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Let’s dig into Best Ideas Newsletter holding Facebook’s (FB) third-quarter results, released November 2.
By Kris Rosemann
What management said:
“We had another good quarter,” said Mark Zuckerberg, Facebook founder and CEO. “We’re making progress putting video first across our apps and executing our 10 year technology roadmap.”
The scoop:
Though shares of Facebook sold off on worries about slowing revenue growth after its third-quarter report, released November 2, the social media giant continues to grow at a tremendous rate. On a year-over-year basis, advertising revenue jumped 59% in its third quarter thanks to mobile advertising revenue growth of 78%. Mobile advertising revenue now accounts for roughly 84% of total advertising revenue. Declining total payments and fees revenue is a non-issue, in our view, as it made up less than 3% of total revenue in the quarter. Revenue in this area is largely generated via games played on personal computers, which has been on the decline and is expected to continue to do so.
The growing share of mobile advertising as a portion of total revenue helped boost profitability in the period, as higher mobile ad demand allows Facebook to charge more for mobile ads than traditional ones. The firm’s operating margin exploded to 45% in the third quarter of 2016 from 32% in the comparable period of 2015. Diluted earnings per share leapt to $0.82 from $0.31, while free cash flow generation, as measured by cash flow from operations less all capital expenditures, came in at ~$2.5 billion, up from $1.41 billion in the year-ago period. Through the first nine months of 2016, Facebook has hauled in ~$6.5+ billion in free cash flow, or nearly 35% of total revenue.
Image Source: Facebook
Insight from the quarterly conference call:
“We had another good quarter. Our community continues to grow around the world. We’re pleased to see nearly 1.8 billion people now use Facebook every month and nearly 1.2 billion people use it every day. It’s also great to see the continued growth and strength of engagement on our platform, and our ads growth is growing at a healthy rate as well.” – CEO Mark Zuckerburg
“We also took some important steps forward on virtual reality to help people experience the world in richer and more immersive ways. At Oculus Connect, we announced that touch controllers for Rift will ship in early December with 35 games and experiences exclusively built for touch. And since we believe the next phase of VR is great software experiences, we’re investing another $250 million in virtual reality content on top of the money that we’ve already invested.” – CEO Mark Zuckerburg
“I…want…to provide some brief comments on 2017. First on revenue, as I mentioned last quarter, we continue to expect that ad load will play a less significant factor driving revenue growth after mid-2017. Over the past few years, we have averaged about 50% revenue growth in advertising. Ad load has been one of the three primary factors fueling that growth. With a much smaller contribution from this important factor going forward, we expect to see ad revenue growth rates come down meaningfully.” – CFO David Wehner
“Secondly on expenses, though it is premature to provide specific expense guidance, as Mark mentioned, we anticipate 2017 will be an aggressive investment year. Adding top engineering talent remains one of our key investment priorities as we continue to execute on our 3, 5, and 10-year roadmap. … In addition, we expect to grow capital expenditures substantially, as we continue to fund the ongoing data center expansion effort that we have underway.” – CFO David Wehner
Are we changing our mind with our position?:
In short, no; Facebook remains a core holding in the Best Ideas Newsletter portfolio. This isn’t the first we’ve heard of slowing growth for the company–as CFO David Wehner alluded to a similar dynamic playing out in the firm’s conference call following the second quarter of 2016–but we’re not worried. The law of large numbers, as in the primary driver behind Facebook’s potentially slowing growth rate, has little bearing on the magnitude of free cash flow generation that forms the basis of our valuation processes.
That said, our current fair value estimate of $142 assumes a slowdown in top-line growth in 2017 that is slightly below consensus estimates—a relatively conservative assumption. Facebook’s strong free cash flow generation and fortress-like balance sheet—it has a cash position of over $26 billion compared to no long-term debt on the books—helps put our mind at ease with respect to its financial health. Though we expect volatility in Facebook’s margins as it continues to invest in the business, both its operating and free cash flow margin will remain impressive for the foreseeable future. We believe Facebook stands alone among social media behemoths.
Related tickers: SOCL, TWTR