After the bell on Wednesday, social media giant Facebook (NASDAQ:FB) reported its fiscal fourth quarter and full year 2013 results. As was the case in recent quarters, it was a complete blowout, and shares rocketed higher in the after-hours session. Despite the great report, Facebook continues to trade at an ultra-premium valuation. Today, I'll analyze the Q4 report, and explain why Facebook might be a good short on a continued rally.
Fourth quarter results:
Facebook came in at revenues of $2.585 billion, which trounced estimates for $2.33 billion. The Q4 revenue growth rate was 63%, fueled primarily by a 76% rise in advertising revenues to $2.34 billion. Mobile advertising revenue came in at 53% of advertising revenues, up from 23% in the year ago period. Facebook needs to carefully balance the number of ads, because I for one think there are too many. If that opinion builds, it could really hurt the Facebook experience, and eventually, users will leave the site.
On the bottom line, non-GAAP earnings per share of $0.31 beat by 4 cents. GAAP operating margins rose from 33% to 44%, and non-GAAP operating margins rose from 46% to 56%. Facebook ended the quarter with $11.45 billion in cash and marketable securities, up from $9.63 billion at the end of 2012. Remember, Facebook did have an equity offering during the quarter.
Overall, this was a tremendous blowout, but we've become used to blowout reports from Facebook. Don't forget, going into this report, Facebook shares were up just under 74% over the past year. That does not include the after-hours jump, which I'll get to in a bit.
User growth slowing rapidly:
One item that worried me a bit was the slowdown in Facebook's user growth. In the following table, I've compiled the daily and monthly active user numbers (including mobile) for the end of each quarter. For instance, the monthly numbers for the latest quarter are as of December 31st, and the daily average is a December average. I also included the year over year growth rate provided by Facebook. The table goes back to Facebook's first report as a public company.
Obviously, Facebook was not going to sustain the user growth rates that it saw a year or so ago. However, the second half of 2013 saw a much larger slowdown than the second half of 2012. For instance, let's look at monthly active users and year over year growth:
- From Q2 to Q4 of 2012, MAU growth slowed from 29.23% to 24.97%, a decline of 426 basis points, or a decline of 14.57%.
- From Q2 to Q4 of 2013, MAU growth slowed from 20.94% to 16.29%, a decline of 465 basis points, or a decline of 22.22%.
This was just one example of a large growth slowdown. If I look at mobile MAUs, the growth slowdown was a bit faster. What's my key point? Well, MAU growth in 2014 will slow into the single digits year over year if the trend continues. At the same time, Facebook's revenue growth rate has been accelerating. While that's a good thing in the sense that Facebook is figuring out to monetize its user base, this divide can't last forever. Revenue growth will start to decelerate in 2014, and at that point, will the ultra-premium valuation hold? I'll examine valuation next.
A very expensive stock:
Facebook is very expensive, and Twitter (NYSE:TWTR) is even more expensive. In the following table, I've compared the P/S and P/E values for these two names against LinkedIn (NYSE:LNKD), Google (NASDAQ:GOOG), and Apple (NASDAQ:AAPL), based on 2013 results (or estimates). In the case of Apple, which uses a September-end fiscal year, I've simply added each individual quarter's revenues and EPS for 2013. I know this won't equal the exact yearly EPS value, but since the valuation is so low, that's not quite the point here, and the difference between the two is not much. For all names, I am using price and market cap data calculated from the last after-hours trade, to show what the Facebook rally meant.
*These names have not yet reported. Google reports on Thursday, with Twitter and LinkedIn reporting during February.
**All P/E ratios are non-GAAP except for Apple.
Thanks to the 12% plus gain in the extended hours, Facebook shares are up to $60, a near double from the $30.79 close a year ago. Yet, revenues and net income were not up that much, so the multiple has actually expanded for Facebook. You might think that makes sense given revenue growth accelerated in the second half of 2013.
For Facebook to maintain its current share price and market cap, growth has to stay high for quite a while. Facebook's market cap can expand without the share price rising thanks to further dilution each quarter. At $60 a share, or a market cap of more than $147 billion, Facebook would need slightly more than 43% revenue growth each year for 2014-2016 just to get to the current P/S value of Google, and I think Google is overvalued to begin with. If Facebook had 24% revenue growth each year, it would take until 2018 for Facebook to equal Google's P/S.
For Facebook to get to the current P/E for Google, Facebook needs non-GAAP EPS of about $2.72, compared to $0.88 in 2013. On the conference call, Facebook provided the following statement about expenses for 2014:
Now I want to share a few thoughts on 2014. In terms of expenses, we're planning that our total 2014 GAAP expenses, including cost of revenue and including stock comp, will likely grow in the neighborhood of 35% to 40%, and non-GAAP expenses, including cost of revenue but excluding stock comp, will likely grow in the neighborhood of 40% to 45%.
Going into Wednesday's report, Facebook analysts were looking for 35.8% revenue growth and 34.9% non-GAAP EPS growth in 2014. Facebook's expense growth will probably be around the company's revenue growth rate, so don't expect too much margin improvement, if any. Until Facebook can get some margin improvement, EPS won't rise that much, and they will be pressured by a rising share count. How long will it take Facebook to get to that $2.72 EPS value? That's the million dollar question.
Now I know that everyone wants to know about the huge discount Facebook trades at in relation to Twitter, especially on P/S (P/E doesn't work as Twitter is still losing money). Twitter just went public a few months ago, hasn't even had its major lock-up expirations yet, and Twitter is a little earlier in its growth stage. Twitter will most likely command a large premium to Facebook for the time being until its growth really slows down in a year or two. Additionally, Twitter is more likely to have a short squeeze, which is why I'm a little more bullish on Twitter until its first public report.
So how do I value Facebook? Well, I think nearly 19 times trailing revenues is a bit much, but I don't exactly think Apple's P/S of 2.59 is reasonable either. If you average the two, you get 10.65, but I think Facebook deserves a bit more than that. I'd go to 12 times sales, which I believe is a more than generous valuation for Facebook. Going into Wednesday's report, the average analyst estimate for 2014 revenues was $10.41 billion. We know that number will go higher. I think it is possible that Facebook could hit $11.5 billion in 2014 revenues, representing 46% growth. A valuation of 12 times sales at $11.5 billion gives me a market cap of $138 billion. With an expectation for 2014 to average about 2.6 billion shares outstanding, that gives me a fair value of $53 a share by the time Facebook reports 2014 final results. The last time I valued Facebook in September, before the last two beats, I had a value of $35.25. So with the two large beats, I have raised my valuation quite a bit.
Thus, I do think Facebook is a bit overvalued at the moment. I wouldn't necessarily go out and short it on Thursday, because I could see the rally potentially going to $65 in the next couple of weeks. Should Facebook get into that mid to upper $60s area, the short case appears more viable. I do think Facebook is a short idea right now, but that idea is just something to start thinking about.
Facebook announced a blowout quarter for Q4, something we've become accustomed to in recent quarters. While revenue growth accelerated in the second half of the year, user growth dropped, and at a rate that seemed a bit excessive for my liking. I'm looking forward to see how the revenue story plays out in 2014 as user growth continues to decline. Facebook trades at an ultra-premium valuation, which means the company needs to execute perfectly going forward. While I still believe in the growth story of this company, I think the stock is a bit overvalued at the moment. Again, I'm not calling for this name to collapse to say $25, as I think $53 is a very respectable value for Facebook. I wouldn't short just yet, but if this stock gets into the mid or high $60s, I think the case for shorting becomes actionable.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.