A month has gone by since the last earnings report for Facebook (FB - Free Report) . Shares have lost about 9.9% in that time frame, underperforming the S&P 500.
Will the recent negative trend continue leading up to its next earnings release, or is Facebook due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.
Facebook Q3 Results Benefit From Strong Asia-Pacific Growth
Facebook (FB - Free Report) reported third-quarter 2018 earnings of $1.76 per share that beat the Zacks Consensus Estimate by a whopping 30 cents. However, revenues of $13.73 billion lagged the Zacks Consensus Estimate of $13.81 billion.
Earnings increased 10.7% from the year-ago quarter on revenue growth of 32.9% (34.5% at constant currency).
Facebook estimates that more than 2.6 billion people now use its “Family” of services, which includes Facebook, WhatsApp, Instagram and Messenger, on a monthly basis. Moreover, more than 2 billion people use at least one of its services daily, on an average.
Geographically, Asia-Pacific was the strongest region with revenues growing 37.6% year over year, followed by Europe’s 33.5%, and U.S. & Canada’s 32.5%. Rest of the World’s (RoW) revenues increased 25.7%.
Average Revenue per User (ARPU) growth was strongest in the U.S. & Canada, up 30.2% year over year, followed by Europe’s 28.8% growth. RoW and Asia-Pacific grew 14.5% and 17.6%, respectively. Worldwide ARPU increased 20.1% to $6.09.
Asia-Pacific: Fastest Growing Market
Facebook believes that developed countries are almost saturated, which was evident from the third-quarter results.
Daily Active Users (DAUs) were 1.495 billion, up 127 million year over year and 24 million sequentially, and represented 66% of MAUs. Asia-pacific was Facebook’s fastest growing market in the quarter, driven by growth in India, Indonesia and the Philippines.
Asia-Pacific DAUs increased 85 million year over year and 15 million sequentially to 561 million. RoW DAUs were 470 million, up 37 million from the year-ago quarter and 9 million sequentially.
However, DAUs in Europe declined 1 million sequentially to 278 million. On a year-over-year basis, the figure increased 4 million. Growth in the U.S. & Canada stalled in the quarter. DAUs were 185 million, flat, both on a year-over-year and sequential basis.
Monthly active users (MAUs) were up 199 million on a year-over-year basis and 37 million sequentially to 2.271 billion.
Asia-Pacific MAUs increased 123 million year over year and 23 million sequentially to 917 million. RoW MAUs were 736 million, up 65 million from the year-ago quarter and 13 million sequentially.
However, MAUs in Europe declined 1 million sequentially to 375 million. On a year-over-year basis, the figure increased 11 million. MAUs in the U.S. & Canada grew 3 million on a year-over-year basis and 1 million sequentially.
Private Messaging & Sharing Gain Prominence
Facebook stated that user adoption of its Messenger service and Stories is increasing rapidly. This is due to the growing user preference to share content within smaller groups. The ephemeral feature of Stories is also a significant attraction to these users.
Management observed that almost 100 billion messages are sent on a daily basis using Facebook services, including Messenger, Stories and WhatsApp. On Messenger, more than 10 billion messages are sent between people and businesses on a monthly basis. Further, users share more than 1 billion Stories every day.
The robust growth in private messaging and sharing bodes well for Facebook. However, the company’s business model will take some time to catch up with this rapid growth.
Facebook also noted that in the messaging service space, Apple’s iMessage is its biggest competitor, particularly in the United States where iPhone has significant user base. In other countries, primarily where Android has dominant presence, Facebook’s messaging services are gaining traction.
The company believes strong demand for its messaging service, particularly WhatsApp, is due to tightened security features, including end-to-end encryption. WhatsApp doesn’t store user messages or keys, anywhere.
Facebook is also focusing on adding user-friendly features like payments to WhatsApp and Messenger. The company is also set to introduce ads in WhatsApp Status in 2019.
The company noted that the connection between WhatsApp business and users is growing rapidly. WhatsApp business currently has more than 3 million accounts. Paid messaging and ads in Stories are two products Facebook is set to release to enhance interaction between users and businesses.
Stories to Eventually Drive Ad growth
Facebook stated that more than 90 million businesses rely on its pages to reach potential customers for free. Further, 6 million advertisers are active across Facebook, Instagram and other services.
Currently, advertisers reach users on Facebook services through Facebook News Feed and Instagram Feed. Feed ads on Facebook and Instagram drive the majority of the company’s revenue growth and are expected to remain so over the next couple of years.
However, due to growing prominence of private messaging and ephemeral sharing, Stories are expected to become a bigger driver in the long haul.
Keeping this in mind, Facebook rolled out ads in Facebook Stories during the quarter. The company also worked on improving the looks of the ads to make them suitable for Stories.
During the quarter, Facebook expanded Marketplace ads to nearly 70 marketers. In Faceboook Watch, the company introduced “a way for advertisers to buy video placements from a selection of the most engaging publishers, choose specific content categories they want their ads to play alongside and pay only for ads that are watched till the end.”
Facebook also added tools that help advertisers to see the placement of their ads on audience network, Instant Articles and Watch.
Facebook is also working on finding ways to help advertisers reach Messenger users through sponsored and inbox ads.
Video Initiatives to Boost Community Feeling
Moreover, the company’s focus on “community” and “meaningful social interaction” are long-term growth drivers.
The company’s initiative to build communities is gaining traction. Marketplace is now used by 800 million people. It has become a well-known place to buy vehicles online. Moreover, Facebook’s new job tool has helped people find more than 1 million jobs. The company also helped people raise more than $300 million for charities through fundraisers.
In case of Instagram, the company is focusing on helping users explore their interests. The company is adding new features in the form of IGTV, new shopping experiences and Explorer tab.
Watch on Facebook core app and IGTV on Instagram are two video initiatives that are expected to promulgate “meaningful social interaction” in News Feed on both the platforms. Management believes that the availability of these dedicated video services will not displace social interactions in Feeds, be it on Facebook or Instagram.
However, Facebook stated that these video services are well-behind in terms of competition, primarily from Alphabet’s YouTube. Moreover, video services generate less revenue per minute compared with other money generating services.
Further, Facebook is heavily investing in augmented and virtual reality (AR and VR), as well as hardware to foster more community feeling and social interactions. The launch of hardware products like Portal and Oculus Quest are steps toward that direction.
Advertising revenues soared 33.5% year over year to $13.54 billion. Asia-Pacific and Europe were the strongest regions, growing 37.6% and 34.2%, respectively.
Advertising revenues in the U.S. & Canada and RoW grew 33.3% and 26.1%, respectively.
Mobile ad revenues surged 40% year over year to $12.5 billion, contributing 92% to total ad revenues. Ad impressions served increased 25%, while average price per ad increased 7% from the year-ago quarter. Growth was driven by higher Feed ads on Facebook and Instagram.
Payments and other fees increased 1.1% year over year to $188 million.
In the reported quarter, costs and expenses jumped 52.6% year over year to $7.95 billion. Facebook’s employee base surged 45% year over year to 33.6K.
Marketing & sales expenses as percentage of revenues increased 270 basis points (bps) on a year-over-year basis to 14%. Marketing & sales expenses jumped 64.8% from the year-ago quarter to $1.93 billion.
General & administrative expenses as percentage of revenues increased 170 bps to 6.9%. General & administrative expenses surged 75.9% to $943 million.
However, research & development expenses as percentage of revenues decreased 50 bps to 19.4%. Research & development expenses increased 29.5% to $2.66 billion.
Although operating income of $5.78 billion grew 12.9% year over year, operating margin contracted 750 bps to 42.1%.
Balance Sheet & Cash Flow
As of Sep 30, 2018, cash & cash equivalents and marketable securities were $41.21 billion compared with $42.31 billion as of Jun 30, 2018.
Capital expenditures were $3.34 billion, driven by investments in data centers, servers, network infrastructure and office facilities. Free cash flow was $4.2 billion compared with $2.8 billion in the year-ago quarter.
Facebook bought back almost $4.3 billion of its Class A common stock in the reported quarter.
For the fourth quarter, Facebook expects revenue growth rate to decelerate mid-to-high single digit percentage compared with third-quarter’s growth rate. Higher contribution from product services and geographies that monetize at lower rates are expected to drive impression growth in the quarter. Moreover, data privacy initiatives are expected to hurt pricing growth.
The company is expected to lose some ad impression opportunities due to its focus on growth of Stories on the core Facebook app.
Facebook anticipates full-year 2018 total expenses to grow roughly 50-55% compared with its previous guidance of 50-60%. Capital expenditures are expected to be roughly between $14 billion and $14.5 billion compared with the previous estimate of $15 billion.
Facebook projects total expenses in 2019 to flare up 40-50% compared with the current year. Moreover, capital expenditures are expected to be roughly between $18 billion and $20 billion.
How Have Estimates Been Moving Since Then?
It turns out, fresh estimates flatlined during the past month.
Currently, Facebook has a nice Growth Score of B, however its Momentum Score is doing a bit better with an A. However, the stock was allocated a grade of C on the value side, putting it in the middle 20% for this investment strategy.
Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.
Facebook has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.