Facebook reported very good September quarter results but surprised investors with its very aggressive expense ramp in 2015 (non-GAAP expenses to rise 50%-70% year over year). September quarter revenue of $3.2 billion increased 59% year over year almost matching June’s 61% growth rate and was $80 million more than sell-side analysts projected (but probably more in-line with buy-side expectations). Non-GAAP gross margins were 82.9%, the fourth quarter they have been above 80%, and non-GAAP EPS of $0.43 was nicely above the sell-side average estimate of $0.40. Overall a very good quarter.
It isn’t very hard to model Facebook generating $17 billion in revenue for 2015, up 37% from about $12.4 billion this year. If you assume non-GAAP gross margins will move up a small amount to around 83.5% and use the mid-point of 60% growth in operating expenses (without stock compensation) you get EPS of $2.03. If expense growth comes in at 70% EPS would drop to $1.92 and if expenses only grow 50% EPS rises to $2.14.
The stocks reaction isn’t surprising since Facebook's EPS growth rate is cloudier
When investors get some cold water thrown on their face such as next year’s expenses going to be much higher than expected it is going to move the stock down (it is down $5 to just under $76). It also gets investors to lower the multiple they are willing to pay for a stock since a bit more uncertainty needs to be factored in.
At the mid-point of guidance Facebook will have a $2 billion increase in operating expenses to almost $5.5 billion in 2015 vs. $3.4 billion in 2014. Investors should reasonably be concerned about management’s ability to ramp expenses wisely.
While in this case it gets financial models to lower earnings and cash flows Facebook is still in a very positive position. It is growing very fast, has high margins and is still in the early stages of monetizing its platform and users.
Valuation isn’t unreasonable but needs to execute
With the shares at $76, down almost $5, they are trading at 38x an EPS estimate of $2.00 in 2015. Expensive but with the company’s potential growth not unreasonable.
The additional stock used by Facebook for the WhatsApp and Oculus acquisitions are helping to drive up the share count to 2.8 billion in the December quarter. At a stock price of $76 its market cap is $213 billion so its market cap to 2015 revenue ($17 billion) ratio is 12.5x. This is high but livable due to the growth rates and margins.
Pretty much all the metrics by geography were solid
While the North America and Europe Daily user growth metrics aren’t anything to write home about, up 8% and 13% year over year, respectively, their advertising revenue growth of 64% and 62% are very good.
Asia and the Rest of the World saw their Daily users grow 28% and 23% year over year, respectively, with their advertising revenue growing 84% and 50%.
To get a feel for user monetization the Average Revenue Per Monthly User (ARPU) for North America was $6.64 in the quarter (up 59% year over year), Europe was $2.66 (up 51%), Asia was $1.12 (up 52%) and the Rest of the World was $0.82 (up 27%).
What sell-side analysts are saying
For a sampling of what the sell-side analysts are saying about Facebook below are six of them, five with positive outlooks and one who is Neutral. First up is Evan Wilson at Pacific Crest who has the Neutral rating.
Evan Wilson at Pacific Crest: Sector Perform with Bear case of $50 and Bull case of $95
‘Facebook once again posted margin upside, with EBITDA margin at 65.8% versus our estimate of 65%. Spending has fallen well behind the rate expected in every quarter since the company went public. Facebook lowered its capex guidance again. However, it continues to forecast much more significant spending growth going forward.’
‘We still expect 30% expense growth in 2014, but are increasing our expense growth expectations to 50% in 2015. Our 2015 EPS estimate goes to $1.90 versus our previous estimate of $2.05. As revenue growth decelerates from tougher comparisons, margin deleverage will be a challenge for shares, especially as large-cap investor scar tissue has built up from
Now for the positive analysts
Anthony DiClemente at Nomura: Buy with $90 price target
‘We expect this morning’s conversations with investors to be characterized by hand-wringing about whether or not Facebook is on the precipice of entering a deep, intractable investment cycle, given the company’s very high 2015 expense growth guidance.’
‘First off, we believe Facebook’s stated investment plan is well-conceived and likely to prove strategically wise in the longer term. Moreover, we believe CFO Dave Wehner may be setting conservative expectations on expense growth, thus borrowing a page out of former-CFO David Ebersman’s playbook on expectation setting practices.’
Mark Mahaney at RBC: Outperform with $92 price target
‘We are Buyers Of This Dip. Why?
* We have already seen relatively rapid share price recoveries post Q3 EPS corrections – AMZN up 4%, EBAY and GOOG up 7%, NFLX up 16% – so this market is buying beaten-down Net stocks.
* More importantly, FB’s Q3 P&L and Metrics results were intrinsically very strong – arguably, the cleanest ‘Net so far.
* Ramping up investments – from a position of strength – in many promising, high-growth areas (e.g. video –now at 1B daily video views).
* Those high growth areas represent four greenfield revenue opportunities (Instagram Monetization, Auto-Play Video Ads, FAN and WhatsApp) that can contribute $2.7B+ in incremental Revenue in ‘15 (per our 8/29 ULT report), offsetting the stepped-up opex, and leaving our near-term EPS estimates largely unchanged, but our long-term estimates increased.
* Per our valuation work, FB remains one of the most attractive Large Cap Nets on a growth-adjusted valuation basis – EV/EBITDA/Growth < 0.5X.’
Bob Peck at SunTrust: Buy with $90 price target
‘Expense guidance for 2015 implies ~$1B higher non-GAAP spend vs. consensus. GAAP spend guidance is further exacerbated by the jump in stock based compensation and amortization per recent acquisitions. The guidance will cause margin and profit forecasts to be reined-in as the company did not provide any revenue guidance to counter.’
‘However, we note at an incremental non-GAAP operating margin of 75% (trailing 4-quarter average), it only takes ~$1.3 billion in new revenue to offset the ~$1 billion higher spend. With a revenue base greater than $16 billion in 2015 and nascent opportunities in Instagram, Video, Graph Search, eCommerce, FAN, WhatsApp and LiveRail, we do not view ~$1.3 billion as a stretch even as we are cognizant that the company will monetize these opportunities at a measured pace. Recall our previous work has suggested these opportunities could ultimately sum to upwards of $9 billion. While higher spend elevates risk and uncertainty, we believe the company is investing ahead of the curve from a position of strength.’
Eric Sheridan at UBS: Buy with $92 price target
‘We were positive on:
a) continued strong engagement and user growth trends for Facebook (MAUs in line at 1.35b, slight DAU beat at 864mm & continued engagement improvement with 64% DAU/MAU ratio);
b) strong ad revs growth (mobile ARPU +71% YoY) even against tough comps;
c) clearly articulated multiple year strategy (3, 5 & 10 years) laid out by management to accomplish goals in areas of public content, community expansion, digital advertising (targeting and attribution), global messaging, next gen computing platforms & expanding global Internet connectivity.’
‘We were less positive on implied guidance for the December quarter (revenue deceleration and foreign currency headwinds) and 2015 non-GAAP operating expense guide for 50-70% YoY growth (vs. our prior estimate of 38.5%).’
Youssef Squali at Cantor Fitzgerald: Buy with $80 price target
‘Management's unexpected decision to make 2015 an aggressive investment year across its multitude of platforms should pressure margins and the stock short-term, but position the company for greater engagement and monetization across core Facebook, Instagram, WhatsApp, and Oculus over time.’
‘We view this decision as being made at a time when Core Facebook is firing on all cylinders, and therefore from a position of strength, not weakness. FB remains a top pick for us, given 1) its position as the largest/most-engaged Internet platform, offering personalized marketing at scale, 2) the on-going shift of ad dollars to mobile/social, and 3) still untapped monetization potential for Instagram and WhatsApp, all at a compelling valuation.’
