Facebook Q1 19 – Project Fear

Project Fear fails to reflect reality.

• Until users vote with their feet, criticism of Facebook’s business practices is irrelevant.
• A cracking set of results further dispel the notion that the end is nigh for Facebook as neither users nor advertisers are deserting the platform as critics claim.
• The only real problem remains AI and profitability which are inextricably linked and will take a little while to fix.
• Q1 19 revenues / Adj-EBIT was $15.1bn (up 26% YoY) / $6.3bn beating consensus estimates of $14.9bn / $5.2bn.
• Furthermore, user growth remained steady with MaUs at 2.38bn up 8% YoY and DaUs at 1.56bn also up 8% YoY.
• When considering all of Facebook’s properties, this number is higher at 2.7bn MaU and 2.1bn DaU.
• This is important as users are the lifeblood of advertising revenues.
• This is a far cry from Twitter whose MaUs are now going backwards which transforms its recent performance from a recovery to a blip (see here).
• Mobile is 93% of advertising revenue and with user growth remaining steady and no one deserting the platform, the outlook for revenue remains good.
• However, the problem is profitability.
• In Q1 expenses grew by 80% YoY against a 26% increase in revenues and the vast majority of these increases are not investments in future revenues.
• Instead, they represent increases in headcount to scan and analyse posted content for what Facebook considers to be objectionable content.
• Facebook has been forced down this road because although some of the great minds in AI work for Facebook, it’s market-facing product remains awful.
• Simply put, the machines are incapable of being able to do what they should and so Facebook has to hire humans to do the machines’ jobs until they can be improved to an acceptable standard.
• The net result of this is falling operating margin which in Q1 19 fell 4% YoY (on an adjusted basis) from the 46% reported in Q1 18.
• This means that EBIT in 2019 is going to decline compared to 2018 as revenue growth is not enough to match expenses.
• Furthermore, there will be no return to better profitability until the machines are good enough to take over from the humans and Facebook can drastically reduce its headcount in this area.
• Google, by contrast, should see growth in earnings this year which I think offers better value as the two companies are trading roughly at the same earnings multiple.
• This is why I would be holding Google over Facebook for 2019 despite the fact that Project Fear and the constant mauling of Facebook by the media is having no effect on its financial performance.