Ad load slowdown could hurt Facebook ARPU growth and drag overall growth. But, should You Short FB stock?
- What are the current problems the social media giant is facing?
- How are they addressing the issues in the short term?
- Does that mean the end of growth, or is there something else investors need to realize?.
Facebook Inc.'s (NASDAQ:FB) stock price has been on a downward trend over the last 30 days. The sharp downward correction can be directly attributed to Facebook’s third quarter earnings where the management warned investors of slow growth.
“Facebook Chief Financial Officer David Wehner said ad growth would likely slow "meaningfully" due to limits on "ad load," or the number of ads that Facebook can put in front of customers without alienating them.” - Reuters
The Problem of Average Revenue Per User (ARPU)
One of the key factors behind Facebook’s phenomenal growth rate in the last few years is the way its ARPU has grown worldwide. ARPU can only grow if either the advertisers are ready to pay more than they did before, or if Facebook shows more advertisements to the same user than it previously did. (See also: FB Stock: This Catalyst Will Drive Facebook Inc. Stock Higher In 2017 And Beyond)
Both these metrics do have a limit. The company cannot indefinitely keep adding more ads for their users to view, which is what ad load implies; nor are advertisers going to be extremely happy to keep paying more and more each year.
This is why ad load is indeed a critical factor in ARPU growth which, in turn, will influence Facebook’s overall revenue growth.
There is one way to address this issue: Facebook can still increase the average number of advertisements it is able to show its user if the user increases the amount of time he/she spends on the platform. Unfortunately, even that number cannot keep growing forever.
The User Growth Dilemma
To break that cycle, the only option left to Facebook is to keep increasing its user base, which is the last part of the growth equation. And that’s something the company continues to do quarter over quarter, year over year.
But that growth has come down from what we saw three years ago, which only explains the natural progress the company has made. As user base keeps growing, the potential market size keeps getting smaller, and the growth trajectory reflects that.
Ad revenue growth has been at the above 50% rate in the last few quarters and, clearly, that rate of growth cannot keep going on forever, which is implied from what Facebook was trying to convey to investors.
The question is: do all these factors align to make Facebook a badly managed company that’s already reached its peak potential? By any standards, absolutely not.
How is Facebook Addressing the Issue In The Short-term?
What Facebook’s management has been doing is astutely lowering expectations, which have been growing disproportionately with each quarter.
The phenomenal growth of Instagram will still provide a lot of support in the short term for Facebook, and then there is WhatsApp to think about in the long term, but the real problem for Facebook lies in the current valuation the market has assigned them. Hence, the attempt to lower expectations.
The FB stock is currently trading at 13.3 times sales and 44 times earnings. Most of these growth factors are already priced into the stock, leaving hardly any room for error. Hypergrowth stocks do attract higher valuations than other companies because they are expected to grow faster than their peers. As a result, the stocks remain volatile, moving sharply on any news that breaks. (See also: FB Stock: Facebook Inc Has Problems, But Then, Who Doesn't?)
The Positive Long-term Outlook
But you have to be wary of one thing. None of this means that you can happily go and short Facebook’s stock. That is extremely risky because you never know when some of these products which are yet to be monetized will start to roar into life. One move by Facebook to monetize WhatsApp could send the stock soaring again, wiping out your short position.
There’s also one more ace up Facebook’s sleeve that isn’t widely known - the fact that they can easily increase their user base inorganically by adding more standalone apps. It’s something they’ve been doing ever since spinning off their core web platform’s chat functionality into Facebook Messenger to take advantage of the ongoing shift to mobile-based media consumption.
Each of these apps potentially adds another platform for monetization. It also helps reduce their overall ad load. Sponsored Messages on Facebook Messenger is just one such example which was rolled out to all advertisers last month.
By getting advertisers to sponsor messages, Facebook offers a way to further target existing ad viewers who engage with the company on the messaging app with highly relevant (and, more importantly, paid) messages. Greater relevance obviously means higher engagement and click-throughs, which translates to more revenue per advertiser and, subsequently, per user.
Facebook’s underlying fundamentals are very much the same but the valuation is still a bit over the top. So, if you are a long-term investor you can still add to your position as the stock shows some weakness, like what happened in November. But the best way to get in at this point is by looking at a five-year period during which you should add stocks in small chunks, instead of plowing all your money in one go and working without any margin for error.
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