Facebook 2Q14 Preview: Positive On Growth, Dilution A Near-Term Negative

| About: Facebook (FB)
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FB will report 2Q14 on Wednesday with consensus expecting $0.32 EPS and $2,79b in revenue.

Revenue trend to remain positive on rising engagement, strong pricing and usage.

WhatsApp monetization in question. Dilution from recent M&A a near-term negative.

Facebook (NASDAQ:FB) will report 2Q14 results on Wednesday (July 23) after market close. Investors can access the online webcast through FB's investor relation site (link). Consensus expects non-GAAP EPS of $0.32 and revenue of $2.79b for the quarter.

Positive on the ad revenue trend

Among the US large cap internet names, I am more positive on FB as the company has demonstrated solid top and bottom line growth over the past several quarters with accelerating growth in ads and total revenue, and triple digit mobile ad revenue growth. Most importantly, engagement metrics expanded 300bps over the past year, in contrast to Twitter's (NYSE:TWTR) engagement metric, which declined 8% y/y. The overall pricing trend and usage seems to be strong judging by the recent quarterly filings and I expect Q2 to demonstrate another round of solid growth in all the key operating metrics.

Mobile revenue accelerating on the back of rising engagement

I expect mobile revenue to accelerate this quarter on the back of rising mobile engagement. Last Q, mobile revenue accounted for 59% of total ad revenue and I expect the proportion to increase to ~65%, on par with mobile engagement.

Video ad showing initial signs of life

Based on my check, FB seems to have been aggressive in pushing mobile video ads. While the coverage is still small (I observe ~5-10%) as FB try to mitigate user experience, I am still positive on the product's long-term potential. However, investors should not expect to see meaningful impact of the video ads in the upcoming Q given the early stage of the product launch.

Negative on the future of Whatsapp

In order for FB to maintain its growth profile, I believe that the monetization of WhatsApp is critical to accomplishing that goal. However, WhatsApp is facing structural challenges in North America, where the most popular form of messaging is texting (thanks to carriers' unlimited text plans) and competitive pressure in the rest of world such as Wechat, LINE, Kakao, and Viber in Asia. Moreover, its Asian rivals, in particular Wechat and LINE, are offering broader functions and features in their platforms (ie. mobile payment, wealth management, restaurant booking) compared with WhatsApp, which is still a messaging-centric app. My view is that WhatApp will continue to face the structural headwind in North America due to the unlimited text plans and the competitive pressure in the other parts of the world. Monetization for this platform will take some time for it to have meaningful impact on FB's overall growth.

Finally, investors should also expect dilution to occur this upcoming Q from the WhatsApp and Oculus VR acquisition. Based on the $12b in stocks (and $3b in stock grants) involving the WhatsApp acquisition and the $1.6bn for the Oculus purchase, I estimate that the total dilution from these two deals will be around 9% of the diluted shares at the end of Q1, and this is a clear near-term negative to the shareholders.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.