones as Google and the Chinese have already done its work for it.
• The net result will be gross margin pressure for the traditional hardware vendors, as from Facebook’s perspective, it makes long term business sense to give away what hardware companies view as their most closely guarded secrets.
• I suspect that the Oculus Rift will also end up as an open source design available to anyone in time.
• To put it mildly, this is bad news for Ericsson, Huawei, Cisco, Nokia and so on.

Third: Put itself firmly in China’s footsteps.

• The direction in which Facebook is taking Messenger is a clear imitation of Weixin (Tencent), LINE and Daum Kakao instant message products which have become go to places to access a huge range of services.
• Usage of mobile devices in China is far more advanced than it is in the West, and consequently it serves as an excellent model for a Western Ecosystem going forward.
• Enabling businesses to develop bots to interact with users and making it easier to access O2O (offline to online) services such as ordering food or shopping will allow Facebook to gain a much deeper understanding of its users.
• The Chinese ecosystems aim to grow their revenues by owning many of these services (like Alibaba does) but Facebook appears to be content just to be the enabler.
• I think that this is because its ability to monetise its users through advertising is much greater than any of the Chinese ecosystems.
• This ensures that Facebook will not have to make the huge investments required to get many of these services off the ground which will help to keep profitability at very good levels.

Take Home Message

• The net result was that Facebook hardly put a foot wrong at its developer conference and demonstrated that it is on the path to become the world largest ecosystem by far.
• The problem is that consensus is already forecasting that some of the benefits from the 10 year roadmap will come through this year.
• I think that this is very unlikely and this is why I fear that Facebook may fall foul of over optimistic forecasts.
• I am currently expecting this to really hit in Q3 this year but there are already rumblings that Q1 16E may fall short due to falling engagement of some users.
• Either way, with the shares valued at 35.0x 2016 PER, there is not much scope for it to miss consensus without paying a heavy price.
• I am waiting for this reset in expectations before I look at pulling the trigger on the long-term story which remains excellent.