Facebook (NASDAQ:FB) will report its Q1 2014 earnings on April 23. Given that the stock has corrected itself in the recent months, investors might not be expecting a big positive surprise. We believe that Facebook will need to demonstrate sustained growth in its ad revenues if it has to meet market’s expectations, and that may not be easy. A seasonal slowdown, coupled with a tougher year-over-year comparison, could well result in slower growth and a sequential sales decline. The broader trends are unlikely to change. The company will continue to profit from increased consumption of Internet media, a growing user base and an increasing number of ad impressions. A lot of businesses have found Facebook’s platform useful in terms of marketing and promotion, and are willing to shell out some money to gain customers. The ROI (return on investment) remains attractive and Facebook continues to attract millions of small business.
Our current price estimate for the company stands at $45, implying a discount of less than 25% to the market price.
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Continued Ad Pricing Growth Will Fuel Revenues, Seasonality Effect Will Be Visible
Facebook’s total revenues jumped by 60% in Q3 2013 and by 63% in Q4 2013 (year-over-year growth), driven by a substantial increase in ad pricing and higher number of ad impressions.  Can the company sustain a similar growth rate in the first quarter of 2014? We believe that the answer is no. We attribute our assessment to the fact that year-over-year growth in ad pricing is going to come down due to a tougher comparison, and the increase in the number of ad impressions will moderate as Facebook’s user base growth slows down. If we are to go by the last two years’ trend, the slowdown in the user base growth cannot be compensated by higher user engagement, as the number of page views per user is declining. There is a strong case to suggest that Facebook’s growth will fall.
Additionally, we expect a sequential decline in Facebook’s revenues due to seasonality. Advertisers tend to divert a larger portion of their annual budget to the fourth quarter to cash in on holiday season sales, which tend to be disproportionately higher for most retailers. As a result, the ad spending typically declines in the first quarter of the new year, and this will have impact on Facebook’s results as well. That said, the overall growth will still be healthy, as its platform remains attractive to advertisers due to high return-on-investment. As we have repeatedly mentioned before, Facebook has efficiently utilized data generated by 1.2 billion active users each month to effectively target advertisements. Advertisers have run successful ad campaigns on Facebook, and that’s something that isn’t going to change anytime soon.
Mixed Impact Of Changing Organic Reach Of Company Pages
A report suggests that organic reach of company pages has come down over the last few months. From about 12% in October 2013, the average figure fell to 6.15% in February 2014, which indicates a greater need for sponsored posts. The declining organic reach could indicate a refined feed algorithm and Facebook’s efforts to make news feed more relevant and limited. In fact, the company announced a series of improvements recently to clean up the news feed.  It is not straightforward to assess the impact of this trend. On one hand, reducing organic reach could become a cause of concern for advertisers and may impact the overall ad spending and ad pricing. On the other hand, one could argue that refined feed will result in more targeted advertisements, thus generating higher return on investment. This in turn, could help Facebook sustain growth in its ad pricing. We’ll keep an eye on the ad trends over the next few quarters to assess the success of this new approach.
No Impact Of Acquisitions Yet
Facebook has announced two major acquisitions in the last couple of months. Its $19 billion bid for Whatsapp came as a big surprise, especially when the latter’s cash flows do not justify the valuation (read Did Facebook Pay The Right Price For WhatsApp?). However, the move was essentially motivated by Facebook’s failure in mobile messaging and its attempt to diversify risk with the understanding that social networking is not going to experience strong growth forever, and may even be threatened as new innovative platforms emerge. Subsequently, the company announced another acquisition. It signed a definitive agreement to acquire Oculus VR, which designs virtual reality kits. The deal is valued at $2 billion. Since both these acquisitions haven’t been closed yet, the acquisition related costs are not likely to impact Facebook’s Q1 2014 earnings. Both these acquisitions are aimed at branching out into adjacent business in the long run.