Wall Street had expected Facebook (NASDAQ:FB) to earn an EPS of 24 cents, almost double the EPS it earned during the first quarter a year earlier. However, Facebook managed to beat analysts' expectations by 10 cents and earned an adjusted EPS of 34 cents for the latest quarter. Analysts had expected Facebook to grow its revenues 60% year over year but again Facebook's revenues for the quarter jumped by a massive 71% year over year. The purpose of this article is to assess the company's performance with respect to various metrics and also to determine whether or not it will be possible for Facebook to continue such a massive pace of growth in the coming years.
Top and Bottom Line Growth
Facebook generated a GAAP operating income of $1 billion on revenues of $2.5 billion. Revenues increased 71% year over year but declined by a meager 3% quarter over quarter. However, in the previous two years this trend has become the norm for Facebook. The revenue of the first quarter falls short of the revenues in the preceding quarter. This trend is illustrated in the figure below.
Source: Facebook Earning Slides
The company derives its revenues from advertising and other fees and advertising is the major revenue contributor with a contribution of 90% to the company's top line in the latest quarter. Advertising revenues surged year over year by a massive 82% while other fees also increased by 11%. Average revenue per user (ARPU) increased 48% year over year, despite the 5% decline in payments per user, because the 57% increase in advertising revenue per user outpaced the decline in payments.
Source: Facebook Earning Slides
Segregating the company's revenues by geography reminds us that the USA and Canada remain a major revenue generating geography for the company. However, revenue sourced from each geographic location increased in value terms but their contribution towards the company's top line almost remained the same as in the first quarter of 2013. This is evident from the graph below. Europe's share in advertising revenues has declined while the USA and Canada and Asia grew their contributions. In terms of total revenues, contribution by each participant remained unchanged. The highest average revenue per user comes from the USA and Canada while the lowest average revenue per user was derived from the rest of the world segment.
Data Source: Company Earnings Slides
Users that act as the cornerstone for Facebook's business are measured in terms of monthly and daily active users (MAUs and DAUs). Due to the increasing use of mobile devices as mediums Mobile MAUs and DAUs are also looked at separately. The company came across the following growth rates in all of the above measures of users. This graph shows that the y-o-y growth rates for the latest quarter have declined when compared to the y-o-y growth rates achieved in the comparable quarter last year.
Almost 79% of Facebook users are accessing the site through mobile phones and mobile-only monthly active users have experienced a huge 80% surge year over year and 15% quarter over quarter. Monthly mobile active users surpassed the one billion mark hence mobile ads accounted for 59% of ad revenue, up from 53% in the previous quarter. The increased penetration of smartphones around the world, particularly in emerging markets, is one of the reasons for Facebook's massive growth.
The Road Ahead
Facebook is the world's number one social networking site and is now more than just a social networking site as it has been transformed into a portfolio company offering its users a messaging app in the form of WhatsApp, a photo sharing platform through Instagram and a social networking site in the form of Facebook itself. Moreover its connectivity lab reminds us that Facebook will soon be an internet provider as well.
Facebook has bolstered its advertising revenues and the growth momentum is expected to continue. Facebook is expected to increase its share of the $31.5 billion mobile ad market from 18% last year to 22% this year. On the other hand Google Inc. (NASDAQ:GOOG) is losing its market share and its share is expected to decrease from 49% to 47% this year. However, as a technology company with continuous developments the company has to be resilient enough to handle competitive rivalry and cope with the fickle nature of consumer preferences. Facebook is working on new revenue streams such as Premium Video Ads, ads on Instagram and mobile ad network but these projects are not low hanging fruit for the company. Therefore investors should not expect these projects to start paying off and contribute to the company's top line this year.
Facebook has made various acquisitions during the quarter that have contributed very minimal revenues to date but these will bear fruit in less than 5 years. These acquisitions include a messaging app called WhatsApp for $19 billion, virtual-reality hardware company Oculus VR Inc. for $2 billion and a U.K. based aerospace company Ascenta. Facebook has not announced any plans yet to monetize WhatsApp however it has announced that Facebook Messenger will no longer be allowed as a messaging medium. This way Facebook is trying to coerce users into downloading WhatsApp for their mobile devices. Apart from the purpose of the Ascenta acquisition is to deliver internet connectivity to those areas of the world that have little to no connectivity. In my previous article, I tried to forecast the monetary benefit that Facebook could derive from its internet connectivity mission. However at that time, Titan Aerospace was being considered for acquisition but was acquired by Google. Oculus VR was an esoteric type of acquisition and it is too soon to make any guesses regarding what Facebook has planned for this acquisition. Nevertheless I believe in the farsightedness of the company's management and if they have made an acquisition this will surely be fruitful for the company in future. Mark Zuckerberg may be planning Facebook's future 5 to 10 years ahead and that may be why he acquired a company dealing in the virtual reality market that is set to grow at a CAGR of 15.18% from 2013-2018.
It is a little disappointing that Facebook has not monetized Instagram yet even though two years have passed since its acquisition. However, for the company itself, consumer growth is more important than the early monetization of the site. Auto-play video ads were also on Facebook's task list since the start of this year where it aimed to allow advertisers to display 15-second video ads on Facebook. Facebook has not yet widely offered the service because the user response to the auto-play video ads is still under observation. Before the earnings release Morgan Stanley had estimated that Facebook could earn $900 million from video ads this year. But after the company announced its results we can argue that these revenues may be delayed by one or two years. Hence Facebook's focus on its video ad format will really boost its top line in the coming years. According to Gartner, video ads worldwide are expected to experience the highest growth in the coming years.
Facebook is considering launching a mobile ad network that will allow it to partner with third party app developers by sharing a portion of its revenues. Third party app developers will showcase the ads sold through Facebook's ecosystem. This way Facebook would be solving a great problem for marketers regarding reaching their target audience according to their search behaviors. Thus Facebook will help companies to understand the search behavior of their audiences, how to target them, and how to show them ads more accustomed to their tastes and choices. Currently, the success of this venture depends on the company's ability to deliver on its ad business and continue its growth momentum. However, for the distant future Facebook will have to figure out new ways to generate revenues and monetize its services in order to keep up the pace.
Facebook experienced a great performance during the quarter and crushed expectations but that does not justify buying this stock because of its current premium valuation. Facebook is trading at a P/E ratio of 96 that is more than 3 times the industry benchmark. In other words, Facebook is trading at approximately 100 times its earnings while its current price is 20 times its trailing 12-month sales. That makes this stock way too expensive to be bought. I would suggest investors hold this stock and closely observe its continued growth prospects.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.