Social networking stocks to follow closely

These companies are rich repositories of consumer data, which makes them attractive acquisition targets.

Vikram Barhat 27 June, 2016 | 5:00PM

Tech giant  Microsoft Corp.'s (MSFT) US$26.2-billion acquisition earlier this month of business networking site LinkedIn Corp. created a big splash in the investment world. Industry watchers say there is a natural synergy between tech companies looking to expand into new areas of growth and social media networks with a sizeable consumer base.

The LinkedIn deal sparked widespread anticipation among investors of similar acquisitions of social media companies that are struggling to be financially sustainable as standalone entities. There's little doubt that leading social and business networking companies provide highly visible platforms for advertisers and effective tools for brand creation. With a sizeable user base, these companies are rich repositories of consumer data which makes them attractive acquisition targets for big tech firms sitting on large piles of cash.

An integral part of the daily lives of millions of users globally, the social media is set to grow 18% annually between 2016 and 2020, forecasts market research firm Technavio. Much of this growth is attributable to the greater adoption of mobile devices and proliferation of the internet. According to a PwC report, the global mobile internet penetration is forecasted to rise from 35.1% in 2014 to 58.5% in 2019. Further, the number of social network users worldwide, as per eMarketer, is set to reach 2.72 billion in 2019, from 2.04 billion in 2015.

This bodes well for the global social networking market, which is controlled by a handful of companies. These players are known to relentlessly innovate and upgrade their platforms and services to keep pace with the latest trends and technologies. Vast amounts of subscriber data, differentiated product offerings and current low valuations make these companies both attractive acquisition targets and long-term growth play as independent entities.

Facebook Inc. A
Ticker FB
Current yield -
Forward P/E 25.6
Price US$113.91
Fair value US$120
Data as of June 22, 2016

With more than 1.6 billion active users,  Facebook (FB) provides the world's largest social platform. The company's products include the Facebook app, Instagram, Messenger, WhatsApp and features that allow members to swap messages, views, videos and photos. More than 90% of revenue comes from advertising, of which 50% come from the United States and Canada and 25% from Europe.

"Facebook will continue to benefit from an increase in allocation of marketing and advertising dollars toward online advertising, more specifically mobile and social network ads where Facebook is especially well-positioned," said Morningstar equity analyst Ali Mogharabi in a report.

The social media giant's ability to garner new users in the expanding mobile market has been "the main driver behind growth in online advertising," Mogharabi said. "Facebook is well-positioned as its users are accessing Facebook and its apps more via mobile devices."

The company has been growing its mobile active users by 42% annually for the last five years and is pushing to boost revenue by launching interactive video ads and chatbots. "Given its ability to profitably monetize its network via advertising, Facebook will generate excess returns on capital over the next 20 years," said Mogharabi, who forecasts a five-year compound annual revenue growth rate of 27% and operating margin of 42% for the same period.

Facebook's competitive advantage springs from 21% annual growth in user base and its ability to monetize its subscriber data, added Mogharabi, who put the stock's worth at US$120.

Twitter Inc.
Ticker TWTR
Current yield -
Forward P/E 20.8
Price US$16.13
Fair value US$18
Data as of June 22, 2016

The online social networking and microblogging service  Twitter (TWTR) boasts more than 320 million monthly active users. The service, primarily known for its real-time content, generates nearly 90% of revenue through advertising.

LinkedIn's recent acquisition deal has not only boosted Twitter's value, but also fuelled takeover speculations. The company is widely considered by Wall Street experts as ripe for acquisition due to slowing growth, dwindling ad revenue and current low valuation.

"While we believe the company still has room to expand its user base, growth will continue to be relatively slow and cap out in the mid-single digits," said a Morningstar report that appears to bear out the prevailing market view. "Furthermore, the company is competing for advertising dollars with juggernauts such as Facebook and  Google (GOOG)."

Twitter may find it hard to attract new ad revenue as advertisers struggle to measure the success of ad campaigns, the report noted.

For now, though, the company with the largest real-time social network in the world continues to enjoy leading market share driven by users and the platform's stickiness. Morningstar equity analyst Neil Macker said he feels positive about the complementary nature of Twitter to traditional content and media, which "will allow Twitter to more cheaply acquire content that flows through its media platform."

That's not to say Twitter will find it easy to attract mass market users, unless it's acquired by a larger firm. Macker pegged the stock's worth at US$18, implying a 6% compound annual growth in monthly active users through 2025, the year in which revenue could hit US$10 billion with 17% operating margins.

NetEase Inc. ADR
Ticker NTES
Current yield 1.41%
Forward P/E 11.6
Price US$167.53
Fair value US$200
Data as of June 22, 2016

China's most popular online game developer and operator,  NetEase (NTES) generates nearly 76% of its revenue through entertainment. The company's business interests include email service, e-commerce and online advertising.

With more than 90 mobile titles, it controls about 60% of China's mobile games market, creating a wide social network of online gamers. "We expect a solid portfolio of in-house and licensed games to keep the firm on a growth track," said Morningstar equity analyst Marie Sun in a report, noting that "the online gaming market in China has had an explosive growth period."

Sun concedes that online gaming is an inherently risky business, but argues that "NetEase's core competitiveness is its intellectual properties, which is one of the key successful factors in the structural shift from casual games to mid-core and hard-core games for mobile."

The shift will help mobile gaming continue its fast-growth momentum in the next two years, says Sun, who recently upped the stock's fair value from US$182 per American Depository Receipt (ADR) to US$200 per ADR.

"We believe that only the gaming companies with strong research and development capability and pipelines including various genres will survive," she added. Sue forecasts 23% average revenue growth for online games in the next five years and a 27% average annual growth for the email and e-commerce segment for the same period.

Complete access to Morningstar's research on equities, mutual funds and exchange-traded funds is available to subscribers to Morningstar Canada Premium.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Alphabet Inc Class C1,229.37 USD-0.75
Facebook Inc A189.88 USD-0.14
Microsoft Corp139.44 USD-1.16
NetEase Inc ADR269.44 USD-0.66
Twitter Inc43.23 USD0.70

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Vikram Barhat

Vikram Barhat  Vikram Barhat is a freelance writer.