Here’s Why Facebook’s Expenses Are Soaring
Facebook (NASDAQ:FB), the leading social network in the world, is expected to see a sharp rise in expenses in the near future. During the entire year, the company’s expenses are forecast to rise by 55% to 65% in GAAP terms, and by 50% to 60% in non-GAAP terms. As a result, the company’s profitability could fall in the coming quarters. In this article, we take a look at the key areas which have caused this dramatic acceleration in expenditure.
Research and development, and marketing and sales represent the major expense items that could continue to see a significant lift in the coming quarters, in our view. Facebook’s investments on people, products and infrastructure will weigh on profitabity. While the company’s headcount has increased by more than 45% annually, it’s investments on various products such as Messenger, Instagram, Oculus, WhatsApp and advertising technology have also played a role in this increase. At the same time, the company continues to invest heavily on data centers and infrastructure to connect billions of users everyday on its several platforms.
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See our complete analysis for Facebook
|
Expense as a % of Revenue |
2012 | 2013 | 2014 | Q1 2014 |
Q1 2015 |
|
Cost of revenue |
26.8% | 23.8% | 17.3% | 18.5% |
18.5% |
|
Research and development |
27.5% | 18.0% | 21.4% | 18.2% |
30.0% |
|
Marketing and sales |
17.6% | 12.7% | 13.5% | 12.9% |
17.5% |
|
General and administrative |
17.5% | 9.9% | 7.8% | 7.5% |
7.7% |
|
Total costs and expenses |
89.4% | 64.4% | 59.9% | 57.0% |
73.7% |
|
Operating Margin |
10.6% | 35.6% | 40.1% | 43.0% |
26.3% |
Cost of revenue generally consists of expenses related to the delivery and distribution of products, such as facility and server equipment depreciation, energy and bandwidth costs, facility and server equipment expense, as well as support and maintenance costs. Facebook has seen leverage with respect to these expenses over the past few years, leading to a rise in its gross margin. Even during the latest quarterly results, Facebook’s cost of revenue as a percentage of top-line remained stable at 18.5%.
Research and development costs saw a major uptick in Q1 2015, rising by 133% annually. This was caused by $385 million annual rise in share-based compensation expense, as well as 55% year-over-year increase in headcount in the engineering and technical fields. We expect R&D expenses to stay elevated in the near-term, as Facebook continues to spend heavily on optimizing its products.
Marketing and sales costs rose by 92% year over year during the latest quarterly results, owing to an increase in: 1) the amortization of intangible assets; 2) people, marketer, and developer facing expenses; and, 3) payroll and benefit costs. We expect the overall marketing and sales expenses to rise in year-over-year terms throughout 2015.
Here Are The Key Areas Where Facebook Is Investing Heavily
People: In line with the expansion in the company’s business, Facebook’s headcount has increased significantly over the last few years — the employee headcount was recorded at 10,082 at the end of March, 2015, which represented 48% increase as compared to the level recorded at the end of March, 2014. We expect Facebook’s employee strength to continue to rise sharply over the coming years.
Products:
- Improving Core Experience On Facebook, Instagram And Messaging Products: Facebook continues to spend considerably on improving the core experience of Facebook and Instagram. At the same time, while the company is investing heavily on its messaging products (i.e. Messenger and WhatsApp), it has yet to see a significant contribution from them to the revenue stream, leading to pressure on margins.
- Strengthening Advertising Business: Facebook also continues to strengthen its advertising technology by improving the quality, measurement, and target-ability of ads. Investments in Atlas and other ad-tech tools represent part of this strategy.
- Long-Term Projects (Oculus and Internet.org): Virtual reality and Internet.org are other long-term bets being taken by Facebook. The Internet.org initiative provides free basic Internet access in developing markets. Moreover, the company is planning to ship out virtual reality headsets to the general public by Q1 2016. [1]
Infrastructure: With Facebook connecting billions of users across the world — its user base and engagement levels are still rising rapidly across multiple platforms. Hence, the company is investing heavily on data centres, networks, and servers to expand its reach throughout the world. The recent push towards online video and Internet.org initiative have also weighed on capital expenditure in the recent past.
Our $87.80 price estimate for the company’s stock, is broadly in line with the current market price.
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Notes:
- First Look at the Rift, Shipping Q1 2016, Oculus, May 6, 2015 [↩]