RBC Capital Markets, LLC Mark S.F. Mahaney Zachary Schwartzman (Analyst) (Associate) (415) 633-8608 (415) 633-8651 [email protected] [email protected] Dylan Haber (AVP) Shweta Khajuria, CFA (AVP) (415) 633-8527 (415) 633-8631 [email protected] [email protected]

July 25, 2018 Sector: Internet , Inc. Don’t Unfriend FB Now… Outperform NASDAQ: FB; USD 173.00 Our view: FB reported a disappointing Q2, with a Revenue Miss (partly driven by European GDPR pressure), a Soft H2 Revenue Guide (due to Price Target USD 225.00 ↓ 250.00 currency, rising Sponsored Stories usage, privacy regs), and a Negative 2-3 WHAT'S INSIDE Year Margin Guide (due primarily to security and growth investments). We Rating/Risk Change Price Target Change EQUITY RESEARCH EQUITY see the outlook as overly conservative. We are buyers w/ $225 PT. In-Depth Report Est. Change Key points: Preview News Analysis Weak Q2 Results: Revenue grew 38% Y/Y ex-FX to $13.23B vs. RBC/Street Scenario Analysis* estimates of $13.37/13.33B. Ad Revenue growth ex-FX decelerated from 42% in Q1 to 38% in Q2 – the largest deceleration we’ve seen since Downside Current Price Upside Q4:16. The region with the greatest deceleration was Europe. Operating Scenario Price Target Scenario Income and EPS, however, beat RBC/Street, primarily due to R&D and G&A 130.00 173.00 225.00 300.00 leverage. All in, fundamentals for FB in Q2 weakened, given Rev Growth 25% 30% 73% Deceleration and Op Margin Y/Y declines, and the Outlook – even if *Implied Total Returns conservative – implies more of same. Key Statistics Shares O/S (MM): 2,930.0 Market Cap (MM): 506,890 Dividend: 0.00 Yield: 0.0% Quarter Keys: 1. Users – MAUs up 11% Y/Y to 2.23B, DAUs up 11% Y/Y to Avg. Daily Volume: 17,282,078 1.47B – both modestly below Street estimate. European MAUs declined 1MM Q/Q and DAUs declined 3MM, as the company had forecasted, RBC Estimates due to GDPR. 2. Engagement – DAU/MAU ratio decreased slightly to FY Dec 2017A 2018E 2019E 2020E 65.8%, down 21 bps Y/Y, with Asia being the only region where it was Revenue 40.7 55.2 71.5 92.8 Prev. 57.2 74.2 92.6 up (up 115bps Y/Y). 3. Rising Monetization – ARPU up 26% Y/Y to $5.97, GAAP Net EPS 5.40 7.09 9.32 11.93 decelerating vs. 31% in Q1. 4. Strong FCF Generation & Share Repos – Prev. 7.81 10.19 12.92 $2.8B in Q2, with over $3B share repos. Margin 66.3% 61.1% 59.7% 57.8% P/E Net 32x 24x 19x 15x Estimates & PT Reduced: ‘19E Rev dropped 4% to $72B & GAAP EPS cut EBITDA 27.0 33.7 42.7 53.6 9% to $9.32. $225 PT ($250 prior) based on 25x ’19E GAAP EPS and 14x Prev. 35.9 47.3 59.7 ’19E Adjusted EBITDA of $43B. Our outlook for 30%+ bottom-line growth Revenue Q1 Q2 Q3 Q4 easily supports these multiples. 2017 8.0A 9.3A 10.3A 13.0A 2018 12.0A 13.2A 13.8E 16.2E Why Not Unfriend FB? Because: 1. FB stills owns two of the largest Prev. 13.4E 14.3E 17.6E EBITDA media assets in the world (Facebook & ) & the two largest 2017 4.9A 6.2A 6.9A 9.0A messaging assets in the world (Messenger & WhatsApp); 2. Our checks 2018 7.4A 8.1A 8.4E 9.9E and mgmt commentary suggest no material change in marketer views of Prev. 7.9E 8.9E 11.7E Note: Priced as of 7:56PM EDT in the after-market on July 25th, 2018 the attractiveness of FB platforms; 3. Monetization of core FB & Instagram All values in USD unless otherwise noted. assets still has material upside potential and Messenger & WhatsApp remain unmonetized; 4. FB’s aggressive investments are improving platform security (Job One) and creating future revenue streams (VR/AR); 5. Even under pressure, FB producing impressive growth (30%+ Revenue & 25%+ EBITDA growth in ’18E); & 6. Valuation looks highly attractive – 17X P/E (ex-cash). This likely constitutes One of the Best Entry Points you can get on FB, in our view.

Disseminated: Jul 25, 2018 22:22ET; Produced: Jul 25, 2018 22:22ET Priced as of prior trading day's market close, EST (unless otherwise noted). For Required Conflicts Disclosures, see Page 13. Internet Facebook, Inc.

Target/Upside/Downside Scenarios Investment summary Exhibit 1: Facebook, Inc. Our Outperform rating is based on several key factors:

125 Weeks 03MAR16 - 25JUL18 1) Very Large, Growing User Base – Facebook has more than 225 UPSIDE 300.00 TARGET 205 225.00 2.5B active users and is still growing this in the teens % Y/Y. 185 175 CURRENT 173.00 The large amount of data collected on these users is a unique 165 155 and valuable asset for ad and content targeting. 145 135 DOWNSIDE 130.00 125 2) Engagement Still High – Although engagement levels are 115 a constant concern, Facebook's measure of DAU/MAU has 105 remained consistently high on an overall company basis. 95 600m 400m 3) One of the Most "Underlevered" Internet Companies – 200m Facebook still has many growth levers left to pull, not least of 2016 2017 2018 A M J J A S O N D J F M A M J J A S O N D J F M A M J J Jul 2019 which is video advertising. FB US Rel. S&P 500 COMPOSITE MA 40 weeks Source: Bloomberg and RBC Capital Markets estimates for Upside/Downside/Target 4) Mobile – Facebook has, so far, effectively addressed one of Target price/base case the most significant overhangs from its IPO days, the lack of We value Facebook using a blended average of 25x P/E Mobile monetization. Mobile Ad Revenue is a material part of multiple and 14x EV/EBITDA multiple on our 2019 estimates. the overall Ad Revenue mix (91%). For key context, we are estimating 30% EPS CAGR for FB through 2020, which we believe supports these premium 5) Very High Margins – FB currently drives EBITDA margins multiples. Our $225 price target is also supported by a DCF, in the low-60%s. An outlook for increased opex investment assuming a 10% WACC and a 4% Terminal Growth Rate. Our should drive these down, but we think that increased price target supports our Outperform rating. investment is actually a positive at this point in the company's growth. Upside scenario In our upside scenario of $300, we estimate a higher Revenue Risks to Our Price Target Include: 1) Broad decreasing CAGR as user growth and sustained engagement drive Ad engagement trends as new competitors arise and take market Revenue. Higher Revenue growth drives EBITDA margins share; 2) failure to drive significant adoption from major higher by 2019. We apply higher multiples to these estimates advertising brands; 3) limitations due to regulatory/user to achieve a $300 upside scenario. actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Downside scenario In our downside scenario of $130, we assume that user growth slows more quickly than expected and that engagement begins to slip in mature geographies. This causes both a deceleration in ad volume growth and pricing pressure as more incremental ads come from lower-monetizing geographies. We apply a lower P/E and EV/EBITDA multiple to reach our $130 downside scenario.

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 2 Internet Facebook, Inc.

Facebook Q2:18 EPS Roundup Metric Trends Monthly Active Users – Below Expectations Monthly Active Users (MAU) grew 11% Y/Y – below 13% in Q1 on a flat comp. This number is below the previous nine quarters’ growth of 13-17%, reaching 2.23B, below the Street’s estimate of 2.25B. While overall growth did not meet expectations, double-digit growth for a platform with over 2B users is still relatively impressive… North America Y/Y MAU growth declined 1-pt to 2% Y/Y in Q2 (vs. 3% in Q1:18 and Q4:17); Europe growth declined by 2-pts to 4% Y/Y (from 6% in Q1:18/Q4:17/Q3:17) while ROW growth decreased 1-pt to 11% Y/Y growth (vs. 12% growth in Q1 and 14% in Q4). Asia also decelerated to 18% Y/Y from 22% Y/Y growth in Q1 and 23% Q4:17. Facebook and its properties are now at roughly 2.2B unique users worldwide on a monthly basis (i.e. FB > China…and the U.S.), including well over 1B users worldwide on a daily basis (1.47B as of Q2). Google is the only other global media company with properties with over 1B daily users. And look at how big their market cap is…

For the first time, Facebook shared a Family Audience metric that includes core Facebook, Messenger, WhatsApp and Instagram, which have combined unique monthly users of over 2.5B. Given these platforms have respective MAUs of over 2.2B, 1.3B, 1.5B and 1B, it is clear that most users engage with FB across multiple platforms.

Though Facebook’s user figures were below expectations, we view these results as only modestly negative given the impact of GDPR (~1M users in Europe) and the plausible headwind from FIFA this quarter. Facebook also commented on their improved ability to identify and remove fake accounts using AI this quarter, likely contributing to the lower number of users.

Exhibit 2: Monthly Active Users and Growth

2,500 30%

2,196 2,234 2,250 2,129 2,072 25% 2,006 1,936 2,000 1,859 1,787 1,712 20% 1,750 1,654 1,591 1,546 15% 1,491 1,500 1,441 17% 15% 1,351 1,394 17% 17% 1,276 1,317 16% 16% 14% 15% 15% 15% 14% 14% 14% 14% 1,250 13% 13% 13% 10% 11% 1,000 5% 750

500 0% Q1:14 Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 Q3:17 Q4:17 Q1:18 Q2:18 Monthly Active Users (left) Y/Y Growth (Right)

Source: Company reports, RBC Capital Markets

Engagement Trends Overall engagement levels in Q2:18 were ever so slightly worse Q/Q in terms of the DAU/MAU Metric (Daily Average Users/Monthly Average Users, Facebook’s best publicly disclosed proxy

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 3 Internet Facebook, Inc.

for engagement). The DAU/MAU ratio was 65.8% in Q2, down only very slightly from 66.0% in Q1 and flat to the 65.8% in Q4:17, down 21 bps Y/Y… the third Y/Y decrease we have seen. This was directly in-line with our 65.9% expectation. The metric was up 115bps Y/Y in Asia but down 108bps in Europe. North America declined (78bps) Y/Y and ROW declined (31bps) Y/Y. These largely remain robust trends, especially in Facebook’s most mature geographies, and we believe Mobile is a major driving factor, along with ongoing product and feature improvements. The company noted that DAU growth was driven by India, Indonesia and the Phillipines. Engagement remains robust, with our thesis remaining that Facebook can maintain high levels of engagement over time… and, in turn, attract more Ad dollars.

Exhibit 3: Engagement (Daily Active Users/Monthly Active Users) Geographic Breakdown

85% 77.9% 77.7% 77.9% 77.8% 80% 76.7% 77.0% 77.0% 77.2% 77.4% 77.5% 77.4% 77.0% 76.8% 76.8% 75.5% 74.3% 74.5% 75.2% 75% 74.8% 74.6% 74.9% 75.1% 75.4% 75.3% 75.3% 74.9% 74.8% 70% 73.3% 73.3% 74.0% 74.3% 74.2% 71.6% 72.1% 70.2% 70.5% 63.8% 63.8% 64.2% 64.0% 64.6% 64.1% 64.1% 63.7% 64.3% 63.8% 65% 61.8% 62.0% 62.6% 62.7% 60.5% 60.3% 59.0% 59.4% 60% 61.1% 59.6% 59.9% 59.9% 60.3% 60.6% 55% 58.1% 58.4% 58.5% 58.8% 56.8% 57.3% 57.5% 57.5% 57.2% 55.4% 55.6% 56.3% 50%

45%

40% Q1:14 Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 Q3:17 Q4:17 Q1:18 Q2:18 US & Canada Europe Asia Rest of World

Source: Company reports, RBC Capital Markets

Global ARPU Global ARPU grew 26% Y/Y to $5.97 in Q2, decelerating 5-pts against Q1’s 31% Y/Y growth, on a 4-pt easier comp but above the Street’s $5.93 expectation. The increase in ARPU is being driven by Ad Revenue, which grew 27% Y/Y on a per-user basis, compared to 9% growth in Payments ARPU per-user – the first time this metric has achieved positive growth since 3Q:13 (benefitting from Go sales). Rising ARPU is a positive sign for advertiser traction and the company’s ability to monetize incremental users/usage. Going forward, we continue to believe ARPU will be a key metric to determine Ad Revenue growth. With Google’s ARPU still materially above Facebook, we believe there is plenty more monetization runway for FB.

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 4 Internet Facebook, Inc.

Exhibit 4: Global ARPU and Growth

$6.5 $6.18 45% $5.97 $6.0 40% $5.53 $5.5 40% 40% 39% $5.07 35% $5.0 35% $4.83 $4.73 33% 33% 30% 31% $4.5 30% $4.23 31% $4.01 28% 25% $3.82 28% 26% 26% $4.0 25% $3.72 23% 23% 24% 20% $3.5 $3.32 $2.96 15% $3.0 $2.81 $2.76 $2.50 $2.40 10% $2.5 $2.24

$2.0 5%

$1.5 0% Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 Q3:17 Q4:17 Q1:18 Q2:18 Global ARPU (left) Y/Y Growth (right)

Source: Company reports, RBC Capital Markets

Ad Metrics Facebook stated that Ad Impressions in the quarter grew 21% Y/Y (driven primarily by feed ads on Facebook and Instagram), vs. the 8% Y/Y growth in Q1, 4% Y/Y growth delivered in Q4:17 and 10% Y/Y growth seen in Q3:17. However, we continue to believe this data point is largely noise, especially with continual ad format changes. Further, we note management stated that pricing is a much more important driver of ads revenue growth, with pricing increasing on average 17% in Q2 (vs. 39% in Q1, 43% in Q4’17, 35% in Q3’17, 24% in Q2’17, 14% in Q1’17, 3% in Q4’16 and 6% in Q3’16). Per our published survey work, the ROIs on FB ad campaigns continue to be viewed very positively by marketers, so expect pricing/yield to keep rising. We note that management highlighted that they expect to be able to continue to grow ad impressions and pricing in 2018.

We continue to look at the growth in overall advertising revenue as the most important factor for FB, which at 38% Y/Y growth (ex-FX) in Q2 is a positive outcome for a business that did $41B in Revenue in 2017 – especially one with 60%+ EBITDA Margins. In fact, Google is the only other platform that comes to mind as being able to do this -- in 2007. We continue to believe Facebook’s focus on ads quality is the right strategy, particularly given management’s previous commentary around ad loads being a less significant factor for growth starting in H2:17. We also think Video Ads (especially with general user adoption of Videos), Carousel Ads, Canvas Ads, Dynamic Ads, and Instagram monetization will be key parts of this trend over the next two years. The release of Instagram TV this quarter is the best example of Facebook’s progress in developing a viral Video platform with great monetization potential. Revenue Results – Slightly Below Expectations Total Revenue grew 42% Y/Y to $13.32B in Q2:18, falling short of RBC/Street estimates of $13.37/13.33B. The key number here was the Advertising Revenue segment (99% of total revenue), which grew 38% Y/Y ex-FX, vs. 43% Y/Y growth in Q1 on a 2-pt easier comp. Mobile continued to drive positive results, growing 50% Y/Y (vs. 61% in Q1) on a reported basis to ~$11.9B in revenue.

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 5 Internet Facebook, Inc.

Exhibit 5: Revenue Growth Trends

($ MM) Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 Q3:17 Q4:17 Q1:18 Q2:18 Total Revenue 5,382 6,436 7,011 8,809 8,032 9,321 10,328 12,972 11,966 13,231 Y/Y Change 52% 59% 56% 51% 49% 45% 47% 47% 49% 42% Q/Q Change -8% 20% 9% 26% -9% 16% 11% 26% -8% 11% Advertising Revenue 5,201 6,239 6,816 8,629 7,857 9,164 10,142 12,779 11,795 13,038 Y/Y Change 57% 63% 59% 53% 51% 47% 49% 48% 50% 42% Y/Y Change (ex-FX) 63% 63% 59% 54% 51% 49% 47% 44% 43% 38% Q/Q Change -8% 20% 9% 27% -9% 17% 11% 26% -8% 11% % of Total 97% 97% 97% 98% 98% 98% 98% 99% 99% 99% Desktop Ad Revenue 936 998 1,091 1,381 1,179 1,191 1,217 1,406 1,062 1,173 Y/Y Change 5% 9% 15% 22% 26% 19% 12% 2% -10% -2% % of Total Ad Revenue 18% 16% 16% 16% 15% 13% 12% 11% 9% 9% Mobile Ad Revenue 4,265 5,241 5,725 7,248 6,678 7,973 8,925 11,373 10,733 11,865 Y/Y Change 76% 80% 71% 61% 57% 52% 56% 57% 61% 50% % of Total Ad Revenue 82% 84% 84% 84% 85% 87% 88% 89% 91% 91% Payments & Other Revenue 181 197 195 180 175 157 186 193 171 193 Y/Y Change -20% -8% -3% -12% -3% -20% -5% 7% -2% 23% Q/Q Change -11% 9% -1% -8% -3% -10% 18% 4% -11% 13% Source: Company reports

Margin Trends In Q2:18, total GAAP Opex grew 50% Y/Y (vs. 39% in Q1). In Q2, Facebook delivered Adj. EBITDA margins of 61.1%, ahead of our estimate of 59.3%, marking a 5-pt Y/Y decrease. Facebook is currently in an investment cycle for both Capital Expenses and Operating Expenses, which generally places pressure on margins. pointed out that their increased investments in Security while maintaining high spend on new products have negatively impacted profitability this quarter. As we have noted in other cases, we believe this is the right step for management to take and are comfortable trading near term margins for long- term growth.

Exhibit 6: GAAP Operating Margins and Adjusted EBITDA Margins

Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 Q3:17 Q4:17 Q1:18 Q2:18 GAAP Operating Income 2,010 2,734 3,117 4,566 3,327 4,401 5,122 7,352 5,449 5,863 Margin 37% 42% 44% 52% 41% 47% 50% 57% 46% 44% Adjusted EBITDA 3,308 4,136 4,532 6,028 4,865 6,161 6,910 9,019 7,353 8,083 Margin 61% 64% 65% 68% 61% 66% 67% 70% 61% 61% Source: Company reports, RBC Capital Markets

Additional Datapoints 2018 Guidance Facebook highlighted that they now expect revenue growth rates to decline by high single digit percentages from the prior quarters sequentially in both Q3 and Q4, citing three reasons: 1) FX - Which has gone from being a tailwind to a modest headwind; 2) Promoting new experiences such as Stories that aren’t as monetizable to date; & 3) Giving users more control and choices around data privacy.

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 6 Internet Facebook, Inc.

On expenses, the company still expects full year 2018 expenses to grow in the range of 50-60% vs. 2017. The company also highlighted that beyond 2018 they expect total expense growth to exceed revenue growth in 2019. Over the next several years, the company noted that they anticipate operating margins to trends towards the mid-30s on a percentage basis. Why? 1) Safety and security investments; 2) Investments in Innovation (AR/VR); 3) Substantial Capex investments; 4) Video Content investments; & 5) Growth in regions that lower ARPUs and thus lower margins.

The company expects 2018 Capex to be ~$15B due to investments in data centers, servers, network infrastructure and office facilities. They plan to continue to grow Capex beyond 2018 to support global growth and ongoing product needs. In terms of tax rates, the company expects 2018 to be in the mid-teens with Q3’s tax rate being 25-30%, due to a one-time charge related to a recent court ruling in the IRS vs. Altera case.

Strong Cash Position Facebook reported Cash and Marketable Securities of $42B at the end of Q2. Free Cash Flow was a very hefty $2.8B. Capital expenditures were $3.5B in Q2 – the company still expects CapEx spend of $15B in 2018. All in, we continue to view Facebook’s liquidity position as unusually strong, and should continue to improve.

Miscellaneous Notes from Earnings  Family Audience Metric, Instagram Now At Over 1B Users: For the first time, Facebook shared a Family Audience metric that includes core Facebook, Messenger, WhatsApp and Instagram, which have combined unique monthly users of over 2.5B. Given these platforms have respective MAUs of over 2.2B, 1.3B, 1.5B and 1B, it is clear that most users engage on multiple platforms. We note that Facebook also disclosed that in Q2 Instagram reached over 1B MAUs for the first time.  Stock Repurchase Program: Facebook’s Board of Directors authorized a $6B stock repurchase program in Q4:16 that began in early 2017 with no expiration date and followed it with another authorization made in Q1:18 for repurchases of up to $9B. In Q2, FB repurchased $3.2B of Class A common stock (vs. $1.77B in Q1, $958MM in Q4:17, 640MM in Q3:17, $150MM in Q2:17 and $228MM in Q1:17).  Stories: Facebook noted that their Stories advertisements currently didn’t monetize as well as advertisements, not due to inferior targeting but because they haven’t built the Ad Formats. Furthermore, they are promoting stories to increase engagement, given that they’ve found that user engagement on the platform is higher for users who use Stories.  Instagram Ad Load: Facebook repeated commentary from Q1 that Instagram’s Ad Load is now the same as core Facebook.  Businesses and Advertisers on Facebook and Instagram: Globally, over 80MM Businesses use Facebook (from 70MM in Q4). Facebook has over six million active advertisers. The vast majority of these are small and medium-sized businesses, which are a major source of innovation and create more than half of all new jobs globally. These businesses often have small ad budgets, so the ability to reach people more effectively is really valuable to them.  GDPR: Facebook noted that European MAUs experienced a ~1M negative impact from GDPR. This is consistent with guidance that they gave in Q1:18. The company noted that GDPR hadn’t had a revenue impact in Q2 though it wasn’t fully rolled out in Q2. The company noted they will continue to monitor for any potential impacts from GDPR.  Video Content and IGTV: Facebook is well positioned to capitalize on the rising trend of video consumption via mobile devices with the new Instagram TV platform designed specifically for watching long-format video on . The Tab also

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 7 Internet Facebook, Inc.

experienced strong growth this quarter with the roll out of Watch Party, allowing groups to simultaneously watch and chat live with friends about the content. Mark Zuckerberg also mentioned their original content such as talk show, Red Table Talk, has gained traction this quarter.  Safety and Data Initiatives: The company’s investments in security have begun to pay off this quarter as they rolled out 2 new ad transparency tools: The first shows users all the ads a certain page is running even if not specifically targeted at that user and the second, which archives ads with political or issue content while labeling the entity sponsoring those ads – the latter to be ready for U.S. midterm elections. These investments will increase the accountability of ads on the platform.  Prioritizing Social Interactions: On the Q1 call, FB reiterated that in 2018 they will be focused on building the platform to prioritize meaningful social interactions over the passive consumption of content. The company continues to work on this and added functionality in the quarter to allow users to create and donate to fundraisers they care about on Pages.

Changes to Estimates Below we present the changes to our 2018 and 2019 estimates.

Exhibit 7: Change to Estimates

2018E 2019E ($ MM) Old New % Change Old New % Change Revenue 57,222 55,172 -3.6% 74,192 71,529 -3.6% Adjusted EBITDA 35,921 33,742 -6.1% 47,345 42,694 -9.8% GAAP Op Inc. 26,126 24,597 -5.9% 34,468 31,035 -10.0% GAAP EPS $7.81 $7.09 -9.2% $10.19 $9.32 -8.6% Source: RBC Capital Markets estimates

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 8 Internet Facebook, Inc.

Valuation Methodology Our Price Target is $225 (from $250). Our 2019 valuation framework is based on an average of GAAP P/E and EV/EBITDA methodologies. In our EBITDA calculation, we are using Adjusted EBITDA.

Our P/E Valuation framework applies a 25x Target Multiple to our 2019 GAAP EPS estimate of $9.32 (down from $10.19) to arrive at $233/share valuation. For key context, Facebook is trading at 24x 2018E EPS and 19x 2019E EPS. Further, our estimates imply a 3-year 30% EPS CAGR, which we believe reasonably supports a Target Multiple of 25x.

Our EV/EBITDA Valuation framework applies a 14.0x Target Multiple to our 2019 EBITDA estimate of $43B (from $47B) to arrive at a $219/share valuation. For key context, Facebook is trading at 14x 2018E EBITDA and 11x 2019E EBITDA. We combine these two valuation frameworks and round the result, leading to our $225 PT.

Exhibit 8: Valuation Methodologies

($ in millions, except per share amounts)

Current Price (After Market) $173.00 Diluted Shares Outstanding 2,930 Current Market Cap 506,890 Less: Cash and Cash Equivalents 42,309 Plus: Debt 0 Enterprise Value 464,581

Price to GAAP EPS 2019 GAAP EPS $9.32 Current P/E on '18 GAAP EPS 24.4x Current P/E on '19 GAAP EPS 18.6x EPS CAGR '17-'20 30% Target Multiple 25.0x Implied Stock Price on Forward EPS $233

EV to Adjusted EBITDA 2019 Adjusted EBITDA 42,694 Current EV/Adj. EBITDA on '18 EBITDA 13.8x Current EV/Adj. EBITDA on '19 EBITDA 10.9x Adjusted EBITDA CAGR '17-'20 26% Target Multiple 14.0x Enterprise Value 597,717 Plus: '18 YE Cash 45,348 Equity Market Capitalization 640,723 Implied Stock Price on Forward EBITDA $219

Price Target $225 Source: RBC Capital Markets estimates, Company reports, FactSet; Priced as of 7:56PM EDT in the after-market on July 25th, 2018)

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 9 Internet Facebook, Inc.

Exhibit 9: Facebook’s Historical Forward P/E Valuation Range

High: 37.2x 40x Median: 25.9x Low: 18.2x 35x

30x

25x

20x

15x

1/1/17 7/1/17 7/1/15 9/1/15 1/1/16 3/1/16 5/1/16 7/1/16 9/1/16 3/1/17 5/1/17 9/1/17 1/1/18 3/1/18 5/1/18 7/1/18

11/1/15 11/1/16 11/1/17 P/E Median

Source: Factset, Company Reports, RBC Capital Markets estimates

Exhibit 10: Facebook’s Historical Forward EV/EBITDA Valuation Range

High: 19.2x Median: 14.3x 21x Low: 9.9x 19x 17x 15x 13x 11x 9x

7x

5/1/16 7/1/15 9/1/15 1/1/16 3/1/16 7/1/16 9/1/16 1/1/17 3/1/17 5/1/17 7/1/17 9/1/17 1/1/18 3/1/18 5/1/18 7/1/18

11/1/15 11/1/16 11/1/17 EV/EBITDA Median

Source: Factset, Company Reports, RBC Capital Markets estimates

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 10 Internet Facebook, Inc.

Valuation We value Facebook using a blended average of 25x P/E multiple and 14x EV/EBITDA multiple on our 2019 estimates. For key context, we are estimating 30% EPS CAGR for FB through 2020, which we believe supports these premium multiples. Our $225 price target is also supported by a DCF, assuming a 10% WACC and a 4% Terminal Growth Rate. Our price target supports our Outperform rating. Risks to rating and price target Risks to our price target and rating include but are not limited to: 1) broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Company description Founded in 2004 and headquartered in Menlo Park, California, Facebook is the world’s most popular social networking site with more than 2.5B users across its products. Through its flagship website, facebook.com, as well as mobile apps and various other tools, Facebook enables users to connect, share, discover, and communicate with each other. Facebook also provides a platform on which developers can build social apps and integrate their own websites with Facebook, further enhancing interactivity among users. Facebook generates revenue primarily through two channels: Advertising (99%) and Payments/Other (1%).

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 11 Internet Facebook, Inc.

Facebook, Inc. 2017E 2018E ($ Millions, Except EPS) 3/17A 6/17A 9/17A 12/17A 3/18A 6/18A 9/18E 12/18E 2015A 2016A 2017A 2018E 2019E 2020E Total Revenue $8,032 $9,321 $10,328 $12,972 $11,966 $13,231 $13,762 $16,213 $17,927 $27,638 $40,653 $55,172 $71,529 $92,783 Cost Of Revenue 1,125 1,190 1,401 1,561 1,871 2,140 2,226 2,594 2,783 3,676 5,277 8,831 12,875 18,557 Gross Profit 6,907 8,131 8,927 11,411 10,095 11,091 11,536 13,619 15,144 23,962 35,376 46,341 58,654 74,226 Operating Expenses 3,580 3,730 3,805 4,059 4,646 5,228 5,450 6,420 8,919 11,535 15,174 21,744 27,618 35,083 Marketing & Sales 961 1,004 1,056 1,268 1,486 1,716 1,789 2,108 2,394 3,401 4,289 7,099 9,060 11,567 Research & Development 1,164 1,132 1,276 1,362 1,520 1,642 1,707 2,010 2,411 3,413 4,934 6,879 8,775 11,197 G&A 588 562 463 615 685 684 716 843 1,068 1,486 2,228 2,928 3,724 4,738 Stock Based Compensation 867 1,032 1,010 814 955 1,186 1,239 1,459 3,046 3,235 3,723 4,839 6,059 7,581 Other 0 0 0 0 0 0 0 0 0 0 0 0 0 0 GAAP Operating Income 3,327 4,401 5,122 7,352 5,449 5,863 6,086 7,199 6,225 12,427 20,202 24,597 31,035 39,144 Depreciation and Amortization 671 728 778 853 949 1,034 1,119 1,204 1,215 2,342 3,030 4,306 5,600 6,900 Adjusted EBITDA 4,865 6,161 6,910 9,019 7,353 8,083 8,444 9,862 11,216 18,004 26,955 33,742 42,694 53,624 Other Income/(Expense) 81 87 114 110 161 5 100 105 -31 90 392 371 600 800 GAAP Pre-Tax Income 3,408 4,488 5,236 7,462 5,610 5,868 6,186 7,304 6,194 12,517 20,594 24,968 31,635 39,944 GAAP Taxes 344 594 529 3,194 622 762 1,732 1,096 2,505 2,301 4,661 4,212 4,745 5,992 Net Income 3,064 3,894 4,707 4,268 4,988 5,106 4,454 6,208 3,689 10,216 15,933 20,756 26,890 33,952 GAAP EPS $1.04 $1.32 $1.59 $1.44 $1.69 $1.74 $1.53 $2.13 $1.29 $3.50 $5.40 $7.09 $9.32 $11.93 Diluted Shares 2,944 2,951 2,956 2,954 2,945 2,930 2,920 2,910 2,857 2,916 2,951 2,926 2,885 2,845 Growth Rate Revenue (Y/Y) 49% 45% 47% 47% 49% 42% 33% 25% 44% 54% 47% 36% 30% 30% Revenue, ex-FX (Y/Y) 50% 47% 46% 44% 42% 38% 33% 25% 53% 56% 46% 33% 30% 30% Revenue (Q/Q) -9% 16% 11% 26% -8% 11% 4% 18% ------GAAP Exp Growth (Y/Y) 40% 33% 34% 32% 39% 50% 47% 60% 57% 30% 34% 50% 32% 32% GAAP Operating Income (Y/Y) 66% 61% 64% 61% 64% 33% 19% -2% 25% 100% 63% 22% 26% 26% Adjusted EBITDA (Y/Y) 47% 49% 52% 50% 51% 31% 22% 9% 38% 61% 50% 25% 27% 26% GAAP EPS (Y/Y) 73% 69% 77% 19% 63% 32% -4% 48% 17% 171% 54% 31% 31% 28% Margin Analysis Gross Margin 86.0% 87.2% 86.4% 88.0% 84.4% 83.8% 83.8% 84.0% 84.5% 86.7% 87.0% 84.0% 82.0% 80.0% Y/Y Change 1.2% 1.0% 0.1% -0.5% -1.6% -3.4% -2.6% -4.0% 1.2% 2.2% 0.3% -3.0% -2.0% -2.0% GAAP Operating Margin 41.4% 47.2% 49.6% 56.7% 45.5% 44.3% 44.2% 44.4% 34.7% 45.0% 49.7% 44.6% 43.4% 42.2% Adjusted EBITDA Margin 60.6% 66.1% 66.9% 69.5% 61.4% 61.1% 61.4% 60.8% 62.6% 65.1% 66.3% 61.2% 59.7% 57.8% Expenses as Pct. of Revenue Marketing & Sales 12.0% 10.8% 10.2% 9.8% 12.4% 13.0% 13.0% 13.0% 13.4% 12.3% 10.6% 12.9% 12.7% 12.5% Research & Development 14.5% 12.1% 12.4% 10.5% 12.7% 12.4% 12.4% 12.4% 13.4% 12.3% 12.1% 12.5% 12.3% 12.1% G&A 7.3% 6.0% 4.5% 4.7% 5.7% 5.2% 5.2% 5.2% 6.0% 5.4% 5.5% 5.3% 5.2% 5.1% Share-Based Compensation 10.8% 11.1% 9.8% 6.3% 8.0% 9.0% 9.0% 9.0% 17.0% 11.7% 9.2% 8.8% 8.5% 8.2% GAAP Tax Rate 10.1% 13.2% 10.1% 42.8% 11.1% 13.0% 28.0% 15.0% 40.4% 18.4% 22.6% 16.9% 15.0% 15.0%

Source: Company Reports, RBC Capital Markets estimates July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 12 Internet Facebook, Inc.

Required disclosures Conflicts disclosures The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated by investment banking activities of the member companies of RBC Capital Markets and its affiliates.

Please note that current conflicts disclosures may differ from those as of the publication date on, and as set forth in, this report. To access current conflicts disclosures, clients should refer to https://www.rbccm.com/GLDisclosure/PublicWeb/ DisclosureLookup.aspx?entityId=1 or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7.

RBC Capital Markets, LLC makes a market in the securities of Facebook, Inc..

A member company of RBC Capital Markets or one of its affiliates received compensation for products or services other than investment banking services from Facebook, Inc. during the past 12 months. During this time, a member company of RBC Capital Markets or one of its affiliates provided non-securities services to Facebook, Inc..

RBC Capital Markets is currently providing Facebook, Inc. with non-securities services.

Facebook's common shares consist of both a Class A and Class B issue. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Any transfer of shares of Class B common stock will generally result in those shares converting to Class A common stock. Explanation of RBC Capital Markets Equity rating system An analyst's 'sector' is the universe of companies for which the analyst provides research coverage. Accordingly, the rating assigned to a particular stock represents solely the analyst's view of how that stock will perform over the next 12 months relative to the analyst's sector average. Ratings Top Pick (TP): Represents analyst's best idea in the sector; expected to provide significant absolute total return over 12 months with a favorable risk-reward ratio. Outperform (O): Expected to materially outperform sector average over 12 months. Sector Perform (SP): Returns expected to be in line with sector average over 12 months. Underperform (U): Returns expected to be materially below sector average over 12 months. Restricted (R): RBC policy precludes certain types of communications, including an investment recommendation, when RBC is acting as an advisor in certain merger or other strategic transactions and in certain other circumstances. Not Rated (NR): The rating, price targets and estimates have been removed due to applicable legal, regulatory or policy constraints which may include when RBC Capital Markets is acting in an advisory capacity involving the company. Risk Rating The Speculative risk rating reflects a security's lower level of financial or operating predictability, illiquid share trading volumes, high balance sheet leverage, or limited operating history that result in a higher expectation of financial and/or stock price volatility.

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 13 Internet Facebook, Inc.

Distribution of ratings For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - Buy, Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick/ Outperform, Sector Perform, and Underperform most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis. Distribution of ratings RBC Capital Markets, Equity Research As of 30-Jun-2018 Investment Banking Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [Top Pick & Outperform] 854 53.61 262 30.68 HOLD [Sector Perform] 665 41.75 142 21.35 SELL [Underperform] 74 4.65 6 8.11

References to a Recommended List in the recommendation history chart may include one or more recommended lists or model portfolios maintained by RBC Wealth Management or one of its affiliates. RBC Wealth Management recommended lists include the Guided Portfolio: Prime Income (RL 6), the Guided Portfolio: Dividend Growth (RL 8), the Guided Portfolio: ADR (RL 10), and the Guided Portfolio: All Cap Growth (RL 12), and former lists called the Guided Portfolio: Large Cap (RL 7), the Guided Portfolio: Midcap 111 (RL 9), and the Guided Portfolio: Global Equity (U.S.) (RL 11). RBC Capital Markets recommended lists include the Strategy Focus List and the Fundamental Equity Weightings (FEW) portfolios. The abbreviation 'RL On' means the date a security was placed on a Recommended List. The abbreviation 'RL Off' means the date a security was removed from a Recommended List. Equity valuation and risks For valuation methods used to determine, and risks that may impede achievement of, price targets for covered companies, please see the most recent company-specific research report at https://www.rbcinsightresearch.com or send a request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. Facebook, Inc. Valuation

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 14 Internet Facebook, Inc.

We value Facebook using a blended average of 25x P/E multiple and 14x EV/EBITDA multiple on our 2019 estimates. For key context, we are estimating 30% EPS CAGR for FB through 2020, which we believe supports these premium multiples. Our $225 price target is also supported by a DCF, assuming a 10% WACC and a 4% Terminal Growth Rate. Our price target supports our Outperform rating.

Risks to rating and price target

Risks to our price target and rating include but are not limited to: 1) broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Conflicts policy RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. To access our current policy, clients should refer to https://www.rbccm.com/global/file-414164.pdf or send a request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time. Dissemination of research and short-term trade ideas RBC Capital Markets endeavors to make all reasonable efforts to provide research simultaneously to all eligible clients, having regard to local time zones in overseas jurisdictions. RBC Capital Markets' equity research is posted to our proprietary website to ensure eligible clients receive coverage initiations and changes in ratings, targets and opinions in a timely manner. Additional distribution may be done by the sales personnel via email, fax, or other electronic means, or regular mail. Clients may also receive our research via third party vendors. RBC Capital Markets also provides eligible clients with access to SPARC on the Firms proprietary INSIGHT website, via email and via third-party vendors. SPARC contains market color and commentary regarding subject companies on which the Firm currently provides equity research coverage. Research Analysts may, from time to time, include short-term trade ideas in research reports and / or in SPARC. A short-term trade idea offers a short-term view on how a security may trade, based on market and trading events, and the resulting trading opportunity that may be available. A short-term trade idea may differ from the price targets and recommendations in our published research reports reflecting the research analyst's views of the longer-term (one year) prospects of the subject company, as a result of the differing time horizons, methodologies and/or other factors. Thus, it is possible that a subject company's common equity that is considered a long-term 'Sector Perform' or even an 'Underperform' might present a short-term buying opportunity as a result of temporary selling pressure in the market; conversely, a subject company's common equity rated a long-term 'Outperform' could be considered susceptible to a short-term downward price correction. 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Analyst certification All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of the subject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report. Third-party-disclaimers The Global Industry Classification Standard ("GICS”) was developed by and is the exclusive property and a service mark of MSCI Inc. (“MSCI”) and Standard & Poor's Financial Services LLC (“S&P”) and is licensed for use by RBC. Neither MSCI, S&P, nor any other party involved in making or compiling the GICS or any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 15 Internet Facebook, Inc.

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July 25, 2018 Mark S.F. Mahaney, (415) 633-8608; [email protected] 16 Internet Facebook, Inc.

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