Facebook Inc (NASDAQ:FB) tends to be conservative with its expense growth guidance. FB stock remains a good buy.
On Wednesday, social media giant Facebook Inc (NASDAQ:FB) reported its third quarter 2017 earnings results. And as we had expected, the Russia controversy dominated the earnings. On the earnings call, CEO Mark Zuckerberg began his statement by expressing outrage over the "Russian interference" for which the company has received a lot of flak lately. Facebook said that it is investing in both technology and people to make its ads more transparent and removing false news, hate speech, bullying, and other problematic content. On the flip side, the company warned that these security measures will hit the bottom line. This, along with other planned investment is the reason why Facebook stock declined during yesterday's trade, despite reporting better than expected numbers. The company delivered its 10th consecutive all-round beat (i.e., the top and bottom lines).
Facebook Inc revenues continue to grow.
Facebook Inc reported non-GAAP EPS of $1.59, 77% higher than same quarter last year earnings and 29 cents more than what analysts were expecting the company to report. This quarters EPS was also 20% higher than what the company had reported in the previous quarter. On the top line, FB reported $10.33B in revenue, representing a YoY growth of 47.4% and conveniently beating analysts estimates by $490 million. Total ad revenue was $10.1 billion, up 49%, driven by strong performance in Europe and APAC with 56% and 54% growth respectively.
Where is the slowdown?
This strong growth is despite Facebook warnings of an impending slowdown in H2 revenues due to ad load saturation. However, ad revenues instead have accelerated in the quarter. While ad impression did see slower growth, ad price increase more than made up for it. In Q3, the average price per ad increased 35%, and the number of ad impressions served increased 10%, driven primarily by feed ads on Facebook and Instagram. For the fifth consecutive quarter, the company saw its YoY ads revenue growth rates decelerated on a constant currency basis. This trend is expected to continue in coming quarters. However, like this quarter, prices are likely to mitigate the impact of stagnation in ad impressions. "Just the auction dynamic, which as supply growth has slowed, then there's more competition, and you're seeing prices increase as demand continues to grow. " Facebook CFO David Wehner said during the earnings call.
Expense growth will impact Facebook Inc's profit margins.
Company's operating margin also improved from 44% last year to 50% in the current quarter. The combination of strong growth and huge profit margins make Facebook stock a really good buy. However, investors are little worried after the management said on the call that heavy investment in security could impact the company's bottom line. "I've directed our teams to invest so much in security on top of the other investments we're making that it will significantly impact our profitability going forward, ... Protecting our community is more important than maximizing our profits." Facebook CEO Mark Zuckerberg said during the earnings call. The company expects expenses to grow by 45 and 60 percent next year. For comparison, in the current quarter, Facebook saw its expenses grow by 34% to $5.2 billion. The company has, however, lower the estimate for this years opex growth from 40%-45% range to 35%-40% range.
This expense growth will be driven primarily by investments in security, aggressive investments in video content, and long-term initiatives around AR/VR, AI, and connectivity. Facebook will hire 10,000 more staff to enhance security and transparency of ads and also to keep a tab on misleading content. The company will also invest significantly in its video platform "Watch". There were reports that Facebook is willing to spend up to $1 billion in producing and promoting video content.
Over the next three years, the biggest trend in Facebooks products will be the growth of video. Facebook wants to build communities around the videos that people share and watch. This is one reason why it is very interested in sports telecasting. The team loyalty factor in sports tends to generate more conversation and interest. Given all these investments, Facebook expects full-year 2018 capital expenditures to roughly double from 2017 levels.
The expected slowdown in revenues and rising expenditure and investments will have an impact on Facebook's profit margin next year. However, for long-term investors this not be a big concern. Facebook's investment will drive the revenue growth in the medium term. Moreover, Facebook has been conservative with warnings. Facebook has generally guided for higher expense growth over the years.
Facebook continues to deliver strong performance quarter after quarter. In Q3, the company generated over $4.3 billion in free cash flow and ended the quarter with over $38 billion in cash and investments. It has several strong growth drivers in form of Instagram, WhatsApp, and Messenger.
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