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After a rough stretch for shares, Facebook’s third quarter report has helped breathe some life into the stock as the company continues to grow at a robust double-digit rate and free cash flow generation remains superb.
By Kris Rosemann
Shares of simulated Best Ideas Newsletter portfolio idea Facebook (FB) have faced significant selling pressure since its second quarter report that indicated it would be taking a number of self-enforced measures that would severely impact its operating margin, but a third-quarter report that included a slight near-term cost and capital spending guidance reduction has breathed some life into shares. We think the company may have given in to political pressures, but we continue to have confidence in its ability to absorb higher costs, higher capital spending, and potentially lower monetization rates given the cash-rich nature of its business. Since the release of the second quarter report, we have lowered our fair value estimate for shares, which now sits at $229 each, as a result of higher capital spending and lower operating margin expectations.
According to Facebook’s third quarter report, released October 30, more than 2.6 billion people use at least one of its platforms each month, including Facebook, WhatsApp, Instagram, or Messenger, and more than 2 billion use at least one of its services every day on average. Monthly active users (MAUs) advanced 10% on a year-over-year basis as of the end of the third quarter, and average revenue per user advanced just over 20% from the year-ago period to $6.09. Total revenue advanced 33% in the quarter on a year-over-year basis, and mobile advertising revenue accounted for ~92% of advertising revenue, which accounted for nearly 99% of total revenue, in the period, up from 88% in the comparable period of 2017.
Facebook’s operating margin faced notable pressure in the third quarter, as was expected as a result of its increased focus on policing and securing its platforms and user base amid political pressure. A rising percentage of impressions from services that carry a lower level of monetization, such as Instagram stories, is also impacting results, but management believes its business is on the path to catching up with its evolving user base. The company’s headcount at the end of the quarter was 45% higher than a year earlier, indicating the additional resources it is pouring in to such efforts. Diluted earnings per share advanced 11% to $1.76 in the period.
The company’s significantly higher capital expenditures in the third quarter was yet another indicator of the increased investments it is making to satisfy critics and mitigate outside pressure. Free cash flow generation in the quarter fell 5% from the third quarter of 2017 to less than $4.2 billion as capital spending leapt 90%, and the measure came in roughly flat through the first three quarters of 2018 compared to the same period in 2017 despite capital spending more than doubling. The company’s balance sheet remains debt free as of the end of the third quarter, and it holds $41.2 billion in cash, cash equivalents, and marketable securities.
Management lowered its expectations for total expenses growth for the full-year 2018 to 50%-55% from previous guidance of 50%-60%, and capital spending guidance has been lowered to a range of $14-$14.5 billion from $15 billion. The company expects 2019 operating expenses to grow 40%-50% over 2018 levels, and capital expenditures are expected to be approximately $18-$20 billion in 2019, driven by ongoing data center investments. Both of these guidance measures add more clarity but are roughly in-line with prior expectations, and we have tweaked our fair value estimate slightly to $229 per share as a result of the more refined guidance.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.