Why Did Facebook Investors Get Scared?

| About: Facebook (FB)

In the after-hours of Wednesday, Facebook (NASDAQ:FB) announced its quarterly earnings. Initially, the earnings release led to a massive rally of 16%; however, all of the gains were given up in the later hours of the evening. Many Facebook investors are confused and concerned about what just happened. In this article, I will try to summarize Facebook's quarterly results as well as the reason why the investors decided to sell off after an initial rally in the share price.

Facebook earned 25 cents per share in the quarter, which easily beat the analyst estimates of 19 cents per share. The company's revenue in the quarter was as high as $2.02 billion, which also beat the analyst estimates of $1.91 billion.

Facebook's daily active users jumped to 728 million, up from 699 million in the previous quarter and up from 584 million in the same quarter a year ago. Since last quarter, the North American daily user volume increased slightly from 142 million to 144 million, the European volume increased from 182 million to 188 million, Asian volume increased from 181 million to 189 million and in the rest of the world, the volume increased from 195 million to 208 million. In terms of the number of active users, Facebook's growth is likely to slow down as it is reaching saturation in most markets. By now, almost every internet user in the world has heard about Facebook, and those who have wanted to join have already joined the website for the most part (with the exception of countries like China where Facebook is banned). While Facebook's number of daily active users will not increase very rapidly, the company's monetization of these users are likely to accelerate in the near future (and they already have in the last couple of quarters as Facebook figured out how to monetize its mobile users).

In North America and Europe, Facebook's monthly active users increased at an even slower rate than its daily active users did. In North America, the volume of monthly active users increased from 198 million to 199 million; whereas in Europe, the number increased from 272 million to 276 million. Outside of North America and Europe, the number of monthly users grew at a faster rate as it jumped from 685 million to 713 million.

Monthly active users that are logging to Facebook using a mobile device saw a sharp increase in the quarter. From quarter-to-quarter, this number rose from 819 million to 874 million. Just a year ago, Facebook had only 604 million monthly active users that are using a mobile device to access the social network. Last quarter, 254 million monthly active users accessed Facebook using a mobile device only (and not PC) whereas this number was as small as 219 million last quarter and 126 million last year. As the growth of mobile users continue to outpace the growth of total and PC users, it becomes more important for Facebook to figure out more ways to monetize the mobile content.

A great majority of Facebook's revenues still come from advertisement. Of the $2.01 billion in company's revenues, $1.80 billion came from advertisement and $218 million came from payments and other fees. Since last quarter, Facebook's advertisement revenues rose by 12.44% and its payments and fees revenues rose by 1.86%. Since the third quarter of last year, Facebook's advertisement revenues grew by nearly 70%. Moving forward, the company's advertisement revenues will continue to outpace its payments and fees revenues, which means that an increasing percentage of Facebook's revenues will be claimed by advertisement. In fact, this is what we are seeing as the percentage of payments and fees in Facebook's revenues fell from 13% to 10% between last year and now.

Currently, 47% of Facebook's revenues come from North America and 27% of the revenues come from Europe. Aggregately, the two regions claim 74% of the company's total revenues. This is in line with the same quarter where the two regions also claimed 74% of the company's total revenues. The company's North American revenues grew by 13.44% followed by its Asian revenues that grew by 12.55% which passed its revenue growth rate in Europe at 6.53%. In the rest of the world, Facebook's revenues rose by 11.74% since last quarter. Apparently, Europe is the slowest growing region for Facebook.

Worldwide, Facebook generated $1.72 of revenue per user in the quarter. In US and Canada, the revenue per user was as high as $4.85, up from $4.32 in the last quarter and $3.40 in the same quarter of last year. Apparently, Facebook is doing a great job of monetizing its American users. In other regions, revenue per user is much less for the company. In Europe, the number stands at $1.96, up from $1.87 last quarter and $1.37 last year. In Asia, the average revenue per user was $0.81, up from $0.75 in the last quarter and $0.58 last year. Everywhere else in the world, Facebook generates 67 cents per user, up from 63 cents last quarter and 47 cents last year. As you can see, even though North American market generates far more revenue per user, Facebook sees double-digit revenue-per-user growth in every market, which is very impressive.

Since last year (as well as last quarter), Facebook's gross margin increased from 74% to 75%. The company's research spending as a percentage of revenue is down to 18% from 19% and its marketing spending is down from 15% of the revenues to 12%. Most impressively, Facebook's general and administrative spending fell from 12% of revenue to 8% of the revenue between last year and this year. These declines are mostly a function of revenue growth outpacing spending growth. If Facebook can continue on this trend, its margins and net profits will increase substantially. Currently, Facebook's operating margin is 37%, up from 31% last quarter and 30% last year.

These results look great. Then what caused the investors to sell their shares off in the later hours of the evening? During the conference call, Facebook's management acknowledged that the company's popularity amongst teenagers might be cooling down as Twitter proves to be a big challenge to Facebook. Apparently, while teenagers are not necessarily closing their Facebook accounts, they don't spend as much time on Facebook either. The declines were very small in size; however, investors usually overreact to things so they decided to sell their shares to erase all the gains in the evening.

In conclusion, Facebook had a pretty successful quarter and the company continues to prove critics wrong. Facebook's growth is likely to continue for the foreseeable future as it finds more ways to monetize content (such as video ads). Out of all the popular online companies in the market today (including but not limited to LinkedIn (NYSE:LNKD), Pandora (NYSE:P), Yelp (NYSE:YELP), Groupon (NASDAQ:GRPN) and Zillow (NASDAQ:Z)) Facebook is the most promising and most reasonably-valued one.

Disclosure: I am long FB. 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.