In the technology trilogy of Mobile, Social and Cloud, Facebook (FB) seems to be the perfect convergence of Mobile and Social platforms, as the stock has taken off with the rapid growth in Facebook's mobile revenues.
Facebook reports their q3 13 financial results on Wednesday, October 30th, after the closing bell, with analyst consensus currently expecting $0.18 in earnings per share (EPS) on revenues of $1.895 billion for expected year-over-year growth of 50% and 50% respectively. (These estimates could change and probably will, although not materially, before the actual earnings report on October 30.)
FB had a monster 2nd quarter, 2013, with the stock rising from $24.88 on the last trading day of June to over $50 on the last trading day of September, increasing 100% in just 3 months, and up a little less than that for full-year 2013. The catalyst for that huge move was the July '13 earnings report, which saw a sharp earnings and revenue beat by FB, of 12% on the topline and a 36% beat on EPS.
The question for FB remains, "Can the growth continue?", and perhaps the next question always closely following for those of us that manage money for a living is, "Does the valuation warrant more risk than reward over the short and long term?"
The 2nd quarter's results were truly startling as revenues rose 53%, operating income rose 250% and EPS rose 58%, all on the burst in mobile revenue of $656 million, which increased to 41% of FB's total revenues.
As someone who survived (just barely) the tech bear market of 2001-2002, obviously growth technology stocks (and sectors) and valuation have taken on a whole new meaning, particularly in a market where long-term secular growth is not rewarded to the extent it was in the mid to late 1990's.
Trading at 50(x) expected 2014 EPS of $1.00 per share, with current growth expectations of 35% in both calendar 2014 and 2015 for EPS, investors have to evaluate where the company is in their growth cycle, and whether the potential upside warrants the risk. Revenue growth is expected in the low 30% range for 2014 and 2015, given the current estimates.
We've always liked Deutsche Bank (DB) equity research, and a recent report by Ross Sandler of Deutsche Bank dated 9/27/13 entitled "Deconstructing the Mobile Opportunity" contained the following opinions and conclusions:
- DB's math shows that just 6% of ad impressions drive the $656 million in mobile revenue;
- Mobile users in US and UK are growing 20% per year, while the rest of the world (ROW) is growing at 60%;
- FB says that the ad load was 1-for-20 in q2 13, while the ceiling is closer to 1-for-5, demonstrating "ample runaway ahead" per Deutsche Bank;
Without getting into further detail, Deutsche Bank thinks that there is more global growth ahead for FB, given that advertisers can reach 1 billion people globally.
From Seeking Alpha, we were doing our Sunday morning reading of the excellent perspectives available on the site, and came across this article on Twitter's valuation from Aswath Damodoran, the famed NYU B-school Professor. Note the tables and statistics that reflect favorably on Facebook, even though that was not the intent of the actual article.
Facebook is second to the Google juggernaut in terms of online advertising market share and its operating margin, which struck me favorably given that Google has been around far longer, and is really still dominated and driven by Search, whereas FB is both Social and Mobile combined.
FB and most of the emerging-technology and newly-minted internet plays will likely get a nice lift from the Twitter IPO, which is due sometime in November, (and there is an opposite argument on that, that says the Twitter IPO could result in some sales of FB and other internet names to fund the Twitter IPO), but we think the renewed interest in tech IPOs and growth stocks is a net positive.
So how do you value an early-stage growth company? At 50(x) earnings for 35% expected growth in 2014 and 2015, the PE-to-Growth ratio (PEG) isn't nearly as stretched as the large-cap tech names became in the late 1990's. However, that is still a lofty valuation given that the downside to the stock will be material if the growth does not materialize.
FB currently sports a $124 billion market cap, which is still less than half of Google (GOOG), but 5(x) the market-cap of LinkedIn (LNKD). Morningstar, whose excellent research we read regularly, and whose conservative discounted-cash-flow (DCF) valuation we look at for our client holdings, values FB at $34, as an intrinsic value for the company. Our internal earnings-based model, which probably gives a company's growth a little bit more of a valuation premium than other models, values FB closer to $80 per share, based on current earnings growth, and returns.
Split the difference and you get a $65 "in between" intrinsic value, in-between the conservative and the aggressive valuation models.
Facebook faces weak comps until mid-2014, since the post-IPO drop in the stock price was the market's way of letting investors know that "free" Facebook wasn't going to generate much growth or profits for the social-media giant.
Here is the EPS and revenue estimate of history for FB since coming public:
|'13 EPS (est)||'14 EPS (est)|
* Source: ThomsonReuters Estimate Detail
Readers can quickly see how growth estimates were too high for FB at the outset of being a public company, got revised lower for a full year, and then turned around markedly after the July '13's quarterly results.
Frankly, the $124 billion market cap scares me to death, particularly given the $2.5 billion cash-flow from operations (CFO) and the $1 billion free-cash-flow, which leaves FB trading at 50(x) and 124(x) the cash-flow metrics.
We are going to remain long the stock but will likely pare the position back before the October 30 earnings report, and if the stock continues strong in December, trim more again. (Our initial FB position was bought under $20, and we accumulated most of the position between $20 and $30 per share, as our blog details, so we have a nice gain in the stock for clients.)
The dominant social media position in addition to mobile advertising revenue growth, combined into one stock, brings two important technology tsunamis together under one roof. Normally growth like FB's doesn't end that quickly, but why be stupid about it?
Selling growth stocks, particularly secular growth stories is always a tough call, but our combined growth and value portfolios for clients warrant we sell positions as they get close to 5% of total accounts.
Facebook is no different, and better to be early than late.