- Analysts debate over whether Facebook results will be driven by Instagram in the upcoming quarter.
- I take on a different stance as I believe the sleeper catalyst is foreign exchange impact.
- While I anticipate a revenue beat, I'm not nearly as optimistic on non-GAAP EPS metrics.
There’s been a lot of debate among analysts in the past couple weeks with regards to the upcoming Facebook (NASDAQ:FB) quarterly earnings report. Needless to say, the stock continues to trade at elevated levels, so it’s worth mentioning that analysts are starting to get jittery on both sides (buy side and sell side).
In a recent article, L&F Capital Management mentions that they disagree with Deutsche Bank’s assessment of sales/earnings going into Facebook’s upcoming quarterly earnings announcement by mentioning that Instagram sales ramp will add materially to ARPU assumptions:
Shares of Facebook are selling off in trading today, 4/4, after a Deutsche Bank analyst released a note that said 1Q16 results may come in light of expectations. After closely examining the numbers, we disagree with this analyst and believe there is upside to the 1Q16 revenue estimate. The 1Q16 revenue estimate seems baked with over-performance expectations for ARPU growth, but we believe Q4's ARPU over-performance will persist due to Instagram's ramping popularity, Twitter's continued weakness and the way FB calculates ARPU growth so as to include Instagram revenue in the numerator without including users in the denominator.
However, while I have deep and fond respect for L&F Capital Management back from the days when I used to publish under Seeking Alpha. I believe the near term catalyst to Facebook’s sales and earnings has nothing to do with Instagram.
And also, I have reviewed Deutsche Bank’s sell side model with fine toothed comb much like L&F Capital Management to arrive at a different conclusion.
Deutsche Bank’s stance on Instagram’s accretion to sales/earnings is consistent with my own modeled expectations:
A combination of strong sentiment (the most-consensus long in large cap internet currently), high quarterly revenue expectations, and our mixed channel checks, lead to an unfavorable set up. Stepping back from 1Q’s potential growth reset, we see few names with as much multi-year revenue runway as FB, hence we would add to positions on any weakness.
Checks have pointed to strong seasonal trends in travel (with travel DPA recently rolled out), offset by softness in retail, agency and select other channels. Instagram appears to be largely incremental, with many DR advertisers running separate experimental campaigns, but not enough to move the needle on overall growth.
Really strong arguments all around, but I have to side with Deutsche Bank’s opinion on Instagram. However, just because I take on the same stance as Deutsche Bank with Instagram doesn’t mean I’m any less aggressive going into earnings.
After modelling out my assumption on ARPU, user growth, and net revenue/profits, I come away with the impression that Instagram will only contribute $300 million incrementally to top line growth in the current fiscal year. The business doesn’t have enough scale to move the needle on quarterly earnings or sales given consensus estimates of $25.55 billion revenue in FY’16.
My estimate for revenue is much higher, but this is driven by the near-term upside from currencies as the dollar depreciated since the beginning of 2016. The currency adjustment swings favorably due to weak prior year comps, which drives y/y ARPU assumptions higher. In the prior earnings conference call, Sheryl Sandberg mentioned, “Q4 ad revenue grew 57% or 66% on a constant currency basis.” In other words, the currency impact negatively impacted sales growth by 9 percentage points. Therefore, if we reverse the impact of currencies given the dollar index readjustments over the past quarter, we have ample evidence to get really aggressive here.
The USD Trade Weighted Index has been declining since the beginning of the year, which gives us room to speculate on FB’s upcoming earnings results on a dollar adjusted basis. While, the dollar hasn’t completely given back all of its gains between the 2014 and 2015 time frame, the currency adjustment should have meaningful impact on the company’s upcoming quarterly earnings report to the tune of 5 percentage points as the USD TWI (trade weighted index) declined by roughly 8 points, which averages to roughly a 4-point decline when averaged over the course of a quarter. Since 52.5% of Facebook’s revenue is derived from international markets, according to the 2015 10-K filings, I believe currency will be the sleeper catalyst going into the upcoming report.
Furthermore, Deutsche Bank never made any mention of F/X adjustments in their report. It doesn’t change the fact that it’s a major catalyst going into earnings. The risks from channel checks are somewhat subjective. I believe, Deutsche Bank is referring to the comScore data points, but as I have mentioned in my prior article, the analysts over at Bank of America Merrill Lynch concluded that the comScore data is a bit wonky due to reporting changes.
Also, Q1’ of any fiscal year is weak on a sequential basis from holiday quarter. As such, the seasonal factors imply a modest drop, whereas y/y comps should look better despite a drop off in comScore metrics. As such, I model revenue of $5.428 billion and non-GAAP diluted EPS of $0.58, which compares to consensus at $5.25 billion and non-GAAP diluted EPS of $.62. I’m a little less aggressive on expense reductions given the low visibility on the cost structure, but I’m slightly more optimistic on revenue due to F/X and historical run rate of ARPU/DAU trends despite seasonality.
As such, I continue to reiterate my high conviction buy recommendation and $163.21 price target.