Facebook: Growth Story Is Not Over

| About: Facebook (FB)

Summary

Facebook performed well across all metrics during the quarter, leading to easy beats on the top and bottom line.

We still believe a mature Instagram business will bring in more than $5 billion in annual revenue, and affirm that Instagram should continue to drive ARPU growth in 2016.

We believe that continued 5%+ Y/Y MAU growth in the US and Canada speaks to our thesis that Facebook's popularity domestically is being assisted by Twitter weakness.

With market-changing catalysts on the horizon, we believe the Facebook growth story is far from over.

Paying attention to the cash flow multiples, we can see that FB is actually trading at a discount to its growth.

Facebook (NASDAQ:FB) reported Q4 and full-year 2015 results Wednesday. As we expected, the report was very strong, with revenues and earnings easily topping estimates, and this has sent shares up more than 15% in trading today, 1/28. We believe the true growth story of Facebook is just beginning, and that 2016 will be a revolutionary year for the company as it attempts multiple-app consolidation. Even at the current valuation, there remains room for multiple expansion on LTM cash flow metrics, and we further believe shares will continue to trend higher throughout 2016.

The company performed well across all metrics during the quarter. ARPU and MAU were up in every geography, with ARPU growth coming in especially strong. The ARPU boost, especially domestically where ARPU jumped 50% Y/Y, can be seen partially as a result of high-demand for Instagram ad-space. According to management, 98 of the top 100 advertisers on Facebook also advertised on Instagram during the quarter. We still believe a mature Instagram business will bring in more than $5 billion in annual revenue, and affirm that Instagram should continue to drive ARPU growth in 2016. We believe the other driving force of higher ARPU will be video ads, as Facebook continues to focus on feeding videos to its users. From a monetary standpoint, we see this as an attempt to take away video advertising market share from YouTube.

On the MAU growth front, we are impressed that Facebook only lost 5 basis points of Y/Y MAU growth in US & Canada in Q4 relative to Q3. The Facebook platform in US & Canada is growing its user base faster this year than it was last year, and this is impressive in what many view as a nearing saturated market. We believe this speaks to our thesis that Facebook's popularity domestically is being assisted by Twitter's (NYSE:TWTR) weakness.

Also during the quarter, margins expanded, with GAAP operating margins expanding ~1200 basis points sequentially and ~1500 basis points Y/Y. Earnings increased dramatically and free cash flow doubled relative to 4Q14.

We believe the quarter strengthens the secular growth story of Facebook becoming a consolidated app marketplace. We have written several times on why we feel Facebook is strongly leveraged in creating an all-in-one multiple-app ecosystem due to the size of its user-base. Despite the strength of the quarter, we still believe Facebook is only touching the surface of its full potential as a consolidated app marketplace. With market-changing catalysts on the horizon such as transforming Messenger and WhatsApp into commerce marketplaces, coupling Services and Places to create a Yelp (NYSE:YELP) substitute, and fleshing out Sports Stadium to be a go-to mobile sports information application, we believe the Facebook growth story is far from over.

At a $100+ quote, the toughest thing to understand about Facebook is its valuation. Many investors will see the earnings or sales multiples and say the stock is overvalued. We contest that even after this 15% pop, the multiples still have room to expand. We are paying specific attention to the cash flow multiples because we believe cash flow is a true measure of the company's profitability. Looking at these cash flow multiples, we can see that FB is actually trading at a discount to its growth. LTM operating cash flow of $8.6 billion means the stock is trading around 36x cash EPS. This ~36x multiple is on operating cash flow growth of 57%. The same story is true for free cash flow. The stock is trading around 51x LTM free cash flow on free cash flow growth of 68% Y/Y. We believe these multiples can expand so that the stock is trading more at a parity to its cash flow growth.

In sum, we believe the 15% pop in shares following what was an exceptional quarter is warranted. We also believe the growth story is far from over for Facebook, with several market-changing catalysts on the horizon. We think the stock is actually undervalued relative to its cash flow growth, and so we believe there remains upside both in the near and long term windows.

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.