Introduction
Today, firms operate in volatile environments. Small changes in the environment could have significant impacts on a firm’s financial performance. Facebook Inc. serves as the perfect case study for assessing the environmental impacts. Recently, the company reported that it had failed to increase the size of its user base as investors had expected. As a result, the company’s share price dropped drastically leading to a $120 billion erosion of the company’s market valuation (Gongloff, 2018). This drop underscores the volatility of Facebook’s operating environment. More importantly, the drop highlights the instability of investor sentiment. Investors tend to be confident in firms whose financial performance is solid. On the other hand, when companies release financial reports which leave investors disappointed, the performance of the company’s stock usually suffers. For the most part, Facebook is a stable company whose financial future is secured. However, for the firm to regain the trust of its investors, it needs to address its weaknesses and eliminate risks.
Overview
Facebook is the largest social media company in the world. As of the end of June 2018, the company’s user population stood at 2.23 billion (“Company Info”, 2018). Of these, 1.47 billion use Facebook actively every day. Facebook’s rise has been phenomenal. With the mission of giving “people the power to build community and bring the world closer together” Facebook strives to establish connections among people from different parts of the world (“Company Info”, 2018). Overall, the company has managed to fulfill this mission. However, its operations have been marred by scandals and allegations of wrongdoing. For example, the company stands accused of hosting individuals and organizations such as InfoWars that are engaged in such activities as spreading fake news. Moreover, further allegations indicate that Facebook was used to misinform the American public during the 2016 presidential elections with the aim of disrupting the country’s democratic processes. While Facebook remains a solid company, its performance could suffer if it fails to address the concerns that its users continue to raise.
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Management
A firm’s leadership is among the factors that determines its performance. Effective and able leadership usually translates to strong growth. The growth that Facebook continues to witness can be attributed, at least in part, to the strong team of leaders that provide direction and oversee its operations. Mark Zuckerberg serves as Facebook’s Chief Executive Officer (CEO) and Chairman. Sheryl Sandberg, David Wehner, Mike Schroepfer, and Chris Cox are the Chief Operating Officer, Chief Financial Officer, Chief Technology Officer, and Chief Product Officer respectively (“Company Info”, 2018). This team of top leaders is supported by a board of directors. Some of the board members are Zuckerberg, Reed Hastings, Peter Thiel and Jeffrey Zients. This board brings together leaders with expertise in different fields and industries. For example, in addition to sitting on Facebook’s board, Hastings also serves as the CEO and Chairman of Netflix.
History
Facebook’s history is as long as it is complex. Incorporated in 2004, the firm has evolved from a small social networking site to a giant in the technology industry. Zuckerberg receives credit for his vision of creating a platform that would allow people to communicate and establish communities. Thanks to funding from such investors as Elon Musk, Facebook extended its reach beyond Harvard as it strived to establish a presence across the US and to a global audience eventually (Weinberg, 2017). The Arab Uprising which toppled governments in various Arab nations offered Facebook the opportunity to become involved in politics. Through Facebook, protestors were able to register their displeasure with the government and demand better treatment and regime change. In 2012, Facebook achieved yet another milestone. It issued an initial public offering (IPO) through which it raised $5 billion (Weinberg, 2012). Apart from investor funding and the amounts raised through the IPO, Facebook’s success has also been driven by the numerous acquisitions that it has undertaken. For example, Facebook purchased Instagram, Oculus and WhatsApp (Weinberg, 2012). Through these acquisitions, the company has been able to expand its product offering while strengthening its position in the technology industry. As noted earlier, in recent past, the company has been dogged by scandals which left unaddressed, could erode its growth.
Product Lines
Being a technology company, Facebook’s primary focus is software and applications. Facebook.com, its social media platform is the company’s main product (“Facebook Inc.”, n.d). On this site, individuals are able to obtain entertainment, connect with their friends and find information. In addition to the site, Facebook also operates Instagram and WhatsApp (“Facebook Inc.”, n.d). These services also offer users opportunities for connection and social networking. Facebook’s product line extends beyond social networking. The company also offers advertising space to companies that wish to engage with their customers directly (“Facebook Inc.”, n.d). Apart from being able to create a presence on Facebook and Instagram, firms are also able to run paid advertising on these sites.
Environmental Factors
There are various social, economic, environmental and technological factors that combine to shape Facebook’s financial performance. Government policy is among these factors (“Facebook Annual Report”, 2018). In such countries as China, the use of Facebook is prohibited. Consequently, the company has been unable to penetrate the Chinese market whose large population offers an opportunity for growth. In other countries, governments occasionally limit access to such sites as Facebook. The actions of these governments further limit the firm’s performance and growth. Security breaches and negative media coverage are other factors that define Facebook’s performance (“Facebook Annual Report”, 2018). When security breaches occur, the company spends huge amounts sealing security loopholes and in public relations efforts to assure users that their data is secure. These costs hurt the company’s bottom line. Negative coverage in the press could also harm the company. In the recent past, the company has been painted as one that prioritizes profitability at the expense of user privacy. It has also been implicated in the interference with the 2016 elections. This negative coverage limits profitability.
Intense competition is yet another factor which significantly affects Facebook’s performance (“Facebook Annual Report”, 2018). Such firms as Google pose a serious challenge to Facebook as it competes for the limited advertising market. Market saturation also threatens the company’s future. The size of Facebook’s user base has stagnated as the company adds more users. Since Facebook’s strength lies in its user population, it can be expected that its growth will plateau in the coming years. Concerns over the negative impact that Facebook and social media in general has on the wellbeing of users are another issue which could hamper the company’s growth. Bullying, fake news and excessive social media use are some of the adverse impacts that have been linked to Facebook’s various social networking platforms. For the company’s future to be secure, the firm must invest in enhancing user welfare.
Financial Ratios
Financial ratios offer insights into the financial stability and performance of a company. The following table outlines key financial ratios for Facebook from 2015 to 2017.
Table 1. Facebook key financial ratios
| Ratio | 2017 | 2016 | 2015 |
| Current ratio | 1292% | 1197% | 1125% |
| Quick ratio | 1292% | 1197% | 1125% |
| Cash ratio | 1109% | 1024% | 958% |
| Gross margin | 87% | 86% | 84% |
| Operating margin | 50% | 45% | 35% |
| Pre-tax margin | 51% | 45% | 35% |
| Profit margin | 39% | 37% | 20% |
| Pre-tax ROE | 28% | 21% | 14% |
| After-tax ROE | 21% | 17% | 8% (“FB Company Financials”, 2018). |
| Return on Assets | 30.11% | 31.48% | 22.95% (“FB’s ROA”, 2018). |
| Return on Equity | 21.41% | 17.21% | 8.3% (“FB’s ROE”, 2018). |
| Earnings per share (Basic) | $5.49 | $3.56 | $1.31 |
| Debt: equity ratio | (10177/74347)= 0.1369 | (5767/59194)=0.09743 | (5189/44128)=0.1176 |
Evaluation of Strengths and Weaknesses
The table above offers insights into Facebook’s financial performance. In particular, one is able to determine Facebook’s strengths and weaknesses from a careful scrutiny of the table. The consistently high current ratio and the high quick ratio are some of the strengths. Since these ratios are high, Facebook is able to easily settle its short-term obligations. The increasing profit margins are another strength. Over the years, Facebook has been able to grow its profit thanks to its investments in expanding its user base and attracting more advertisers. As is shown in the table above, Facebook’s ROE has been high. The implication of this is that investors receive reward for their faith and confidence in the company. Another strength that is driving Facebook’s growth is its high ROA. From 2015, the company’s ROA has been increasing. This means that the firm is efficiently exploiting its assets to maximize revenue and stimulate growth. Perhaps the only weakness is the company’s rather low figure for EPS. In 2015, investors earned a meager $1.31 for every share owned. However, it is encouraging that in 2016 and 2017, the EPS increased significantly.
Comparison of Ratios
To gain a full understanding of Facebook’s performance, it is necessary to compare its data with that of its competitors. Google and Snapchat are some of Facebook’s fiercest competitors. The following table shows key ratios for the three companies.
Table 2. Facebook versus competitors
| Ratio (2017) | Google (Alphabet Inc.) | Snapchat (Snap Inc.) | |
| Current ratio | 1292% | 5.14 | 6.84 |
| Quick ratio | 1292% | 5.11 | 6.84 |
| Cash ratio | 1109% | 4.21 | 5.90 |
| Gross margin | 87% | 58.94% | 7.45 |
| Operating margin | 50% | 26.17% | -422.52 |
| Pre-tax margin | 51% | 24.49% | -419.83 |
| Profit margin | 39% | 11.40% | -417.61 |
| Pre-tax ROE | 28% | - | - |
| After-tax ROE | 21% | 8.30% | -152.73 |
| Return on Assets | 30.11% | 6.94% | -133.94 |
| Return on Equity | 21.41% | 8.69% | -152.73 |
| Earnings per share (Basic) | $5.49 | $18 | -0.27 |
| Debt: equity ratio | (10177/74347)= 0.1369 | 2.60 | 0.53 |
Evaluation and Strengths and Weaknesses
By reviewing the figures in the table above, one is able to understand the complexities of the competitive environment in which Facebook operates. Based on the figures, Facebook’s performance is undoubtedly better than that of its competitors. Some of the company’s strengths lies in its profitability, earnings per share, return on assets and return on equity. On the other hand, the performance of its competitors is rather disappointing. For example, despite being the provider of the leading search engine and having a wider array of product offerings, Google’s current ratio, quick ratio, gross margin and return on assets and equity are lower than those of Facebook. Google’s main strength lies in its high earnings per share compared to Facebook. Whereas Google and Facebook reported impressive financial results, Snapchat’s performance is poor and disappointing. While the company is able to meet its short-term obligations given the fairly high quick and current ratios, it has been unable to reward its investors with profits. The negative figures for operating margin, return on investment, return on equity and earnings per share point to a struggling company. Overall, the financial strength of Facebook and Google lie in their capacity to meet obligations and their high profit margins. On the other hand, Snapchat is a struggling firm whose competitiveness is severely compromised. It can be concluded that while the competition in the technology and social networking industries is fierce, Facebook is a stable company that is able to tackle its competitors.
Evaluation of Capital Structure and Financial Risk
Ensuring that operations run smoothly is a capital-intensive endeavor. To finance their operations, firms usually rely on capital from its investors. However, this capital may not be sufficient to fully finance the operations. It is for this reason that companies often turn to third parties for extra funding. The mix of capital raised from internal sources and the debt provided by third parties constitute a company’s capital structure. The debt to equity ratio offers an indication of a company’s capital structure. Ideally, the ratio should be low. A low ratio suggests that a company is not too heavily dependent on debt to fund operations (Peterson & Fabozzi, 2012). Table 2 offers the debt to equity ratios for Facebook and its competitors. For Facebook, the 2017 ratio was 0.1369. This means that for every $0.1369 of debt that Facebook spends on its operations, it also uses $1 of its own capital (equity). On the other hand, the ratios for Google and Snapchat are 2.60 and 0.53 respectively. Google’s high ratio should concern its leaders and investors. A high ratio means that much of a firm’s operations are funded using debt. When a firm’s debt to equity ratio is high, it risks volatility since a significant portion of its earnings will be used to settle interests accruing from the high debt. Google is a rather unconventional firm. Despite its high debt ratio, it is still able to offer its investors fairly decent earnings as indicated by the EPS of $18. It must be that the company’s aggressive borrowing is translating into increased profitability.
The discussion on Facebook’s performance would not be complete without an evaluation of its financial risk. A company’s debt level offers the best indication of its financial risk. The more a firm borrows, the higher the financial risk. Since Facebook’s debt to equity ratio is low, it can be said that its financial risk is low. The implication of this conclusion for investors is that they can expect handsome turns since Facebook will not be spending huge amounts to repay debts. Instead, the company will use significant portions of its earnings to reward investors. The fairly high EPS points to the low financial risk of Facebook.
Advantages and disadvantages of capital structure
As already noted above, Facebook finances a majority of its projects using equity. Its capital structure presents a number of advantages and drawbacks. The main advantage of Facebook’s capital structure is that it does not have to spend huge amounts financing its debt obligations (Miglo, 2016). Capital structures composed mostly of equity enable firms to direct most of their cash to financing projects instead of settling debts. Another advantage is that Facebook is able to focus on the long-term bottom line. With no massive repayments to worry about, firms whose projects are financed mostly using equity re able to direct their effort and resources at their long-term vision (Miglo, 2016). Facebook’s capital structure is not without its flaws. Among these flaws is that the company is not leveraging the debt facilities available. The low ratio implies that the company is not borrowing as it could. Therefore, some of its projects may go unfinanced since the company relies heavily on equity.
Characteristics of Common Stock
For a full understanding of Facebook’s financial affairs, it is important to examine the features of its common stock. The company’s common stock is of two types: class A and class B (Udland, 2016). Numerous characteristics distinguish the two classes of stock. On the one hand, holders of class A stock are able to vote for the company’s leaders. Moreover, the class A stock is traded on the exchange. On the other hand, while class B stock is not traded on the exchange, its owners have voting rights (Udland, 2016). Individuals who own class A stock have are able to exercise one vote for every share held while class B stock grants its holders 10 votes per share. Recently, the company announced plans to introduce a third type of stock, class C. Those who will own this stock will have a stake in Facebook (Udland, 2016). However, they will be denied voting rights. Facebook does not issue preferred stock or bonds. In the recent past, the company’s stock has been performing poorly. Its performance is captured in the image below:
1
As noted earlier, the company’s announcement of financial results that left investors disappointed and fell short of expectations is to blame for the poor stock performance.
Beta
Beta is among the measures of a firm’s performance. This metric indicates the level of volatility of a company’s stock. A high beta suggests that a firm’s stock is risky but promises higher returns. In addition to shedding light on the volatility of the stock, the beta also represents the relative volatility of the stock compared to the market. Currently, Facebook’s beta is 0.89 (“Facebook, Inc”, 2018). Since it is less than one, this beta shows that Facebook’s stock is of low volatility is low compared to the larger technology industry. The implication of the beta is that those who purchase Facebook stock should expect low return. However, they will enjoy the benefit of owning stock that is stable. It is important to compare Facebook’s beta with that of Google, its chief competitor. According to Yahoo Finance, Google’s beta is 1.31 (“Alphabet Inc.”, 2018). This figure means that compared to the market, Google’s stock is very volatile. Owners of its stock expect high returns but face high risk. For Facebook, the low beta is a source of competitive advantage. Since the low beta suggests stability, the company can attract investors, thereby strengthening its capital base. However, the low beta can also be a source of competitive disadvantage. Investors who prefer riskier stocks that promise higher returns would not be attracted by Facebook’s low beta.
Weighted Average Cost of Capital
As of 29, July 2008, Facebook’s weighted average cost of capital (WACC) was calculated as 7.98%. 2 This figure offers important insights into the company’s financial health. Essentially, WACC represents the cost that a firm incurs as it raises funding. Facebook’s WACC of 7.98% mean that if Facebook is to secure $1 in funding from investors, it needs to pay them $0.0789. Compared to Google, Facebook is an attractive investment for providers of funding. Google’s WACC is 10.74%. This means that Google incurs higher costs when seeking capital for its projects. Facebook’s lower WACC is a source of competitive advantage. The key advantage is that the company is able to secure funding in a cost-effective fashion. Furthermore, since it incurs lower capital-acquisition related costs, the company is more likely to attract investors.
Areas of Financial Risk
For the most part, Facebook is a strong company. However, there are numerous risks that threaten the company’s operations and future. Interest-rate risk arising from the fact that Facebook has operations in various markets across the globe is among the threats it has to contend with. As the interest rate fluctuates, Facebook’s financial situation may become volatile. Its over-reliance on equity to fund operations is another risk. While the company’s low debt as evidenced by the low debt to equity ratio should calm investors, it limits the company. With more funding from external sources, Facebook will be able to take on more projects. Most of the risks that Facebook faces stem from environmental factors. For example, calls for the company’s social platforms to be regulated and the threat of such ills as fake news and violations of user privacy could erode its performance. However, overall, Facebook remains a stable company whose impressive financial performance should boost investor confidence.
Recommendation and Conclusion
Facebook is not a perfect firm. There are some flaws which hamper its growth. By fixing these flaws, Facebook will unlock opportunities for greater growth. It is recommended that the company should alter its capital structure. Currently, much of the funding for projects comes from internal sources. As noted in an earlier section, equity accounts for a bulk of the firm’s capital structure. That the company does not rely too heavily on debt is encouraging and should keep investors committed to the company. However, Facebook is not leveraging debt optimally. By seeking more debt, the company will have adequate funding for all its projects. The recommendation that Facebook should reduce its reliance on equity is also based on Biblical principle. In Genesis 2:15, the Bible describes how God placed man in the Garden of Eden and mandated him to make the garden productive. Essentially, this verse underscores the importance of responsible stewardship. God expects individuals to make the best use of their gifts, resources and talents. Since Facebook can access debt, it should seek more of it so that it is able to pursue its vision of uniting the world. There is no doubt that Facebook is one of the firms that will deliver the world into a future of connectivity and community. The company’s leaders need to remain committed to their investors and customers to secure the company’s future and the wellbeing of mankind.
References
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FB Company Financials. (2018). Nasdaq. Retrieved July 29, 2018 from https://www.nasdaq.com/symbol/fb/financials?query=ratios
FB’s ROA over the last five years. (2018). CSI Market. Retrieved July 29, 2018 from https://csimarket.com/stocks/FB-Annual-Return-on-Assets-ROA.html
FB’s ROE over the last five years. (2018). CSI Market. Retrieved July 29, 2018 from https://csimarket.com/stocks/FB-Annual-Return-on-Equity-ROE.html
Gongloff, M. (2018). Facebook is now $120 billion smaller . Bloomberg. Retrieved July 29, 2018 from https://www.bloomberg.com/view/articles/2018-07-26/facebook-is-now-120-billion-smaller
Miglo, A. (2016). Capital structure in the modern world. New York: Springer.
Peterson, P. P., & Fabozzi, F. J. (2012). Analysis of financial statements. Hoboken, NJ: Wiley.
Udland, M. (2016). Facebook has a new class structure and Mark Zuckerberg is still in control .
Business Insider. Retrieved July 29, 2018 from https://www.businessinsider.com/facebook-new-stock-structure-2016-4?IR=T
Weinberg, M. (2017). 33 photos of Facebook’s rise from a Harvard dorm room to world
Domination (FB). Business Insider. Retrieved July 29, 2018 from https://www.businessinsider.com/facebook-history-photos-2016-9
Appendix
2017 annual report: https://s21.q4cdn.com/399680738/files/doc_financials/annual_reports/FB_AR_2017_FINAL.pdf
2016 annual report: https://s21.q4cdn.com/399680738/files/doc_financials/annual_reports/FB_AR_2016_FINAL.pdf
2015 annual report: https://s21.q4cdn.com/399680738/files/doc_financials/annual_reports/2015-Annual-Report.pdf
1 Image retrieved from https://finance.yahoo.com/quote/FB/chart/
2 Figure obtained from valuenet.pro
