One company Wednesday reported “spectacular” Q3 2017 earnings results. It’s a big company that you compete with, and there was “outperformance” on revenue growth, operating cost management, and earnings per share.
This company is Facebook, which enjoyed revenue growth of 47% and ad revenue growth of 43%. But, something’s troubling FB in 2018, says prolific Wall Street investment professional Brian Wieser, Senior Research Analyst – Advertising at Pivotal Research Group. What’s the issue? What does it mean for you? We let Wieser share, in his own words, how Facebook will be slightly hampered by issues you should be selling potential clients against.
In an investor note released late Wednesday, Wieser warned that 2018 guidance from Facebook around operating and investing measures it is undertaking to improve safety and security, video, AI, Virtual Reality and connectivity “represents a substantial step up versus prior expectations.”
Facebook reported operating income margins of 50% and earnings per share of $1.59.
This compared with Pivotal forecasts of 42%; advertising revenue growth forecasts were right on the money.
But, Facebook greatly surpassed Wieser’s operating income margins of 43% and EPS of $1.24 and consensus that was similar on revenue expectations, but higher on profitability, he says. “Foreign exchange provided a modest tailwind to growth for the quarter, adding 2% to the company’s top-line,” Wieser notes.
HAS FACEBOOK HIT A BUMPY ROAD?
Despite the outperformance, Wieser warns, “the most critical aspect of the earnings call related to management’s commentary on operating expense and capital expenditure growth for 2018 and, implicitly, beyond. In light of concerns around safety and security (which includes the companies intended efforts to solve for foreign government interference in elections, and which includes the hiring of 10,000 additional employees), increased spending on video content and increased investment on artificial intelligence, virtual reality and connectivity, preliminary guidance calls for an increase of expenses of between 45-60%. This is substantially above our prior expectations.”
However, the news “is both unsurprising and in many ways positive,” Wieser says — especially with respect to Facebook’s needed investments in safety and security.
“The company (along with Twitter and Alphabet) has been appropriately criticized for not pro-actively addressing problems uncovered on social media problems over the past year around foreign government involvement in elections. However, the commitment conveyed on the earnings call to hire 10,000 new employees to focus on safety and security appears to indicate that an appropriate degree of attention will be paid to the matter.”
Another key element of Facebook’s guidance, Wieser says, is that capital expenditures are expected to double next year to $14 billion, versus $7 billion for 2016. “This is also well above our prior expectations,” Wieser says. “These expenditures are likely to be higher than this level in subsequent years.”
MILLION-CLIENT MARCH
What else stood out from Facebook’s third quarter earnings call for Wieser?
Facebook now has 6 million active advertisers, compared to 4 million at this time last year.
“We estimate that [small to medium sized businesses] account for around 25% of the company’s advertising base,” Wieser says.
Post these results, Wieser says many financial models will require “significant re-assessments.”
He says, “Beyond the new expense issues, we note that the biggest issue limiting growth for Facebook (and for Alphabet) is that the faster the two companies grow, the sooner growth will converge with the rest of the advertising market.
“In our view, overall expenditures in the advertising industry will not rise simply because Facebook (or other media owners) can create innovative and efficient ad products. Consequently, we think ongoing revenue deceleration is inevitable and expect our current 28% growth rate for 2018 to fall towards ‘teens levels in following years. We think that, per guidance, margins will fall off significantly next year, but toward 2020 we are assuming that margins get back to where they will be this year even as absolute costs continue to rise.”
Wieser also expects to make a change to Pivotal’s capex expectations in line with management commentary, assuming that perhaps some aspects of 2018 are elevated.
This leads Pivotal to reduce is valuation on Facebook to $136 from $140 on a year-end 2017 basis.
Pivotal continues to rate the stock “Sell.”
