Despite The High Expected Growth, Facebook Is Overpriced

May. 9.13 | About: Facebook (FB)

In a recent call, Facebook's (NASDAQ:FB) management announced its Q1 2013 operational and financial results. The company was able to meet its revenue estimates, but missed its earnings estimates - although only by a few pennies. The details of the operational and financial results of Q1 2013 are given in the following table along with comparable quarter results.

The company's overall revenues increased by 37.81% YoY, but fell by approximately 8% QoQ. The company's advertising revenues, which have always been the company's largest source of revenues, increased by an amazing 42% YoY. The most exciting point in the earnings of the company is that mobile ad revenues accounted for 30% of the overall ad business of the company. It was the fastest-growing segment for the company, increasing from 23% of total ad revenues in Q4 2012 to its current level.

The company's diluted EPS has improved significantly from last quarter, but is relatively stable compared to a year ago. Despite this increase in the overall EPS from last quarter, the company's margins shrunk. The largest contributors to this decline in margins are the cost of revenues, which jumped from 25% of total revenues in the last quarter to 28% of revenues in this quarter, and marketing and sales cost, which increased to 14% of revenues from 12% of revenues in the previous quarter. The management stated that it is expecting a further squeeze in margins in the coming periods as expenses are likely to increase while the company develops more infrastructure, new campuses, new products and builds a larger team.

Historic Performance

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Advertising revenues have historically accounted for around 84 to 85 percent of the company's total revenues and have achieved a CAGR of around 8.75% over the past 9 quarters. However, the growth in ad revenues has picked up over the past 4 quarters, achieving a CAGR of more than 9.3%.

Despite an almost consistent quarter-on-quarter increase in revenues, the company's EPS has fallen from $0.11 in Q1 2011 to $0.09 in Q1 2013, achieving a negative EPS in Q2 and Q3 of 2012. The fall of more than 18% in 2 years was primarily caused by a sharp decline in the company's margins. As can be seen from the table below, the operating margin fell from an impressive 53% in Q1 2011 to 26% in Q1 2013. Similarly, the net margin dropped to 15% in Q1 2013 from almost 32% in the same quarter of 2011. The Q2 2012 period is to be considered an anomaly as it included close to $1 billion in share-based compensation that is unlikely to be repeated in the coming periods.

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The company's debt level has also increased significantly in the last two quarters as the company acquired a loan worth $1.5 billion. Although this transaction raised the company's D/E ratio above that of the industry, its healthy coverage ratio and high cash from operation allows the company to sustain a higher level of debt.

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There has been a constant improvement in the user metrics of the company, with improvement over two years. The Daily Active Users (DAU) and Monthly Active Users (MAU) grew by an average of 7.5% and 6.3%, respectively. Average Revenue per User (ARPU) has also increased by 2.14% over the past 2 years.

For FB the largest source of growth in terms of users were Asia and the Rest of the World (RoW) regions. These regions are also the largest for the company in terms of MAUs, with 319 million MAU in Asia and 327 million MAU in the RoW region. The Asian DAU and MAU grew at 11% and 9.35% over the past two years. The RoW region DAU and MAU grew at 11.75% and 9.26%, respectively.

The US and Canada continue to dominate the company's financials as the region achieved the highest ARPU of $3.50 in Q3 2013, far ahead of second-place Europe, which posted an ARPU of $1.6 in the same period. Despite the financials being dominated by the developed markets, the largest growth was achieved in the emerging market regions of Asia and RoW. The Asian ARPU grew by an average of 5.10% from Q1 2011 to Q1 2013, while RoW region's ARPU grew at an average of 6.16% over the same period. Going forward, these two regions are expected to continue to achieve large growth.

Industry Outlook

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As can be seen above, the online ad market continues to be dominated by Google (NASDAQ:GOOG). FB could only grasp a 6% share in the market. The global digital ad spending was around $102.83 billion according to eMarketer. The market is expected to grow by 58.55% to an estimated $163 billion by the year 2016.

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Going forward, it is expected that the competition amongst the top players will intensify. However, the bulk of the competition will be in the mobile advertisement arena. As per estimates, global mobile traffic now accounts for more than 10% of total internet traffic. This trend is likely to continue in the future as smartphones and tablets quickly replace traditional computer systems.

Mobile ad revenues are expected to cross $24.5 billion by the year 2016. As is evident from the table below, the fastest-growing market and the second-largest in the category is the North American market. The North American market will grow by almost 179% to cross the $8.86 billion mark by 2016, followed by the Western European market at 178% and RoW by 175%.

FB has done well over recent quarters to boost its presence in the mobile market. Its mobile advertisement accounted for around 30% of all of its advertising revenues and it has increased its mobile users.

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The mobile MAUs have increased to 751 million users, achieving a growth of more than 12.5% while mobile-only users have experienced a phenomenal growth rate of almost 23% over the last 4 quarters. The growth has also been persistent over all the quarters. Such a rapid growth has allowed FB to achieve a 9.5% share of US mobile ad revenues in 2012, and is expected to achieve 13.2% in the coming year. If the company's new releases such as Facebook Home are successful, then FB would be able to gain a substantial share in the market.

Conclusion

Despite such potential and high growth opportunities, the true value of FB is still a mystery and lies on the success of its future products such as "Home". Although it has been able to attain a 6% market share in internet advertising, the company's ability to increase this share is still a mystery. Although the recent quarter of the company has been quite impressive, it still has not achieved the earnings base that could justify its current price of $28, with a trailing P/E of more than 550 times. Even if we incorporate the analysts' estimated growth of close to 30%, the stock is still highly overvalued. Thus, I would advise not investing in FB right now, even with the growth potential, as I strongly believe the stock to be immensely overpriced.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.