Facebook Inc. Finally Receives Credit For Strong Underlying Trends

| About: Facebook (FB)

Shares of Facebook (NASDAQ:FB) have seen an incredible jump after the release of its second quarter earnings report. As the company is boosting its average revenue per user (ARPU) and is succeeding in mobile advertising, investors are wildly enthusiastic.

While shares still trade below their public offer level of $38 per share, the structural improvements provide a roadmap to return to those levels.

Second Quarter Results

Facebook generated second quarter revenues of $1.81 billion, up 53.1% on the year before. This implies that revenue growth is accelerating as revenues for the first half of the year rose by 45.9%. Revenues came in far ahead of consensus estimates of $1.62 billion.

Non-GAAP earnings rose by 65% to $488 million. GAAP earnings came in at $333 million compared to a loss of $157 million last year. Non-GAAP earnings came in at $0.19 per share, while GAAP earnings came in at $0.13 per share. Consensus estimates for non-GAAP earnings stood at $0.14 per share.

CEO and founder Mark Zuckerberg commented on the developments, "We've made good progress growing our community, deepening engagement and delivering strong financial results, especially on mobile. The work we've done to make mobile the best Facebook experience is showing good results and provides us with a solid foundation for the future."

Looking Into The Results

Facebook generates the majority of its revenues from advertising. Total advertising revenues make up almost 90% of total revenues, rising by 61% to $1.60 billion. Total advertising revenues rose by an impressive 28.4% compared to the first quarter. The growth acceleration is attributable to mobile advertising revenues which now make up an astonishing 41% of total advertising revenues.

Total costs fell from $1.93 billion to $1.25 billion. This picture is severely distorted because of much lower share-based compensation expenses. Total share-based compensation was $224 million for the quarter, compared to $1.10 billion last year due to share-based compensation related to the public offering. Excluding the impact of share-based compensation, operating costs rose by merely 10% on the year.

Other interesting metrics were solid as well. The company now has 699 million daily active users, roughly 10% of the global population. This is up 27% on the year and 5% on the previous quarter. Notably Asia and emerging markets were driving growth, as the monthly active user base rose to 1.15 billion. An impressive 469 million, or 67% of daily active users, do log in via their mobile phone.


Facebook ended its second quarter with $10.25 billion in cash, equivalents and marketable securities. The company operates with $2.17 billion in total debt and capital lease obligations, for a net cash position of around $8 billion.

Revenues for the first six months of 2013 came in at $3.27 billion, up 46% on the year before. GAAP earnings rose to $552 million, up from merely $48 million a year ago. At this rate the company should quite easily be able to report annual revenues of $7 billion on which it could earn $1.5 billion.

Factoring in the 25% gains, with shares exchanging hands at $33 per share, the market values the company at $80 billion. Excluding the net cash position, operating assets are valued at $72 billion. This values the firm at roughly 10 times annual revenues and roughly 50 times 2013's expected earnings.

Facebook does not pay a dividend.

Some Historical Perspective

Facebook's failed public offering is obviously well known to the investment world and even to the general public. By August of last year, shares were exchanging hands at just $18 per share, as investors had lost half their investment. Shares have bounced back nicely, trading with losses of merely 15% from their offering level at the moment.

While the share price took a beating, revenue growth continued. Between 2009 and 2012, Facebook increased its annual revenues from merely $777 million to $5.1 billion. Earnings took a beat last year, but for this year the company is on track to report record earnings.

Investment Thesis

A few trends are crucial for Facebook in my opinion. This includes user engagement, average revenues per user and a successful mobile advertising campaign.

The latest report reveals that the company is doing well in all areas. Engagement continues to be high as both the monthly and the daily user base show healthy growth. Worries about a declining or stabilizing user base are not yet occurring, despite the fact that an incredible 1.15 billion users log in every month.

With a slowing growth in the user base, average revenues derived from those users is key. Global ARPU came in at $1.60 per user, up $0.25 on the previous quarter which is really big. Interesting is the widening dispersion of ARPU across geographic areas.

North American ARPU hit highs of $4.62 over the past quarter. It is not just increasing ARPU but global convergence which could drive revenue growth. Asia and the rest of the world saw their ARPU increase towards $0.75 and $0.63, respectively. If they could even slightly narrow the gap with the North American operations, the impact is huge as the user base in those regions are the biggest for Facebook.

The best surprise came from mobile advertising revenues which rose 76% on the quarter to an astonishing $656 million. New formats like news feed do really seem to be working. As such, advertising revenues make up an astonishing 41% of total advertising revenues. Note that this percentage stood at merely 30% in the first quarter.

After the first quarter earnings release I took a look at Facebook's prospects. I concluded that the company is following a healthy strategy by sacrificing short term gains for long term profits, as it has been investing heavily in the business. Yet profit improvements are already seen in Wednesday's report.

Looking three years ahead, it is not impossible to envision 1.25 billion monthly users which could generate ARPU of $2.50 per quarter. This would translate into annual revenues of $12.5 billion and profits of $3-$4 billion. At current valuations, even after factoring in the 25% jump, a price-earnings ratio of 20 for 2016 seems justifiable.

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.