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We did a more in-depth analysis of the “investability” of social media players at the end of the second quarter, and not much has changed. Twitter (TWTR) found its long-term answer at CEO, but its valuation distribution, or range of probable fair value outcomes, is equivalent to a lotto ticket, one that’s not likely to pay off. Facebook (FB) continues to put up astounding numbers of active users, and LinkedIn (LNKD), while offering potential as a business-networking social media site remains unproven through the course of a more challenging job market, in our view. On fundamental basis, Facebook is our favorite one, and the social media giant remains near the top of our watch list for new idea considerations. Let’s take a look at the third quarter results of the three companies.
User Growth Remains Prevalent at Facebook
In September 2015, Facebook had just over 1 billion daily active users. For perspective, nearly one-seventh of the world’s population uses Facebook every single day. This figure represents growth of 17% on a year-over-year basis. Monthly active users grew 14% to 1.55 billion in the third quarter, while mobile daily active users and mobile monthly active users advanced 27% and 23%, respectively. The solid user growth helped drive revenue 41% higher from the year-ago period to $4.5 billion. Average revenue per user increased nearly 24% on a year-over-year basis to $2.97, a figure that increases to $10.49 when considering users in only the US and Canada.
Despite the strong top-line trends that continued in the quarter, aggressive investments in research and development and sales and marketing slowed the pace of bottom-line growth at Facebook. Research and development spending grew to over 28% of revenue from ~19% in the third quarter of 2014, and marketing and sales expenses advanced to nearly 16% of revenue from just under 12% in the year-ago period. GAAP income from operations grew 4% in the quarter, and GAAP diluted earnings per share advanced 3% to $0.31 on a year-over-year basis. We would have liked to see faster bottom-line expansion, but the expenses for investments are understandable.
Free cash flow growth may have been the most impressive aspect in the quarter for Facebook, as it advanced 84% despite capital expenditures growing nearly 62%. This helped the company grow its cash, cash equivalent, and marketable securities total to ~$15.8 billion as of the end of the third quarter from ~$11.2 billion a year ago. This substantial cash balance will come in handy as Facebook continues to invest in its efforts to connect the world as the ‘new Internet.’ Judging by its recent growth and CEO Mark Zuckerberg’s visionary abilities, we aren’t ruling this out as a potential reality. We continue to look for an entry point in shares.
Twitter Still Free Cash Flow Negative
Twitter’s user growth is far short of that of ‘big brother’ Facebook. In the third quarter of 2015, the firm reported monthly active users of 320 million, good for growth of 11% from the year-ago period. Monthly active user growth in the US was a lowly 4%, while the pace was 13% internationally. This helped push revenue up 58% on a year-over-year basis to $569 million. Advertising revenue growth outpaced total revenue growth, as it advanced 60% in the quarter on a reported basis.
Adjusted EBITDA may have been the biggest highlight for Twitter in the third quarter, as adjusted EBITDA margin grew to 25% of revenue from 19% in the year-ago period, more than doubling the total to $142 million. Another bright spot for the company in the period was the 39% decline in cost per ad engagement. This, along with significant operating margin improvement, helped non-GAAP earnings per share grow to $0.10 in the period from $0.01 in the third quarter of 2014. Nevertheless, the firm still failed to turn a profit on a GAAP basis.
In addition to recording a GAAP loss, Twitter remained free cash flow negative in the quarter. The firm’s cash, cash equivalent, and marketable securities total fell $100 million in the quarter sequentially to ~$3.5 billion. Improvement in cash flow will be paramount to the health of the company and will perhaps be a byproduct of its main initiatives, which are disciplined execution, the simplification its services, and improved communication of the value of its services. We think these initiatives are a fine place to start, but the future of Twitter remains a speculative bet at best.
LinkedIn Still Benefiting from Strong Job Market
In the third quarter of 2015, LinkedIn reported member growth of 19%+, to $396 million on a year-over-year basis, and member page views grew nearly 36% in the period, to ~38 billion. This helped the company advance total revenue 37% from the year-ago period to $780 million. The firm’s highest revenue growth came from its Talent Solutions segment, with a growth rate of 46% from the third quarter of 2014, to revenue of $502 million. The company’s ‘Marketing Solutions’ revenue grew 28% on a year-over-year basis to $140 million, and ‘Premium Subscriber’ revenue advanced 21% to $138 million.
LinkedIn grew adjusted EBITDA in-line with the pace of revenue to $208 million, as its adjusted EBITDA margin remained unchanged from the year-ago period. An increase in depreciation and amortization and stock based compensation led to the company recording a GAAP loss of $0.31 per share in the third period of 2015, but on a non-GAAP basis, earnings per share grew 50% on a year-over-year basis to $0.78. That’s some nice bottom-line growth.
The increase in non-GAAP earnings helped grow cash from operations–depreciation and amortization and stock based compensation are added back to GAAP net income in the calculation of cash from operations–and consequently free cash flow, which advanced nearly 21% from the year-ago period to ~$73 million. This came despite the 38% increase in capital expenditures on a year-over-year basis. The firm’s cash, cash equivalents, and marketable securities grew slightly on a sequential basis to ~$3.1 billion in the period.
Though we note LinkedIn continues to put up strong growth, we’re not sure the firm will be able to handle adversity well during the next economic downturn. Even under a situation where there may be more job-seekers in tough times, they will have less cash to spend on membership fees, and the firm’s ‘Talent Solutions’ and advertising-based revenue streams may face significant pressure during slow economic periods as employers scale back recruiting needs. LinkedIn has benefited from 67 straight months of private sector job growth from February 2008 through September 2015. We maintain our view that the company’s business model has not yet been tested, and we think investors may be surprised when times get tough.