Facebook (FB - Free Report) reports Q2 earnings today after the close and any investor who gets excited about advertising sales growth of 45% year-over-year, and 15% sequentially, should read this article and get ready to buy FB shares on any dip.
Ten Points On Why It's All About the Ecosystem
1) Consensus Projections & Raised Estimates
Facebook is expected to report just over $9 billion in ad revenues for the quarter and $1.13 EPS, representing 49% profit growth. Since the company will be evaluated on many other growth metrics besides the top and bottom lines, my last point will briefly address the "What if they miss?" question.
What's been fascinating for me to watch as a Facebook bull in the face of so many who doubt the ad growth can continue is how estimates have just kept moving higher all year. In January, we started out with the consensus for full-year 2017 revenues projected to be under $36 billion in ad sales (fully 98% of total revs), or 32% growth.
In the past few weeks, as analysts have done more channel checks, the numbers have climbed to just over $38 billion in advertising revenues for over 40% top line growth. And the 2018 estimates keep getting bumped too with revenues to hit over $49 billion and EPS of $6, representing 28% and 24% growth.
2) Ad Inventory Shrinking?
Part of the doubt about how Facebook could continue to grow ad sales as such a clip was that even they warned about reaching capacity on the News Feed for ads. But this is clearly the right side of the supply and demand curve to be on.
As Facebook COO Sheryl Sandberg said last quarter, they diligently track the impact of "ad loads" on the user experience, going for quality and relevance over quantity and annoyance (my paraphrase).
The key has been to innovate and execute on a plan to shift more advertising to Instagram where social audience targeting can be just as effective as on the core FB feeds.
3) Instagram Leapfrogs Snapchat
Instagram hit 700 million total users and 400 million DAUs (daily active users) as of Facebook's last quarterly report May 3. The real growth has come from Instagram Stories which has greatly surpassed that of rival they copied, Snapchat (SNAP - Free Report) .
Stories passed 250 million DAUs in June, up from 200 million in April, 150 million in January, and 100 million in October -- only two months after launch.
While the company is taking their time to monetize Instagram, we could see a dramatic shift forward in those efforts in Q2. They might even begin to break-out Instagram revenue as a segment. Until then, analysts estimate the photo-sharing app could generate over $4 billion, or 10%+, to Facebook's top line.
4) Super FAN
Facebook says their "ads work because they’re personal, relevant and easy to measure on both desktop and mobile." I know for a fact, from talking to hundreds of small business owners who advertise on Facebook, that they work because the marketer can design ads and experiment for very low cost until they begin to find something that works.
The freedom is enhanced by precision tools to target audience demographics and get analytics that tell them what's working.
The Facebook Audience Network (FAN) brings these same powerful features to additional app-based mobile experiences, giving marketers even more scale for their Facebook campaigns. The FAN uses the same targeting available for Facebook ads, including Custom audiences, Core audiences and Lookalike audiences.
But wait! There's more. For marketers already running News Feed ads on Facebook, using the Audience Network takes just one click to get extended reach. Once a campaign is running in the Audience Network, the system handles optimization and delivery. And it features the same measurement tools marketers use for their Facebook ads, too.
This is where you begin to see the "ecosystem" that Facebook is creating, and not just separate apps like Instagram. More pieces to come.
5) Video is Where It's At
Zuckerberg is smart because he looks around and copies what's working. Snapchat for one. YouTube for another.
This year, FB began rewarding longer videos with more views and viewing time by ranking them higher in the News Feed. This opens up more opportunity for the so-called "mid-roll" ad.
While they are cautious to begin a lot of "pre-roll" ads in front of videos, the mid-roll ad is serving advertisers and consumers quite well.
And from what I can tell, as marketers get better at making short, impactful video commercials or branding messages, they aren't as annoying as they used to be. In other words, people accept them much better say than 3 minutes of radio commercials.
6) Digital Ad Agencies
I am no expert on "how to advertise" on Facebook. Sometimes I get the terminology wrong, and I'm probably not the guy to go into your FB Ads Manager and start messing around.
But I pay attention to the experts and one group in particular are the small and medium-sized ad agencies who served like-sized marketers. These guys and gals know their stuff, especially if they've helped lots of different types of businesses to scale their advertising ROI -- in essence, to grow more sales with less ad dollars.
A few things stand out when I listen to them. First, they are busy. Every small and medium-size business owner is waking up to the power and flexibility of Facebook advertising whether they are selling products (tires, tea, t-shirts) and services (classes, coaching, consulting) around the world or just locally.
This is not a fad. It's an entrepreneurial revolution of targeted, cost-effective reach to new and existing customers that will not slow down (much) for another decade, especially when you consider international opportunities.
Second, the agencies are thrilled with all the tools they can use to help their marketing customers, from Dynamic Ads to Messenger Bots. These are more pieces of the Facebook ecosystem.
Dynamic ads look exactly like other single image ads or ads created in the carousel format on Facebook, Instagram and Audience Network. However, instead of individually creating an ad for each of your products, you create an ad template that automatically uses images and details from your product feed for things you'd like to advertise.
Dynamic ads use a marketer's Facebook pixel or SDK (software development kit) to show ads to people who have already shown interest in their business. To be able to track and re-target these potential customers is part of the precision that makes Facebook ads so attractive.
And the latest innovations with Messenger Bots for communicating, sharing, and marketing to existing fans or followers is one area I am really excited about and talked about on my recent podcast The E.T. Economy: Disruptive Technology and the Behavior of Shopping. The marketing potential for Facebook's WhatsApp must be nearly as significant.
7) TV Could Be Where It's At Next
With the introduction this year of longer-form video content, FB is ready to go head-to-head with YouTube -- and TV. According to a June 15 article by Hannah Kuchler in San Francisco and Shannon Bond in New York, writing for the Financial Times...
"The world’s largest social network is wading into a crowded field by funding original content, in an effort led by Ricky Van Veen, co-founder of comedy site College Humor. The company has also signed deals to stream live baseball in the US and football in Mexico, and launched a Facebook app for Apple and Android smart TVs."
If original content and licensing exclusive shows works, it could create a whole new stream of revenues that most analysts haven't even modeled yet. Especially if traditional TV advertisers move on over. According to Robert Elder writing for Business Insider in January...
"Facebook unveiled a tool last year that makes ad-buying on the platform more TV-like. Several months later, it commissioned a Nielsen study that showed Facebook ads reach an additional 5% of people who can’t be reached on TV."
8) Zuck Goes DARPA
A few years ago, Google parent Alphabet (GOOGL - Free Report) hired an engineer by the name of Regina Dugan. But this wasn't just any engineer, and it wasn't just any IT job.
Dugan used to run DARPA, the Pentagon's Defense Advanced Research Projects Agency, responsible for the development of emerging technologies for use by the military.
And Larry Page and Sergey Brin already had plenty of laboratory space and Skunkworks projects for Dugan to play with and create in, including GoogleX and ATAP (Advanced Technology and Projects).
That changed last year when Facebook poached her for their own designs. Dugan runs a research group housed in Facebook Building 8. What are they up to?
I think it will have a lot to do with the next potential iterations of Oculus virtual reality (VR) and augmented reality (AR) for gaming, education, and shopping. I could be wrong. But Mark Zuckerberg and Sheryl Sandberg strike me as leaders who carefully craft their business and media platform ambitions. They don't seem like they just throw spaghetti at the walls.
They may not have had it all planned out four years ago when Facebook bought Oculus Rift for $2 billion, but they had a good idea of where technology could lead us in the social + business playing field and they have surrounded themselves with the most creative and visionary thinkers and tinkerers anywhere to figure that out.
9) Valuation Stretched? Nope.
Together, Google and Facebook will do about $110 billion in digital ad sales this year. While I used to think that Facebook was just stealing market share from Google, now I know better. The pie is growing larger as more business owners realize the power, affordability, and versatility of these platforms.
So how long can Facebook keep growing sales at 40% annually? The safe bet might be to say the end is nigh.
But then you'd have to conclude that we are close to some upper limit to either the demand for or the supply of advertising space. While Facebook voluntarily put the brakes on their "inventory" of digital ad space, they also found other outlets beyond the main News Feed.
And I don't see an upper limit to ad demand in a global economy that is humming and with Asia-Pacific countries still discovering the power of Facebook. As a matter of fact, Amazon (AMZN - Free Report) just announced yesterday that they are breaking digital ground in Singapore with a full suite of e-commerce services, plus Prime delivery options.
My followers know I'm also a huge fan of Alibaba (BABA - Free Report) , the "Amazon of China," and its growth opportunities. When I spoke about both on the radio yesterday, a friend asked me, "Quick--If you had to choose just one company to buy, which would it be--Facebook or Alibaba?"
I couldn't choose because I believe in both of their dominant positions and growth prospects so much, as each can gain more access to the largest middle classes in the world in China and India. But today, it's all about Facebook!
And I have little doubt that Zuck and Co. will keep innovating and executing as they do in a global economy full of so many opportunities. They'll probably maintain 25-30% sales growth for the next 3 years, much like Amazon did for years.
So, I think one can easily pay 30X 2018 EPS estimates of $6 and watch your investment grow in Facebook. That makes FB a $180 stock this year.
10) Hope They Miss
But don't rush out and buy before tonight's report. Wait... and hope they "miss" on some growth or user metric that causes Wall Street to take profits after the 10% run the stock has had this month.
And then you buy it around $155 or lower to hold into the next earnings report. There should be good support in the May-June consolidation we just experienced between $145 and $155. You might make 20% in a quarter that way.
Or you could just buy it and keep it for much longer. I expect Facebook will be a $200 stock next year, and higher longer-term.
Disclosure: I own FB and BABA shares for the Zacks TAZR Trader.
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