Facebook: Mobile Powers Growth

| About: Facebook (FB)


Facebook's quarterly results easily beat expectations thanks to strong mobile monetization.

Mobile now accounts for 59% of total revenue and was up 258% year over year.

The user base shows strong level of engagement, suggesting fatigue is not a problem yet.

With strong execution and 70% earnings growth, Facebook shares are not exorbitantly valued.

On Wednesday afternoon, Facebook (NASDAQ:FB) reported strong quarterly earnings that suggest the company's growth remains on track. Shares were volatile in after-hours trading, though they were generally up around 3%. Facebook announced its CFO would be stepping down, and I suspect shares would have gone up even more if not for this announcement. Facebook, like many internet companies, is extremely hard to value because it is growing at an astounding rate. As a consequence, many high-growth stocks trade at very high multiples on the belief that earnings will grow into that multiple. After these numbers, it is clear that Facebook's momentum, at least over the near term, is to the upside.

In the quarter, Facebook earned $0.34 on revenue of $2.50 billion (all financial and operating details available here). These results blew away analyst consensus of $0.24 on revenue of $2.36 billion. Impressively, revenue was up 72% year over year. Say what you will about its valuation, Facebook is unequivocally an amazing growth story. Over the past twenty-four months, Facebook has also successfully shifted its business towards an advertising model. Ad revenue was up 82% to $2.27 billion. On top of the revenue growth, Facebook delivered massive margin expansion. On a non-GAAP basis, operating margins rose from 39% to 55%. On a GAAP basis, the expansion was strong as well, from 26% to 43%. Facebook is generating more revenue and earning more profit on each incremental dollar of revenue. This is a recipe for massive profit growth, which we saw. EPS nearly tripled year over year to $0.34 from $0.12. With $642 million in GAAP net income, Facebook is without a doubt a "real" company unlike some of the tech companies launched during the bubble of 1998-2000.

Facebook has also proven it can win in a more mobile world. Many sites have struggled to generate mobile ad revenue, and consumers' shift to mobile from desktop viewing has caused problems for some firms. After its troubled IPO, some analysts worried that mobile usage would be a problem for Facebook. CEO Mark Zuckerberg has proven skeptics wrong by successfully monetizing mobile views. Mobile ad revenue accounted for 59% of all ad revenue in the quarter, compared to 30% a year ago. Facebook's mobile strategy has worked.

In dollar terms, mobile ad revenue was about $1.34 billion in the quarter compared to $374 million a year ago. Mobile ad revenue growth was an astounding 258%. That growth is downright astounding. There is perhaps no company that has done as good of a job on mobile as Facebook has. Facebook can continue to grow as the world becomes even more mobile; these results prove that.

Importantly, Facebook's user base is not yet showing signs of fatigue. Daily active users jumped 21% to 802 million while mobile daily active users jumped an ever faster 43% to 609 million. 76% of daily active users are now accessing Facebook daily on a smartphone or tablet. Facebook is still expanding its base, and customers have a higher propensity to use Facebook on a mobile device. Monthly active users now total 1.28 billion, up 15% year on year. If Facebook were a country, it would be the second most populous nation on the planet, behind only China. Mobile monthly active users jumped 34% to 1.01 billion.

It is important to note that Facebook grew daily users faster than monthly users. This suggests that "Facebook fatigue" has been an overstated concern. Facebook's user base is increasing engagement and is more likely to be accessing the site on a daily basis. If we see monthly active users growing at a faster pace than daily active users, that will be an early indicator that users are tiring of Facebook. User fatigue is one of the most important risk to Facebook investors, but right now, we are not seeing fatigue. In fact, users are becoming more engaged.

Now, management has come under fire for the recent acquisitions of WhatsApp and Oculus. However, it is important to note that the majority of these deals are being paid in stock not cash. Facebook maintains a pristine balance sheet with $12.63 billion in cash and marketable securities. Two years ago, Wall Street was quick to minimize Zuckerberg's chance of succeeding in mobile, and he has proven them wrong. I would not be so fast to label these deals busts. WhatsApp expands Facebook's presence on mobile devices where it is increasingly dominant and Oculus has a fascinating virtual reality technology that may prove revolutionary. At the very worst, these deals are paid for in stock, so they don't endanger the financial stability of the firm. With a 70x trailing multiple, paying with stock may not be such a bad idea.

After this quarter, I expect analysts to increase their estimates for the rest of this year. User growth has remained strong as has engagement. Facebook is also growing mobile revenue at an outstanding pace, and mobile monetization will drive substantial earnings and revenue growth for the year. On a non-GAAP basis, I expect Facebook to earn $1.50 this year compared to $0.88 in 2013. Facebook shares are trading 42x 2014 earnings, but earnings growth will be an even faster 70%. With continued mobile monetization, Facebook is on track to earn over $2.00 in 2015. Facebook is by no means a cheap stock, but it has unparalleled growth and scale. Management has also shown an ability to confront challenges to the business model and continue to grow. If I were to bet on any "momentum" or high-growth tech stock, I would pick Facebook.

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.