- Facebook beat on earnings and sales, which was mostly due to taxes and slower OpEx ramp.
- I anticipate healthy sales growth due to new ad products and ramping monetization of Instagram.
- I have revised my estimate on earnings even higher, but lowered my price target to reflect risks in the market capitalization.
Facebook (NASDAQ:FB) was one of my favorite ideas going into this quarter’s earnings season, and it remains one of my best ideas coming out of earnings. The company continues to sustain its momentum even off of a massive revenue base, as the metrics on revenue, margins, tax, and foreign exchange pulled ahead whereas other tech peers struggled with both bottom and top line results as evidenced by the massive divergence in performance following earnings.
That being the case, Facebook delivered above consensus results due to the company’s ability to lower its effective tax rate when compared to prior year, which was mostly due to the revenue mix shifting to international (lower taxes globally when compared to the U.S). The company’s non-GAAP operating expenses increased at a slower pace when compared to the implied cost guidance as well. As such the entire consensus (including yours truly) got this quarter wrong by a fairly fat margin. However, FB’s deliverance of outstanding results continues to reassert my bullish thesis.
The company reported revenue of $5.382 billion and non-GAAP EPS of $0.77 for Q1’16. These figures compared to the analyst consensus of $5.26 billion and $0.62 respectively. Facebook delivered a blowout quarter, and while initial channel checks pointed to positive ad-revenue comps, the divergence in operating performance was what truly stood out in the current quarter. Unlike some of its peers, Facebook reduced its expenses, which translated into non-GAAP operating margins of 55%, which compared to 52% in Q1’15. Furthermore, the non-GAAP tax rate was 27%, which compared to 37% in the prior year and estimates of 32% to 31% among the consensus.
Key analyst commentary coming out of the quarter:
Tweaking Ests & PT to $165: ‘16E Rev decreased 2% to $26.1B, with EPS boosted 6% to $3.60, due to lower taxes. PT increased to $165 (prev. $160) on increased EPS estimates. Our $165 PT (rounded) is based on 35x ’17E EPS of $4.93 and 20x ’17E EBITDA of $21.9B. – Mark Mahaney, RBC Capital markets
For us, the main themes from Facebook's Q1 results were the consistency & scope of ad revenue strength (+63% YoY F/X-neutral), the balance of investing for the long term while demonstrating operating leverage, and the continued runway for consumer & ad product initiatives to drive engagement & revenue growth in forward forecast periods (SMB advertising, video, Instagram, messaging, VR/AR, AI, Internet connectivity, etc.). We now expect 45% non-GAAP opex growth in '16 (vs. 46% prior). Maintain Buy Rating; Raising PT to $150 (from $130). – UBS, Eric J. Sheridan
For FY16, our estimates for revenue/adj. EBITDA/adj. EPS are now $25.3b/$15.6b/$3.49 vs. prior $26.0b/$15.7b/$3.12. We maintain our Outperform rating and our PT increases to $145 vs prior $142 as we push Oculus units into 2H16 and beyond, positively impacting our gross profit estimates. – Credit Suisse, Stephen Ju
Modestly lowering our '16E/'17E revenue by 1%/2% on lower core-FB estimates. Increasing '16E EBITDA by 1% on lower non-GAAP Opex; '17E EBITDA largely unchanged. Increasing '16E/'17E non-GAAP EPS by 9%/10% on lower tax rate. Our $140 price target is based on 26x '17E non-GAAP, plus $19B for WhatsApp. – Oppenheimer Co., Jason Helfstein
Initial checks imply that the consensus revenue estimates will decline by a couple of percentage points for FY’16, and adjusted EPS estimates will move to a range of $3.60 to $3.80. I model my own estimates below, and have revised my somewhat aggressive price target lower. My estimate corresponds with Facebook’s headline earnings figure, as I have reconciled the non-GAAP adjustments.
After coming out of a quarter where apparently none of the analysts including myself modeled anything correctly, I feel fairly confident in my adjusted forecast, as my revenue model held up going into the quarter (FB reported revenue of $5.382 billion versus my prior est. of $5.428 billion, I was off by less than a single percent). There’s slightly more upside left in the tank, as Facebook’s revenue could be driven by foreign exchange assuming the federal reserve maintains benchmark rates of 25 to 50 basis points. If the dollar continues to decline, FB’s f/x adjustment could add a couple of additional percentage points to revenue. So, foreign currencies and initial ad-agency checks are the main things to keep an eye out for.
Furthermore, I don’t anticipate significant surprises in the company’s cost structure going into the back half of the year, as Facebook already scaled back its SG&A and R&D ramp, which drove a significant operating beat. Further reduction to operating expense ramp is extremely unlikely, as such I have modeled non-GAAP operating expenses to stay at 29.1% of revenue with expenses increasing sequentially due to on-going headcount additions. The company also guided to a 27% non-GAAP effective tax rate thus reducing the variability of results. Furthermore, I have modeled share dilutions in-line with historical trends, as the stock price was below its all-time high of $117.59 at the time of the Q1’16 earnings report. So, the impact of dilution was less significant in Q1’16, but as we progress through the year, I anticipate Facebook to sustain price momentum, which will trigger employee options, i.e. higher share dilution.
I anticipate Facebook to report FY’16 non-GAAP EPS of $3.77 and Q2’16 non-GAAP EPS of $0.77. Furthermore, I’m lowering my $163.21 price target to $150.98 (implying a market cap of $430.29 billion, which is 40x earnings). This is lower than my prior estimate as the largest constituents of the S&P 500 trade at roughly an 18% discount (historically), according to Deutsche Bank’s Sherri Scribner.
Now, obviously Facebook isn’t the most valuable company on the S&P 500, but attaching a mega cap discount seems to make sense given the limitations on asset weightings across mutual funds/hedge funds and the discount it already trades at on a PEG basis. Furthermore, I’m not saying that the stock is any less attractive, but value accretion to shareholders won’t be driven by as much multiple expansion as we have witnessed in the past. Even if earnings growth were to sustain at a healthy enough CAGR, the valuation will need to be discounted even further to reflect limitations on market liquidity. Even on a relative basis there aren’t easy value comps given growth rate, sector classification, market cap and net margin. As such, I’m being a little more conservative here on valuation, but remain bullish nonetheless as I anticipate the stock to rally by 30% over the duration of the year.
As such, I continue to reiterate my high conviction buy recommendation.