Thursday, January 31, 2013

Facebook Update ...

Facebook (FB) reported slightly better than expected Q4 numbers.  The stock was down 3.4% in AH.  We are not sure how the stock will react to the numbers on Thursday.  But as we said in our prior post, it may have been priced to perfection.  While the numbers came in better than expected, the same issues linger - slowdown in user growth within the most profitable region (North America), while better user growth is in regions with much lower ARPUs; monetization of users moving onto mobile devices; and the decline in average price per ad.  In our opinion, FB is taking the right steps to address these issues, but it will take time to see if those moves will be considered as successful.  From a fundamental standpoint, the stock remains overvalued. 

Total revenues of $1.59bil, exceeded the Street's $1.52bil and our $1.49bil expectations.  We note that due to some accounting adjustments, FB actually recognized $66MM more in payments & other fees revenues (one-time).  Without that, total revenues would have been pretty much in-line with the consensus.  FB also beat one the bottom-line, with GAAP EPS of $0.03.  We actually had estimated a net loss of $0.03.  We had over-estimated stock based compensation and the Company's income taxes.

Growth in North American MAU continued to slowdown.  Y/Y MAU growth in that region was only 7.8%, while growth in Europe, Asia, and other regions were 14.0%, 40.6%, and 35.1%, respectively.  Unfortunately, highest ARPUs came from the slowest growing region, North America.  We must note that ARPU in the 'other' regions did grow north of 40% Y/Y, but it was only $0.56.  In fact, revenues from that region accounted for only 10% of FB's total revenues, while revenues from North America were nearly 50%. 

Based on the mobile MAU of 680MM provided by the Company, we estimate that mobile ARPUs were only around $0.45 in Q4.  Although this figure is significantly above Q3's $0.25, we believe it must grow much further and much more quickly to make up for what we believe to be cannibalization of revenues generated from users on desktops or non-mobile platforms.  But again, it appears that the Company is moving in the right direction. 

Whether the initial success seen in News Feed on mobile will continue or not, remains to be seen.  Increase in total mobile ad revenues as a percentage of overall ad revenues could be due to many companies wanting to be the first ones trying out marketing on this platform.  With high expectations, such growth may not last, and/or businesses may demand a lower price per ad.  So FB will need to demonstrate consistent acceleration of growth in both the number of ads on mobile platforms and mobile ARPUs.  As noted before, if ads are successfully designed to target specific users, which means they could have a higher return for the advertisers, then their prices, and therefore the ARPUs will increase.  However, the question of whether users will accept the ads or will reduce their time on FB, as a result of possibly too many ads, remains.  The line between the push and pull ads is getting blurrier.

Also, returns on mobile ads for advertisers are a bit more difficult to measure.  In our opinion, the regular click per ad may not be a good measure.  We think mobile ads will be considered successful if they lead to a transaction, at that time or at a later time, and on the mobile device or in the store.  However, given that most user growth is coming from developing regions which do not have the American consumption-only culture and have much lower wages and disposable income, growth of mobile ads and their ARPUs in those regions will remain very limited, in our opinion. 

One of the least talked about issues surrounding FB is the fact that while ad impressions are increasing at an impressive rate, 46% Y/Y in Q4, average price per ad continues to decline.  Yes, lower prices are coming mainly from lesser developing markets, but then again, so are the faster growing impressions.  This is similar to the dilemma FB is facing regarding the slowdown of its user growth in the region with the highest ARPU that is also cash flow positive and is the main reason why FB was profitable. 

We remain optimistic about the Company's Gift strategy and how it can actually drive impressive growth in the payments & other fees segment.  Unfortunately, this will take some time and requires a lot of patience. 

Again, overall, FB's Q4 results were slightly better than expected, mainly due to the one-time lift in revenues from the payments & other fees segment, along with lower stock-based compensation expenses and income taxes.  The balance sheet remains strong with net cash and marketable securities of $8.13bil or $3.24/sh.  However, the stock is overvalued; trading at 36x FY '13 EPS with a PEG of 1.6.  A forward P/S multiple of 10 also indicates it is overpriced for the top-line growth that the market is expecting.  It is also trading at nearly 20x our FY '13 EBITDA estimate.  We continue to value FB at $23/sh.

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