Facebook: Expecting Strong Q4 Assisted By Twitter Weakness

| About: Facebook (FB)

Summary

FB reports Q4 earnings Wednesday after the close.

We are bullish on the quarterly results because we believe FB is adding functionality to its multiple-app ecosystem concurrent with other social media platforms ceding market share.

More specifically, TWTR's fall off coincides with a rampant increase in overall social media usage, and we think the increased time is being spent on growing and popular platforms like FB/Instagram.

We are also bullish that ad partner Kenshoo's strong Q4 results are indicative that FB had a likewise strong quarter.

Despite a strong secular growth story and bullish Q4 trends, we are slightly tempered by the stock's historically shaky post-earnings performance, and believe day trading FB around earnings lacks favorable asymmetry.

Facebook (NASDAQ:FB) reports Q4 earnings Wednesday. While we are bullish on the quarter given strong Q4 trends which reaffirm a secular growth story, we are also tempered by inconsistent stock price performance following earnings. Overall, we are buying shares into earnings because shares are beaten down and we expect the company to deliver strong results. We do not, however, plan on selling those shares post-earnings, but rather holding for longer-term gains.

Q4 Trends

We are bullish on the quarterly results because we believe FB is adding functionality to its multiple-app ecosystem concurrent with other social media platforms ceding market share.

FB made several moves this quarter which added crucial functionality to its platforms. FB struck a deal with Uber to enable ride requests via Messenger, and we believe this is the beginning of FB transforming Messenger into a consolidated commerce marketplace. FB also prepped a local services site, and we believe this service will couple with Places and takeover Yelp (NYSE:YELP) in the near future. Most recently, FB launched Sports Stadium, and while this wasn't launched during Q4, we do believe it will create strong user engagement tailwinds in 1Q15.

While FB added these functionalities, other social media giants, namely Twitter (NYSE:TWTR), ceded market share. According to Morgan Stanley, a June survey pegged TWTR as the third leading social media application, behind FB and Instagram but ahead of LinkedIn (NYSE:LNKD) and Pinterest. The same survey in November showed TWTR had fallen in popularity behind both LNKD and Pinterest. Morgan Stanley also indicated that TWTR app downloads fell 3% Y/Y in 4Q15 and mobile time spent on TWTR fell over 20% Y/Y, marking the fifth straight quarter of 20%+ mobile time decline. It is important to note that in the survey, there was a wide discrepancy between FB and Instagram as the top two social media apps and the rest of the pack.

Evercore mirrors this sentiment, noting that TWTR continues to cede market share to faster growing competitors like Snapchat and Instagram. Similar to Morgan Stanley's findings, Evercore found that total time spent on the platform continues to fall while other social media platforms like Instagram and Snapchat demonstrate double-digit growth off of larger bases.

This TWTR fall off coincides with a rampant increase in overall social media usage, and we think a lot of the increased time is being spent on dominant and growing platforms like FB and Instagram.

Moreover, we are bullish that ad partner Kenshoo's strong Q4 results are indicative that FB had a likewise strong quarter. Kenshoo reported that social media ad spend by its clients rose 50% Y/Y, in large part driven by Instagram's ad ramp and FB's introduction of Dynamic Product Ads. Clicks rose 30% thanks to a 64% increase in click-through rate while cost per click rose 10%. These results speak particularly to the high-demand for Instagram ad-space. As we have argued before, we believe a matured Instagram business will bring in more than $5 billion in annualized advertising revenue.

Historical Earnings Performance

Despite a strong secular growth story and bullish Q4 trends, we are slightly tempered by the stock's historical post-earnings performance. Despite beating EPS estimates in each of the past four quarters and topping revenue estimates in all but one of those quarters, the stock performance immediately following earnings has been unexciting. The missed revenue estimate in 1Q15 led to a sell-off which proved to be a good buying opportunity. The stock bump following 3Q15, which we previewed in this report, is the only noteworthy upward move in the past four quarters.

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This is normal for a stock with a premium valuation relative to the market (100x EPS, 39x EBITDA, and 17x Sales), as volume growth dictates the valuation. A miss on any front kills shares. An unconvincing beat is unexciting to investors and shares are equally inclined to go up or down. A strong beat can lead to a nice bump.

Given this information, we do not think FB is a great pre-earnings trading stock. We do not believe there is favorable asymmetry for a day-trade when it comes to FB earnings.

Final Remarks

Because of the shaky historical earnings performance, we buy FB on value and hold for longer-term gains. This is not a day-trading stock to us, especially around earnings. We use earnings to either load up on or unload shares, but not to buy-then-sell in a two-day window. Because the stock has been beaten down into what we expect to be a very strong quarter that will reaffirm the secular growth story, we will be loading up on shares into the Q4 ER.

We think shares will continue to trend significantly upward in the long-term window. We also would not be surprised if we get a nice bump following Q4 ER of greater magnitude than the bounce we saw following Q3 ER.

Disclosure: I am/we are 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.