Facebook Q3 14A – The morning after

The easy growth looks over. Investments are now required.

• Facebook reported good Q3 14A results but there are signs that growth is starting to slow meaning that investments have to ramped up to develop the addressable market further. .
• Q3 14A Revenues / EPS were $3.2bn / $0.43 compared to consensus forecasts at $3.1bn / $0.40.
• Facebook has been enjoying very strong growth for the last year as it has been benefitting from what I call the “catch-up effect”.
• Until recently, Facebook was capturing a lot of mobile traffic but was failing to monetise it effectively.
• With the launch of its mobile advertising platform, this problem was solved.
• Revenues immediately started to grow very strongly as the mobile traffic it was receiving was more and more efficiently monetised.
• This “catch-up effect” now seems to be abating as mobile is now 66% of revenues meaning that Facebook will now have to look to other avenues to find further growth.
• This is where investments come in and a major reason why the guidance for expenses next year is surprisingly high.
• Guidance for Q4 14E revenues was disappointing with $3.6bn-$3.8bn in revenues expected compared to consensus at $3.73bn.
• This represents very healthy YoY growth of 40%-47% but with the stock on 46x 2014E PER and 37x 2015E PER, clearly the market was looking for more.
• Furthermore it seems very unlikely that revenues will accelerate next year, meaning that with expense growth of 50%-70% in 2015E, margins are going to fall.
• The problem here is one that I have highlighted before. (see here)
• Facebook occupies only a slice of Digital Life.
• Social networking is a big slice, making up 24% of smartphone usage, but it means that users are spending 76% of their time doing something else on their smartphones.
• In order to grow revenues further, Facebook needs to get users to engage with it when living other aspects of their Digital Lives and this requires investment.
• This is why I believe that expenses will be growing so quickly next year while revenues lag.
• Facebook is investing for another growth cycle but it is going to take some time for this growth to show through in the numbers.
• In the meantime, the quarterly focused eyes of Wall Street will be focused on declining profitability and slowing growth in the short-term leading to a de-rating of the shares.
• This began over night with an 11% hit in after-hours trading.
• There is significant risk that this continues.
• I suspect that the time to take profits is here.