Analysis: FB

On Wednesday, shortly after the closing bell, Facebook (FB) reported a top and bottom line beat with its fourth quarter earnings release. On the top line, revenues of $16.91 billion (+30% YoY) came in ahead of the $16.4 billion consensus, and earnings per share of $2.38 topped the consensus of $2.19. In other positive news, Facebook's operating margin came in a 46%, an encouraging sign that Facebook is managing its ongoing transition well.

Before getting into the quarter, we must call out how the combination of a "low bar" expectation and the much better than expected results are taking this stock materially higher in after-hours trading. At the time this was written, shares of Facebook stood at about $167, which tacks-on a gain of about 11% on top of the +4% rally during Wednesday's session. While we believe the positive after hours move to be a result of the top and bottom-line beat, we believe the magnitude of the move to be representative of the overly negative sentiment coming into the quarter. Additionally, we think a tailwind to the stock's after-hours performance was the lack of ownership in the name. Shareholders capitulated when the stock price deteriorated to below $130 in late December. However, if you held steady and pushed through the difficult headlines and focused instead on positive hints management's big $9 billion buyback authorization in late December (see our Alert here ) and understood the view of how advertisers lack a real, high ROI alternative, then with this after-hours move you would be rewarded with a stock that is up roughly 27% year to date.

Digging into the quarter, breaking down the top line number, advertising revenues of $16.64 billion (+30% YoY) topped expectations of $16.189 billion while payments and other fees revenues came in at $274 million (+42% YoY), well ahead expectations of $196 million. On the advertising front, 93% of revenue came from mobile, up from 89% in the year ago period. That puts mobile ad revenue for the quarter at $15.5 billion, increasing 36% year over year to a level that was well above the $14.944 billion consensus.

On the expense front, while capital expenditures for the full year 2018 more than doubled, coming in at $13.9 billion, the result came in below the low end of prior guidance of $14.0 to $14.5 billion. Looking to total costs and expenses for the full year 2018, the 51% annual increase in 2018 came in at the low end of management prior guidance for a 50% to 55% annual increase, a factor we called out as a potential positive catalyst in our earnings preview (here:) noting that analysts at MoffetNathanson were "above consensus for Facebook into the print as they expect expense growth (which has weighed heavily on shares in recent quarters) to come in at the low end of guidance (implying growth of ~50% in 2018)."

Taking a look at the various industry metrics, total Daily Active Users (DAUs) of 1.523 billion, which were marginally above expectations (encouraging given the slew of negative headlines in recent months) of 1.522 billion, remain at 66% of total Monthly Active Users (MAUs), which came in at 2.312 billion versus consensus of 2.31 billion. DAUs are up from 1.495 billion in the third quarter and 1.401 billion in the year ago quarter while MAUs are up from 2.271 billion in third quarter and 2.196 billion in the same period last year. The growth in DAUs were led by India, Indonesia, and Philippines as Facebook expanded its reach in the Asia-Pacific market that isn't as tapped as the likes of the U.S. and Europe. And if we are talking about reach, we must acknowledge how management revealed how around 2.7 billion people in the world used one of the company's platforms in December-that's roughly 35% of the world's total population.

Additionally, worldwide average revenue per user (ARPU) came in at $7.37 (+19.2% YoY), topping expectations of $7.11. This is an excellent result because it is evidence of how the company continues to make a significant (and growing) amount of money off its user base, despite all the noise and negative press about the product. On a regional basis, U.S. & Canada ARPU was $34.86 (+30.2% YoY), Europe ARPU jumped to $10.98 (+24% YoY) because of a rebound from GDPR, Asia-Pacific ARPU was $2.96 (+16.5% YoY), and the Rest of the World APRU was $2.11 (+13.4% YoY). In terms of regional ad revenue growth, Asia-Pacific led the way with a 34% increase, followed by North America with a 31% increase, then Europe at 28%, and then Rest of World which increased 24% as currency weakness and macro challenges impacted the total.

How about pricing power? There has been a thought that Facebook would lose its grip on advertisers due to the barrage of negative press about how the company handles its data, as well as fallout form those who question the core platforms engagement metrics. The average price per ad did decline by 2% in the quarter, but this decline was attributed to the ongoing transition towards product services and geographies with lower monetization levels. That would be like Instagram, for example. But there has been strong growth on the supply side of the equation, as Instagram is where the number of ad impressions are the strongest. In fact, of the 34% increase in the total number of ad impressions served on Facebook's services, growth was primarily driven by ads on the popular photo and video sharing social network.

Taking a look at first quarter guidance, management expects total revenue growth rate to decelerate by a mid-single digit percentage on a constant currency basis compared to the Q4 rate. For some perspective, revenue growth on a constant currency basis was 33% in the fourth quarter. We believe a mid-single digit percentage deceleration was the expectation by the sell side, so the upside in this quarter's constant currency growth rate may suggest first quarter revenue expectations will be raised. For the full year 2019, management expects revenue growth rates will continue to decelerate sequentially throughout 2019 on a constant currency basis.

On the expense side, management continues to expect full year total expensive will grow approximately 40% to 50% compared to 2019. Also, the 2019 capex outlook was unchanged at $18 billion to $20 billion

Below are some general CEO Mark Zuckerberg comments about the current state/future of the company:

"Going into 2019, we're focused on 4 priorities: first, continue making progress on the major social issues facing the Internet and our company; second, build new experiences that meaningfully improve people's lives today and set the stage for even bigger improvement in the future; third, keep building our business by supporting the millions of businesses, mostly small businesses, that rely on our services to grow and create jobs; and fourth, communicate more transparently about what we're doing and the role our services play in the world. And I want to take a minute talk about each of these."

"On Facebook, I also expect this to be the year where Watch becomes more mainstream. There are now 400 million people who use it every month, and people on average spend over 20 minutes on Watch daily. This means we're finding ways for video to grow outside of News Feed so it doesn't displace social interactions that people primarily come to our services for."

"In Instagram, one of the areas I'm most excited about this year is commerce and shopping. There's a lot of natural activity happening here, in this year, I expect us to deliver some qualitatively new experiences around that. Longer term, I remain very focused on building technology that brings people together in new ways, including through AR and VR. I'm looking forward to Oculus Quest shipping this spring. The feedback there so far has been very positive. And I've also been positively surprised that the Portal has done better than I expected, too."

Bottom line, the long knives have been out against Facebook for quite some time, but the upside to the numbers should put them to rest for the time being. Although revenue growth will continue to slow in 2019 and pressure on margins will continue, these results showed how the company is managing the transition it laid out for some quarters now. Also importantly, the engagement trends were solid if not better than feared, and that should reduce some of the uncertainty that has weighed on the stock. After a long stretch in 2018 when we held a TWO rating on the stock, we believed Facebook's valuation became attractive again on October 31st which was the day we upgraded our rating back to a ONE in our Alert here , a time at which the stock traded at about $150. It's been a long, strange trip, but the stock has finally (and meaningfully) eclipsed that level. Given the strong after-hours move that we never like to chase, the team will review its rating and discuss it further tomorrow.