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Outlook Dampens FB Earnings Beat

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Facebook Inc. (FB - Free Report) reported third-quarter earnings (including stock-based compensation and payroll tax expense related to it) of 17 cents per share, which beat the Zacks Consensus Estimate by 4 cents. Earnings per share improved considerably from 6 cents in the year-ago quarter.

Quarter Details

Revenues (excluding foreign exchange effect) surged 60.0% from the year-ago quarter to $2.02 billion, which comfortably beat the Zacks Consensus Estimate. Average revenue per user (ARPU) increased 33.0% year over year to $1.72.

The strong revenue performance was aided by robust advertising revenues that jumped 65.7% from the year-ago quarter. Advertising revenues were driven by higher number of marketers, healthy advertising demand scenario and robust performance of its news feed ads.

Mobile comprised 49.0% of ad revenues, up from 41.0% in the previous quarter. The sequential increase in mobile ad revenues was driven by an increase in average price per mobile ad, number of mobile users and ads shown per mobile user. Ad revenues from the web decreased both sequentially and year over year.

Ad impressions were up 16.0% on a year-over-year basis, primarily driven by increased user engagement and effects of reduction in prices in the year-ago quarter. Average price per ad increased 42.0% from the year-ago quarter driven by favorable mix shift from low priced web ads to high priced news feed ads (due to high user engagement levels).

Average price in the developed countries continued to increase strongly, with the U.S. and Canada increasing 60.0% from the year-ago quarter, primarily attributable to higher engagement and performance of news feed ads.

During the quarter, Facebook’s Monthly Active Users (MAU) improved 18.0% year over year to 1.19 billion. Mobile MAUs surged 45.0% year over year to 874 million. During the same period, Daily Active Users (DAU) increased 25.0% year over year to 728 million.

However, management remains cautious on Facebook usage among teenagers, which was almost stable in the third quarter on a sequential basis. At the end of September, Instagram had more than 150 million monthly active users.

Payments and other fees surged 24.0% year over year to $218.0 million in the third quarter as revenues from games soared 18.0% from the year-ago quarter.

Total cost and expenses as percentage of revenues plunged 660 basis points (bps) from the year-ago quarter to 63.5%. Cost of revenues, research & development, marketing & sales and general & administrative expenses decreased 40 bps, 100 bps, 170 bps and 350 bps, respectively.

The lower-than-expected increase in operating expenses drove operating margin, which surged 660 bps on a year-over-year basis in the third quarter. Net income margin improved to 20.9% compared with 12.9% reported in the year-ago quarter.

Facebook exited the quarter with cash & cash equivalents and marketable securities of $9.63 billion compared with $10.25 billion in the previous quarter. The company paid back its 1.5 billion term loan during the quarter. Currently, Facebook has a $6.5 billion line of credit.

Facebook generated $955.0 million of cash flow from operating activities compared with $1.32 billion in the previous quarter. Free cash flow was $666.0 million compared with $1.05 billion in the previous quarter.


Facebook expects to carry on with its investments for improving the quality, engagement and value of its ads, which will further boost advertisers’ demand over the long term. To meet these ends, management stated that Facebook will not increase the quantity of ads as a percentage of news feed stories from the last quarter level.

Facebook expects payments revenue to decline in the upcoming quarter on a year-over-year basis. The company had recognized four months of revenues in the year-ago quarter.

Total expenses are expected to increase approximately 45.0% for 2013. Capital expenditure is likely to be $1.4 billion during full year 2013.

Our Take

Facebook’s impressive third quarter results were marred by a cautious outlook. The company’s announcement of not increasing news feed ad quantity and a decline in payments business dragged down the shares in after-hours trading.

However, we believe that the teenage fatigue issue is the most significant headwind for Facebook. In this regard, we believe that the company’s strategy of restricting ad quantity is a positive step to increase user engagement.

We also believe that Facebook’s recent decision to allow users in the age group of 13 and 17 to make public posts is a positive step. So far, posts made by teenagers could only be seen by their friends and "friends of friends."

We believe that this is a clear cut strategy to combat rivals such as Twitter as well as attract more advertisers, particularly those targeting teenagers. Moreover, the recent partnership with Google’s online ad-placing service Doubleclick is a significant positive for the company going forward.    

We believe that the company has gained significant traction in its mobile ad business within a very short span of time. This combined with its massive user base and its ability to track personal details over time makes it a formidable force in the online ad market. Its integration with Apple’s (AAPL - Free Report) iOS and Google’s mobile platforms is also commendable.

However, a volatile macroeconomic environment, increased investments to expand mobile offerings and increasing competition from the likes of LinkedIn are expected to hurt margins in the near term.

Currently, Facebook has a Zacks Rank #2 (Buy).

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