Facebook’s move into cryptocurrency could strengthen the investment case for the business, according to Morningstar analysts.
The social media giant has confirmed it is developing a digital currency, named Libra, which it plans to launch next year. Libra will initially be able to be sent using apps Whatsapp and Facebook Messenger but the firm hopes it will be accepted as a form of payment before long.
A newly launched subsidiary company – Calibra – will develop products and services around the cryptocurrency, starting with the creation of a so-called digital wallet, which is a way of making transactions using a computer or smartphone.
A Major Shift
While Facebook’s (FB) move into currency had been expected for some time, it does mark a major shift in the business and how it will make money. There are inherent risks when a company moves away from what it does best and Facebook has already faced trust issues with its 2.4 billion users after last year’s Cambridge Analytica scandal, which prompted many users to question how the firm was using their data.
Ali Mogharabi, senior equity analyst at Morningstar, says the cryptocurrency and digital wallet are unlikely to drive profits at the firm in a meaningful way over the next few years. Morningstar is maintaining a far value on the stock of $200, just slightly higher than the $190 the shares are currently trading at after climbing 44% this year.
While Mogharabi thinks the move could be effectively monetized and may strengthen Facebook’s wide-moat he adds: “We would recommend new investors wait for a wider margin of safety before allocating capital to this wide-moat and high uncertainty brand.”
Crypto Is Volatile
Cryptocurrencies such as Bitcoin and Ethereum have attracted attention from investors in recent years but are yet to become mainstream currencies. The values of these digital currencies have been incredibly volatile.
However, Libra is likely to be less so because it will be backed by bank deposits and short-term government securities held in the “Libra Reserve”, points out Mogharabi. This Reserve will be managed by the Libra Association, which will monitor the development of the currency. The 28 members of the Association include Visa, Mastercard, Uber, Lyft and Spotify.
Mogharabi says: “While the costs of Libra’s development are probably minimal for Facebook, in our view its creation will not result in a significant improvement of the firm’s user monetization during the next few years.” This is for a number of reasons, including the fact that data related to Libra transactions will not be used to attract targeted advertising.
Margaret Vitrano, co-manager of the ClearBridge US Large Cap Growth fund, agree that it is likely to be years before the new arm of the business is material to its financial results. She thinks the primary drivers of profitability at the firm for the foreseeable future will be growth in users, engagement, and pricing of advertising on their existing apps.
“That being said, digital payments is a very big industry, and if the company were to develop a payments ecosystem, one could envision how it could quickly scale by leveraging its highly engaged, already-installed based of users,” she adds. Facebook is the second largest holding in the four-star rated fund, accounting for 5.1% of assets.
Libra Has Potential
Christopher Rossbach, chief investment officer at J Stern & Co, thinks Libra has the potential to be a significant positive to Facebook’s business. With 2.7 billion monthly active users across its suite of apps, Facebook is in the positive to help drive the broad adoption of the cryptocurrency, particularly if the accompanying e-wallet is well designed.
“Payments and the wallet create additional reasons to log into and interact with Facebook,” says Rossbach, “Meaning Facebook and its family of apps can become even more important for its users’ daily lives. And the more commerce there is on the platform, the more it will encourage advertising.”
Facebook has a three-star stock rating from Morningstar, a high uncertainty rating and a wide economic moat, indicating strong barriers to competition. Facebook’s Marketplace – which users can browse to buy and sell items – already attracts almost 1 billion users a month and Libra could further widen the appeal of the platform. It could also be rolled out to Instagram.
Libra will also embrace the so-called unbanked population across the globe, a move governor of the Bank of England Mark Carney says could “substantially improve financial inclusion and dramatically lower the cost of domestic and cross-border payments.”
However, Facebook still faces antitrust issues which may stop users immediately embracing its currency and there are also regulatory risks to consider.
Rossbach adds: “The Libra project shows how innovative Facebook can be and allows investors to focus on growth opportunities rather than the negative news flow over the past two years.
“We think Facebook has great prospects for value generation from its core social media businesses and that Libra is a further interesting growth initiative that could add significant value to the company, its users and its shareholders.”
