Event: Facebook (FB) reports Q3 results tomorrow night after the close. The options market is implying about a 6% one day move which is rich to the 4 qtr average of 3.25%, and the long term average of about 8%. Prior to FB’s Q2 report on July 29th, the stock closed at $97, about 5.5% lower than current levels, but the options market was implying about an 8.5% one day move. Needless to say the stock declined a tad less than 2% the following day.
Price Action / Technicals: Most of the stock’s 31% ytd gains have come since the start of Q3. Prior to the stock’s breakout to new highs, I mistook FB’s consolidation between $75 and $85 as investor concern with valuation vs expected growth (that was clearly wrong). Since the stock established a new range above prior resistance in late June, $100 has been important psychological technical resistance, now support:
The move in the last couple weeks above $100 probably has less to do with optimism about Facebook’s results and guidance, and more in sympathy with investor excitement in growth stocks like AMZN & GOOGL that put up big Q3 results.
Sentiment: Wall Street analysts remain overwhelmingly bullish with 47 Buy ratings, 4 holds and 2 Sells with an average 12 month price target of $114. Short interest sits at less than 2% of the float.
Implied Volatility Snapshot: The implied earnings move is well below last quarter, and that is for a couple of reasons, most notably positioning, but with 30 day at the money implied vol at 36%, well below the 46% heading into the Q2 print in late July suggests less investor worry just three months later despite what was a fairly volatile quarter for the stock:
Options Open Interest: Another way to explain last quarter’s high implied move vs this quarters is too look at options trading volume (orange below) and the explosion in open interest (yellow below) heading into late July, both topping 2015 highs. However you want to dice it up, investors went from fairly complacent in June to a heightened sense of urgency of trading options (a ton of bullish call positioning as we highlighted here back in July) in the stock in front of the Q2 print:
As for current open interest, 9 of the top 10 largest strikes are calls, with the top four: 66k of the Jan16 100 calls, 50k of the Jan16 110 calls, 49k of the Dec 110 calls and 44k of the Nov 90 calls.
Expectations: RBC Capital’s Mark Mahaney highlighted the following items for investors to focus on in a note to clients:
1) User growth and engagement – FB has continued to grow users at a reasonably robust pace off a very large base (13% Y/Y growth and 1.49B users in Q2:15). At the same time, engagement hit all-time highs in several regions in Q2. In Q3, we are estimating Y/Y MAU growth of 12% to 1.48B, with a Q/Q rise in the DAU/MAU ratio to 65.2%, 20bps above Q2:15’s tie for record high.
2) Advertising revenue growth – FB saw ad revenue growth of 55% (ex-FX) in Q2. In Q3, FB will face a 2-point easier Y/Y Ad revenue comp (ex-FX), and we are modeling a Q3:15 Ad Revenue growth rate (ex-FX) of 49%. We view anything close to 50% as a positive.
3) Margin levels – FB produced a strong 55% NonGAAP Operating Margin in Q2, despite entering an investment cycle. For Q3, we are also looking for a 53% Non-GAAP Op margin, down 360bps Y/Y. We note management stated opex will grow 50–55% Y/Y in 2015.
Estimates & Forecasts from Bloomberg:
-3Q adj. EPS est. 52c (range 47c-55c)
-3Q rev. est. $4.37b (range $4.25b-$4.42b)
-3Q mobile ad rev. est. ~78% of total ad rev. (avg. of 3 ests. compiled by Bloomberg); ~76% last qtr
-3Q monthly active users (MAUs) est. 1.52b (5 ests.)
3Q daily active users (DAUs) est. 995m (5 ests.)
Note: July 29, FB reported MAUs 1.49b as of June 30; mobile MAUs 1.31b; DAUs 968m on avg. for June
My Take: Expectations are not low, which has moved in lock step with the stock’s valuation. Valuation though, has been a tough determining factor to own or not own FB (and been downright wrong input to short on). There are a couple ways to think about it. The company is dominating and devouring nearly all social media and short messaging platforms, has a massive 1.5 billion person audience and growing, that will continue to be monetized (despite mobile ad rates being lower than desktop). The company will experience decelerating growth, but consensus is calling for 32% eps (adjusted) and 36% sales growth in 2016, there is not a single company with more than $50 billion market cap in the S&P 500 that can boast that (let along FB’s $290 billion market cap). On a PE/Growth, on a forward basis at 1.2x, the stock is not exactly expensive. On a price to sales ratio, FB trades at 17x current and 13x forward, vs GOOGL with a forward PE/G of 1.4 and trades 7x sales, FB a tad rich. If you are of the mindset that FB can grow sales north of 25% in an increasingly profitable manner then the current multiple is ok. But that’s a big if. With a company like FB that has grown sales from $5 billion in 2012 (the year it went public), to an expected $17 billion this year, means at some point the law of large numbers is likely to kick in. But when you consider that GOOGL is expected to grow sales this year to $60 billion, up 15% year over year, maybe there could be a lot more room to go for FB. To be fair, the stock’s $290 billion market cap, making it one of the largest market caps on the planet speaks volumes for the opportunities that lie ahead. Long term investors refuse to get off the bus in what could be the next $50 billion revenue company.
Taking a look back at Q2 results reported on July 29th, the company said that mobile ad growth rates will continue to decline, expenses are going up (op margins were down to 31% in the qtr from 48% the prior year), while daily active users came in slightly below expectations. The stock briefly sold off as investors digested what was not unexpected news. So decelerating growth is expected, but maybe more importantly investors want to hear about monetization of Instagram, which they reported in the quarter now has 400 million monthly active users, well above Twitter’s 320 million.
It appears once again, like in late July, expectations are high, sentiment remains white hot towards the stock, but investors are prepared for higher spending and decelerating growth rates. Investors seem to think the stock is in a bit of a goldilocks period.
This makes me a tad nervous, but the recent investor crowding into growth stocks suggests the stock will be bought on weakness, as NFLX was post results.
On Friday we laid out a defensive overlay for long holders who don’t want to sell, but are willing to give up some near term upside to protect against a sharp move lower, read here.
We will offer some other trade ideas tomorrow prior to the print.