Thursday, October 31, 2013

We're back ... for now; let's talk about FB

We thought we should update our valuation of Facebook (FB), the momo stock (momentum stock), which shot up from below $18/sh to nearly $55/sh.  Of course, this was after the stock closed at $38.23, below its IPO price, after the first day of trading in May '12.  Simply put, FB dropped more than 50% below its IPO price to $17.73 (which we enjoyed), and it climbed nearly 200% which was certainly welcomed by many FB fans.  The stock has been a momo one for the past 3.5 months. 

The Company reported its Q3 results on Wednesday, handily beating, on the top and bottom-line.  The mobile ad strategy has certainly begun to payoff for FB as its overall ARPU grew 7.5% and 33.8% Q/Q and Y/Y, respectively.  Such growth was driven by increase in MAUs and number of ads within news feeds, mainly on the mobile platform.  In fact, we estimate mobile ad ARPU (mobile ad revenues per mobile-only users) of $3.47 in Q3, significantly above the $1.51 total ad ARPU.  Impressive top-line growth certainly helped the bottom-line as we did see a Y/Y non-GAAP EBIT margin expansion of 430bps.  In addition, management touched on some of the newer products that the Company is currently working on.  However, we will need to have patience in order to see some return on those.    

There were some negatives that came along with the positives we just mentioned.  For example, management acknowledged it believes daily active usage by younger teens is slightly declining, which is basically the last thing that advertisers want to hear.  

Management also stated that the Company will not increase the number of mobile ads (via news feed).  We believe, based on its own research, the Company has learned that given the limited amount of space on mobile devices and the users' limited attention span, additional ads will not only reduce ad ROIs, they may drive away users.  This is something that we briefly touched on more than a year ago.   We actually believe that when it comes to mobile advertising, it must be based on a 'pull' strategy and not a 'push' strategy.  This becomes even more important when FB is dealing with large brand names and trying to help them create long-term marketing and advertising strategies.  An analyst touched on this during the call by asking a push/pull question.  Unfortunately, the CEO did not necessarily answer the question.  

Fear of decline in prices may be another reason why management has decided to no longer increase number of mobile ads via news feeds.  By limiting the supply of ad space (number of places available to place ads in) and assuming that demand will stay constant or increase, management is managing the ad prices, in our opinion.  This becomes even more important when user growth begins to decelerate, which we have seen in the North American region.  In addition, we believe prices of ads placed on desktops have plummeted, and management is hoping mobile ads' significant revenue growth will continue, as it certainly has to more than offset the decline in desktop ad revenues.   

We also believe FB has realized its 'closed network' strategy is not paying off as well as it had hoped, especially when there are more open players, such as Twitter, in the social media space.  In fact, we were amused at how much the CEO tried not to mention Twitter when answering a question regarding FB's 'latest strategy' of using hashtags ('#').  This is one reason why Instagram has been successful as it is more open than original Facebook.  However, FB is yet to monetize Instagram.  It is progressing slowly as the Company does not want to risk turning Instagram users away by throwing too many ads (whether text, images or video) at them.  Successful monetization of Instagram does represent an upside for FB.

With the upcoming Twitter IPO, we believe FB will be facing a lot more competition as it seeks more ad dollars.  As management said, current mobile ad dollars represent only 3% of total ad budgets, which means it has a lot of room to grow.  However, we believe such growth will be accompanied by more ad distributors, somewhat limiting growth of the size of their piece of the pie.  Twitter is also well-suited for most mobile device users, as they likely have short attention span and will be multi-tasking, at least while using the device.  And twitter is open; open not only for users, but also for advertisers and companies.  

Going back to FB, we continue to value it below where it is currently trading.  Our DCF model spit out a $25.94/sh valuation, significantly below where the stock closed at on 10/30.  At $49.01, FB is trading at an FY '14 EV/Sales multiple of 12, higher than its peers' 6.  It is also trading nearly 50x its FY '14 non-GAAP EPS, which is below its peers' average of 95x.  However, we note the group P/E average is significantly inflated by AMZN's 133 and YELP's 268.  Our updated estimates are provided below.    

Lastly, we will provide updates on IACI, AVID, and BCOR (reporting Q3 next week) by Sunday.  IACI did report earnings on Tuesday and missed big on the top-line.  It closed down 8.5% at $53/sh, barely below our valuation of the Company, which is $54/sh.  We will review the numbers and provide an update later this week.  Also, since the last time we posted some BS on our blog (7/30), AVID has gone up 16%, compared to S&P 500’s 4.6% increase.  In fact, the stock has jumped 39% since mid-Sep.  As a reminder, AVID is currently in the process of reviewing its revenue recognition, and it may get de-listed from NASDAQ.  However, NASDAQ has given the Company more time to update its financial results and file the necessary 10-Qs and 10-Ks with the SEC.  It is up only 6% from when we initially suggested it, compared to S&P 500’s 24% increase since then.  We note the stock had climbed more than 17% before taking a dump after the revenue recognition review announcement. BCOR closed at $23.18 on Wednesday, up 53%+ since we suggested it in late Jan '13; this is compared to S&P 500's 17% increase since then.  Similar to AVID, BCOR has gone up 16% since our last post, higher than the market's 4.6%.