$FB Q3 Earnings Preview

by Enis October 29, 2013 1:10 pm • Commentary

Event:  FB reports its Q3 earnings tomorrow after the close.  The options market is implying about a 12.5% one day move, which is below the 5 qtr avg (FB has reported 5 times in its history) of about 13.5%.  The average is skewed higher by the 30% move higher after its last earnings report in July.

Sentiment:  Wall Street analysts are very positive on the stock, with 37 Buys, 9 Holds and 0 Sells, though the average 12 month price target is only around $54.  The stock’s short interest stands at only 1.75% of float.  That’s down from around 6% a year ago.  The stock more than doubled from early July to today.

Options Open Interest:  Open interest is heavily skewed to calls vs. puts, by a ratio of 1.55 to 1 (this ratio was 1.4 prior to its last earnings report).  The activity over the last month has favored calls to puts by a ratio of 2.25 to 1.  The Nov15th 65, 70, and 75 calls all have open interest over 60k, and the Jan14 60 and 65 call lines both have open interest over 70k.  In Jan15, the Jan15 22 puts and the Jan15 32 calls both have over 80k of open interest (traded as a strangle).

Price Action / Technicals: 

Facebook’s advance since its huge post-earnings gap on July 31st has been very impressive, especially since FB more than doubled its market cap to $120 billion, making it one of the largest internet companies in the world.  We noted in our CotD last month that FB had advanced after earnings on a series of high volume bars, indicating substantial institutional demand.  The stock’s breakout above the $45 level, which was near its intraday high on the IPO, has held ever since.  That is now crucial support:

FB daily chart, Courtesy of Bloomberg
FB daily chart, Courtesy of Bloomberg

The stock’s all-time high was set earlier this month at $54.83.  From a technical perspective, the 45 to 55 range is the highest probability area for the stock, though I view $45 as much stronger support on the downside given the long-term perspective than the potential resistance around $55, which just happens to be the recent high.

Fundamentals:   This was our takeaway from our last earnings preview in July, when the stock was around $26:

Mobile is the key to this earnings report.  While many reports show decreased engagement on FB, the fact remains that it is the largest social media platform on the internet.  So the opportunity is there.  The real question is whether FB can entice advertisers to pay up for mobile and desktop ads.  In that respect, GOOG’s recent earnings report highlighted the continued concern of decreasing cost per click in the internet advertising space.  Analysts have modeled in a decline in desktop CPM, but mobile is still a nascent market where little historical information exists about user experience and ad effectiveness.

Of course, FB went on to handily beat mobile estimates, and raise guidance on that front as well. Analysts quickly ratcheted earnings estimates and price targets higher, but even they couldn’t keep up with the stock’s actual price appreciation after that report.

In reality, the report itself was not as strong as the price action seems to indicate.  But this was a stock that went from 35% institutional ownership before that earnings report to around 55% institutional ownership today, a big move in just 3 months, and an indication that large fund managers have felt forced to buy Facebook as one of the few major growth stories in large cap tech.

Heading into this quarter, expectations are higher, and the comps are tougher too, as Facebook’s CFO noted on the conference call of the July report:

“ 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.”

However, once again, the real figure to watch will be the mobile ad spend (consensus estimates around $800 million, +20% quarter-over-quarter).  If mobile growth is higher than expected for the second straight quarter, market participants won’t care much about a slowdown in desktop ad revenues.  If mobile growth disappoints, then $45 will be the level to watch for support on the downside.

Volatility:  Facebook’s 30 day implied volatility is much higher this time around than it was prior to its last couple earnings releases, as traders take into account the huge 30% move higher on the last earnings report:

FB 30 day implied vol vs. 30 day realized vol, Courtesy of LiveVolPro
FB 30 day implied vol vs. 30 day realized vol, Courtesy of LiveVolPro

Recent realized volatility has been around the mid-30’s, which is probably where implied vol will fall after the earnings report. Nov IV is almost 75 and December is about 53 so that will be a big vol crush from a percentage standpoint.

Our View:  FB is one of the biggest winners of 2013, and all of the performance has occurred over the past 3 months.  After posting strong mobile revenue growth last quarter, institutions were stumbling over themselves to buy the stock, as evidenced by the big volume on each push higher.

Expectations have been reset ahead of this earnings report, but this is still a friendly market for internet stocks that show revenue growth (see GOOG or AMZN).  If FB shows more momentum on mobile, then a new all-time high is likely in the cards.  If not, then $45 is strong support, and many institutions will likely be happy to buy more on any weakness.