Facebook Q3 16A – Straight line headache
This is the beginning of the pause we have been looking for.
Facebook reported excellent Q3 16A results but it was made clear that the slowdown that we have been anticipating is now upon us.
Q3 16A revenues / EPS were $7.01bn / $1.09 compared to forecasts of $6.92bn / $0.97.
User numbers showed slow but steady growth at 1.79bn MaUs during Q3 16A while mobile revenues made up 84% of advertising revenues.
Facebook’s execution when it comes to the move to mobile and the importance of video has been flawless but there are limits to which you can stuff the services full of advertisements.
It is this limit that is now beginning to be reached which is why Facebook warned that in 2017 “we expect to see ad revenue growth rates come down meaningfully”.
2017 is also expected to be an aggressive investment year meaning that margins could easily come under pressure next year as Facebook invests for its next leg of growth.
This was disappointing news to the street which sent the shares down 8.5% in after-hours trading and is likely to lead to a round of estimate cuts.
This has nothing to do with Facebook and everything to do with analysts’ love of straight lines.
Edison research has long indicated that Facebook was likely to hit the limit in terms of very rapid growth towards the end of this year because it has now hit a ceiling in terms of the amount of money it can squeeze out of the traffic that it has.
To return to rapid growth, Facebook needs to address the other segments of the Digital Life pie.
We have observed for some time that this is exactly what Facebook is doing but its developments in these segments are not yet mature enough to begin generating revenue.
This is where we think the street has got it wrong as its love of straight lines has forced it to implicitly include revenues in its estimates from services that are not yet ready for monetisation.
Facebook is not going ex-growth but merely returning to something more like Google which means that its valuation needs to come down.
Facebook is trading on a 25%-35% premium to Google depending on which forecast year is compared and we would be much more comfortable with parity.
Hence we can see Facebook’s shares declining by around 25% over the next few months and it is at that point that we will be looking for my long-term entry point.
Facebook is doing everything right but its unwillingness to control market expectations is what has triggered this bump in the road.
For the short-term we still prefer Microsoft, Baidu and Tencent.
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