MorningWord 7/25/13: FB’s Q2 results last night shattered a main tenet of the near-term bear thesis on the company, that FB was unable to monetize their mobile users in a manner that offsets declining user activity on PCs in what appeared stagnating user engagement. FB’s total Q2 sales were 13% ahead of consensus, with mobile ads making up 41% of total ads, was up 30% sequentially. On the conference call (transcript here), FB’s CFO David Ebersman did not give specific forward guidance, and while suggesting that drivers of mobile ad strength are fairly recent, he appeared to tempter expectations for growth at similar rates of late:
” We expect newsfeed ads to remain the main driver of revenue growth in the second half of the year and we believe we have a great opportunity to continue to drive long-term growth by improving the quality and relevance of these ads. However remember that newsfeed ads really began to contribute to our revenue in the third and fourth quarters last year which will make for more difficult year-over-year comparisons in Q3 and Q4 relative to Q2.”
I am not going to knock the quarter and their execution, there appears to be little reason to do so, but for those of you who are not on the Facebook, like me, let’s get a sense for how they are getting this mobile ad growth. Your Newsfeed is the stream of all your Friend’s status updates on your main page. FB is getting most of their ad sales, (as stated above) by placing targeted ads in that feed based on all of the info that can get from you on your profile and on you and your linked friends’ pages and even shopping you do elsewhere both by following you with cookies to toher sites, or even into the real world at places like Walmart through technology tracking your credit card ourchases provided by Datalogix. Creepy but profitable. To me the rapid mobile adoption is clearly part of a secular shift and had to be expected, so the recent trend of rapid ad growth comes hand in hand with mobile adoption, but at the expense of their core desktop business. In our FB earnings preview, Enis highlighted what should have been a fairly obvious assumption:
To get a sense for the potential for growth in the mobile business, mobile accounted for almost $500 million in revenues in 2012. In 2013, analysts estimate it could amount to almost $2 billion, and possibly over $3 billion 2014. That’s massive growth. In contrast, the desktop business booked about $5 billion in revenues in 2012, expected to grow to $6.5 billion 2013 and $8.5 billion in 2014. Solid growth (around 30% yoy), but dwarfed by the rate of growth in mobile. In that sense, investors today are paying 35x 2014 estimated earnings because of that potential in mobile. The company must execute and deliver there to meet or surpass those expectations.
To Enis’ last point, they are clearly executing, but I wonder how much it has to do with FB’s targeted action or user behavior that FB has no control over?
The stock is up 30% in the pre-market, and frankly I am shocked, not because the quarter and the commentary wasn’t good, it was great, but how could so many analysts and investors underestimated the potential reaction to the least bit of good news in a stock that has had so little? Heck we even set up an options trade in late May to play off of the poor sentiment in the stock and looking out to Q2 earnings as the next identifiable catalyst, suggesting:
while I remain very mixed on the company and their products, if the stock could stabilize in this $24-$26 area over the next couple months and establish a new base, the stock could set up for a re-test of the $30 level following a better than expected Q2.
Just because I am not a fan of FB’s products doesn’t mean I am not happy for FB investors. But frankly, I am shocked that a company that had a $65billion market cap yesterday at 4pm will open with an $85 billion market cap this morning at 9:30am. In my nearly 17 years in this business I can’t remember more than a handful of instances that this sort of market cap increase happened on an earnings beat. My main issue with FB is that I think the quality if users going forward in mature markets will be weak, and that user engagement should decline with increased advertising intrusiveness. Aside from that, every friend of mine who I ask who has been a FB user for years is using it less and less (so they say), and my young kids who have iPads and soon to have iPhones will most likely never have a FB account (so they say). Where is their user growth going to come from in the developed world, where ad rates are the highest?
Just as GOOG’s mature advertising network is struggling with cost per clicks on their shift to mobile, FB will have to contend with this headwind after their period of rapid growth. In the meantime, could earnings increase at a much faster rate while the company goes a low revenue base in a fast growing secular shift? Sure, and could this growth justify a higher multiple? No doubt about it. SO the question is do you buy it here at $34, up nearly 30%??? No. And if you’re long you may even want to start laying into the stock on its way back to its IPO price. For those looking to get long you have to wait for a pullback now. The market cap increase overnight is just too big a jump to chase. The story might have changed, and the stock might have room to run back to IPO price, but who in their right mind buys a large cap stock up 30% in one day? $31/$32 is the first pullback support level to look to as that would be a healthy a healthy re-tracement of a portion of the move to what was the previous 52 week high.