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I never understood the hype of Facebook (NASDAQ: FB). I knew it would probably make some decent money, but I thought it would have a hard time breaking out into a long-term growth business.
The reason is that Facebook doesn’t solve a problem. It kind of does, in a transitory sense, in that it can help you connect with people. Yet, search engines do the same thing.
Without a problem to solve, there’s no real business model. So Facebook is basically a big advertising machine. It’s actually not that much different than CompuServe.
Let’s see what the second-quarter earnings report tells us about where Facebook is headed and see if my theory is right.
Reliance on Ad Revenues
Revenues did jump 39% year over year to $4 billion and it was driven by ad revenues. In fact, when you remove the negative effect from currency rates, revenues actually leapt 50%.
Specifically, ad revenues came to $3.8 billion, which was a 55% currency-adjusted increase over last year. But this says it all, doesn’t it? 95% of revenue came from advertising.
There’s a major problem with a business runs solely on ad revenues. If the platform declines in popularity, the business gets wiped out. Remember MySpace?
If ad spending declines significantly, the business is in big trouble. During the financial crisis, ad-driven businesses really struggled.
Setting that aside, mobile continues to explode; Facebook generated revenues of $2.9 billion, an increase of 75% year over year. That speaks to the overall explosion of mobile technology. Frankly, this bodes well more for other companies that can improve the mobile experience than for Facebook.
Also note that this number accounts for about 75% of ad revenues, which is an increase over last year’s 62%. While nobody can foresee anything supplanting mobile right now, some day a new platform may roll around, and that means 75% of 95% of Facebook’s revenues are hooked into this one platform.
Is Facebook conquering the world? Well, it has a pretty solid base. The company’s Monthly Active Users (MAU) rose 13% to 1.49 billion. Mobile MAUs were 1.3 billion at the, which was growth of 23%. Now this is just one metric. I’m more interested in daily usage, which is an impressive 968 million. Still, that number only increased 17% year over year.
$3 per Million Daily Users
You know what strikes me here? It’s that Facebook generates $3 per 1 million daily users per quarter. That’s 90 billion daily users per quarter. Somehow, I would expect more than $3 per million daily users.
Indeed, average revenue per user (ARPU) increased to $2.76 in the second quarter from $2.24 in the year-ago period. That increase was driven by a 220% increase in the cost of ads despite the fact that ad impressions fell 55%.
That tells me advertisers are being whittled down. Those who get value from the platform stick around and pay more.
But here’s the kicker. Despite all this apparently decent news, net income FELL from $791 million to $712 million. I’m not impressed.
A Bit of Good News
There is good news on the balance sheet. The company has $14 billion of cash and pumped out $1.9 billion in operating cash flow, ending with $1.3 billion in free cash flow. This puts the company on solid ground.
Look, analysts peg long-term growth at 27%. I’ll give it a 33x valuation for its brand name, cash position and free cash flow. Yet even at 33x, fiscal year 2015 earnings of $2.01 mean the fair value is $66. The stock trades at $95. It’s not outrageously unreasonable for a growth company. I think you can go either way here. For now, it isn’t an insanely overpriced growth stock, but its not cheap either.
Tesla, Apple and Google are creating this
When people think of Tesla, what immediately comes to mind is the world’s first electric car. It’s an astounding achievement. But what few people realize is that Tesla’s next technological wonder could easily put it to shame. Morgan Stanley says this breakthrough could save the American economy $1.3 trillion each year. And Tesla’s not the only one racing to get it out the door. Apple and Google are working on their own versions too. Get the whole story right here.