- Facebook again reports very strong second quarter results, pushing up shares to fresh all-time highs.
- What is really becoming apparent is the very strong operating sales leverage of the business model.
- While shares remain astonishingly expensive based on the current results, it is easy to envision a scenario two or three years down the road justifying the valuation.
Facebook (NASDAQ:FB) continues to fire on all cylinders with very strong second quarter results sending shares to fresh all time highs.
Despite the huge run-up of its shares in recent times, Facebook can easily justify the valuation if it can continue to grow its user base but more importantly increase its ARPU.
Key Second Quarter Results
Facebook posted second quarter sales of $2.91 billion, up an astonishing 60.5% compared to last year. Revenues came in far ahead of consensus estimates at $2.81 billion.
Strong operating leverage allowed the social networking website to increase its net earnings by 137.5% to $1.39 billion. This results in truly astonishing after-tax margins of 47.8%.
Reported GAAP earnings came in at $0.30 per share for the quarter, while non-GAAP earnings revealed a profit of $0.42 per share. Analysts were looking for non-GAAP earnings of $0.32 per share.
Looking At The Incredible Margins Expansion
What is truly astonishing is the very strong operating leverage displayed by the company. As topline sales were up by 60.5%, total costs were up by just 21.5%.
As a matter of fact, the strongest growth in operating expenses was the result of higher R&D expenses/investments which were up by 43% to $492 million, which thereby made it the largest expense incurred by the company. R&D even surpassed the ¨Cost of revenue¨ which rose by just 1.7%.
Earnings growth was even limited to some degree due to higher effective taxes, with Facebook's tax rate coming in at 42.9% of operating earnings, leaving quite some work for its CFO. Total dilution of the shareholder base was limited to 4% on an annual basis.
The Key Metrics User And Engagement Metrics
The daily active user base increased towards 829 million for the quarter, up 27 million compared to the previous quarter and up a 130 million versus last year. Of these an incredible 654 million accessed the website on a daily basis from their mobile device, which implies that 79% of daily active users access the social network through their mobile device.
The monthly number of active users rose to 1.32 billion, up 41 million compared to its previous quarter and up 162 million on an annual basis. Of these some 1.07 billion access the website through their mobile device. As a matter of fact nearly 400 million monthly users access the social network only via their mobile device.
While the 1.3 billion monthly active users of the main Facebook website/network are impressive, don't forget that the company has another 500 million monthly annual users for WhatsApp as well as 200 million users for Instagram and its Messenger service.
North America Drives The Results
North America continues to drive the total revenue results, although its growth rate is the slowest across the geographies as defined by the company. Total revenues in the continent rose by 54% to $1.31 billion, mainly driven by the growth in ARPU of course. Total ARPU was up by 49% to $6.44 per user, an incredible number.
The rest of the world is lagging in terms of ARPU, but revenues are rising quickly on a relative basis thanks to quicker user growth in combination with a higher ARPU. European sales were up by 63% to $824 million as its ARPU of $2.84 increase by 52%.
ARPU in Asia broke the dollar mark, increasing by 44% to $1.08 per user. This is as the solid increase in the active user base pushed up total sales by 74% to $431 million. The rest of the world generated $347 million in sales, a nearly 63% improvement with ARPU advancing to $0.86.
Everyone knows that Facebook's valuation is tied to the future and not necessarily the current performance or asset base. It is still impressive to see that cash, equivalent and marketable securities balances have increased towards $11.5 billion for the quarter, while the company has no outstanding debt. Facebook has a few hundreds of million in capital lease obligations on its balance sheet, but this is negligible.
On a trailing basis Facebook has now posted sales of $10 billion on which it net earned about $2.4 billion. Yet the continued high growth creates a much higher run-rate with sales closer to $12 billion and earnings coming in North of $3 billion.
Trading around $75 per share, equity in the business is valued at roughly $195 billion, or at about $185 billion excluding the high cash balances. This values the company at about 15 times running sales and 60 times earnings.
What Is The Fair Valuation?
Valuation is always a very tedious issue, especially at Facebook. According to many shares were too rich at the $38 IPO price, but ever since shares have doubled. Of course, shares first fell by some 50% as investors worried about the popularity of the network and the challenges to monetize mobile advertising.
Facebook has overcome these issues given that it has a record user base and that it generates 62% of its revenues already from its mobile advertising solutions, up 21 percent point compared to last year. This is driven by very strong pricing for mobile advertising, while the number of impressions is actually falling.
The company is moving quickly to adopt and try new things. This includes the once criticized $1 billion acquisition of Instagram which appears to be a very good deal now. The company faced even bigger scrutiny after acquiring WhatsApp in a $19 billion deal earlier this year.
Yet the company has not even monetized these opportunities and the incredible margins of the business are only now really becoming apparent. Therefore the main task for Mr. Zuckerberg is to continue to dominate, stay relevant and avoid common pitfalls.
Upto a few quarters ago, all eyes were on growth of the user base which is obviously slowing down due to the limitations of people across the globe being online. The next level of growth is coming from increased monetization and ARPU which is a much more important number these days.
Global ARPU rose by exactly 40% on an annual basis to $2.24 per user. As usual it is important to look at the US & Canada to see the future trends, an area in which ARPU rose by 49% to $6.44 per user.
Now let's assume that Facebook indeed can get to 2 billion active users three years down the road. In that case I won't rule out ARPU of $10 for North American users and global ARPU closer to $5, especially if the company will monetize other assets. That would create a $40 billion revenue base which combined with after-tax margins of 35% does result in $14 billion in annual earnings, making the current valuation very appealing.
Given the incredible pace of growth and the huge developments, any estimate for the future is a ¨guess¨. What is clear is that Facebook has continued to surprise towards the upside, even compared to already very bullish scenarios. With the company posting annual earnings of $3 billion at the moment, I can not rule out that the company can fivefold this in the coming few years.
Topline growth, further operating leverage and lower tax rates could and should all aid to achieve such a number. As such I reiterate my stance. Facebook never appears cheap on current numbers, but the valuation requires some imagination and assumptions to justify. As recent history and some of the assumptions above have shown, this can still create an appealing valuation.
With shares having tripled from their lows, I won't expect a similar move upwards for the coming years. Yet that does not mean that shares are obviously overvalued or don't have any upside.
I continue to follow the story with great interest especially if a material correction like the one in April might repeat itself.