Our last coverage of Facebook (NASDAQ:FB) post the Q4 2013 Facebook earnings release put the company as an attractive investment to the GARP (Growth at Reasonable price) investor, but a lot has changed since the earnings release on Jan 29. Today we review the events since, and their implications for a Facebook investor. Reported cases of click frauds add a degree of risk to Facebook’s bread and butter revenue stream. On a positive note, video ads are on the verge of a release, which could cause the next big jump in revenues for the Menlo Park social giant.
Facebook Financial Overview
Facebook has been on a roll for much of the last year, be it on the bourses or in terms of operations. Not even critics can find fault with the numbers which the company has churned out during the second half of 2013. The revenue growth has been back on the fast lane after the company reportedly found an effective strategy to monetize its huge and fast growing mobile user base. A look at the chart below shows the significant change in revenue growth and profit margin expansions which have happened in second half 2013.
Yet another testimony of the company’s success in the mobile platform has been the growing contribution of mobile revenue to its total advertising revenue. The table below displays the Mobile v/s PC contribution to total advertising revenue at Facebook.
The success of mobile is clear once we notice that Q4 2013 saw mobile advertising dollars outsize the PC contribution to topline, a first for the social giant. A more detailed review of Facebook’s historical performance has been covered in our earlier articles on Q4 2013 Facebook earnings preview and Facebook earnings review. With no new numbers reported regarding the social media giant post its Q4 ER, our fundamental outlook remains more or less unchanged post the time. Let’s now look at some critical events which have occurred post the Q4 earnings release and how they alter our outlook on the FB stock.
Facebook Click Fraud
Reports of click frauds thriving on the social platform have surfaced. According to a report on Business Insider, one small business owner lost a significant amount to such practices on Facebook. There has been no official statement from the company addressing the problem of click fraud apart from some information on its ‘click and impression page.’ Critical questions which come up: What is the quality of the clicks on the social platform? What is the company doing to prevent such frauds from occurring on its platform?
The most disturbing fact is the non-allowance of click audits by third parties, which could provide a more accurate measure of advertising effectiveness on the social platform. The silence of the company on the matter, the non-allowance of third party audits and absence of robust security systems could negatively impact advertiser’s trust on the social platform. Loss of this trust equates to negative impact on 85% of Facebook’s revenues, which is the percentage contribution of advertising revenues to the total revenues of Facebook. The foregone conclusion: address the issue or the consequence could be disastrous.
Facebook Announces WhatsApp Acquisition
The company also announced the acquisition of WhatsApp, a chat application with close to 500 million subscribers for a whopping $19 billion. The rapid growth in users which has been seen at the chat app has been unheard of previously. The messaging service, completing 4 years of existence has close to 420 million monthly active users (MAU), a number second only to ‘adopted-parent’ Facebook. The chart below shows the user (MAU) growth in various online services at time of 4 years of existence.
Though the popularity of the messaging app is undisputed, the fact that Facebook has no clear stated strategy in place to monetize this user base is something which Zuckerburg and his team will have to figure out, sooner than later. If monetized carefully and effectively, WhatsApp could provide significant momentum to continue the scorching rate of topline growth.
While monetization of WhatsApp user base is unclear and lies far into the future; something closer to reality is the implementation of video ads on Facebook, which have already been rolled out to advertisers, according to this post on Motley fool. The launch of video ads could be the next big thing at Facebook, a success of which will further boost the profitability of the social networking giant. Add the possible monetization of Instagram and the levers to boost profitability and earnings at Facebook become clear and comfortable. The company has come a long way in terms of its fundamentals from where it was a year ago. Let’s now look at the current valuation multiples of Facebook relative to those of LinkedIn (NYSE:LNKD) and Twitter (NYSE:TWTR), the other two popular social networking platforms.
|Price to Sales ratio (LTM PS ratio)||21.67||44.41||16.13|
|Price to Earnings ratio (LTM PE ratio)||76.98||NA||126.97|
|One Year forward PE ratio||52.73||5,012.00||127.76|
Facebook is clearly the best stock among the social networking platforms, given the current growth rate in earnings. The forward valuation is very attractive when compared against what most companies in the internet space are currently valued at.
Facebook is clearly a good investment option for investors patronizing GARP (Growth at reasonable price) investing. The immediate redressal of concerns regarding the fraud clicks is something which should be topmost on the company’s radar, as loss of advertiser trust is something the company simply cannot afford. Aside from that, successful implementation of mobile advertisements and ability to monetize Instagram provide levers to boost profitability even in a scenario of slowing topline. Read our Facebook stock analysis