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Facebook Heading Higher

Ahead of the 3Q 2014 Facebook (NASDAQ: FB) earnings results and call, we at Ideal Asset Management believe that year over year (YOY) Facebook earnings growth will be faster than the 25% YOY currently predicted by analysts (according to Yahoo! Finance). Below we have outlined a few catalysts we believe will contribute to Facebook’s expedited growth in 2015. While Facebook does not need all of the following catalysts to surpass earnings expectations, if even a few emerge, then the stock is likely to rally:

• Continued increase in price charged for ads in the newsfeed: In its most recent quarter, Facebook ARPU (average revenue per user) was $2.24, an increase of 40% year over year. Worldwide daily active users increased 19% YOY to 829 million people. This translated into revenue of $2.910 billion for the second quarter, an increase of 61% YOY. Looking ahead, the ARPU for Facebook ads is likely to increase along with user growth translating into to higher growth. Currently, Wall Street analysts estimate revenue growth of only 34.8% for 2015, a sharp deceleration from Facebook’s current growth. These estimates are likely too low, and investors can potentially reap huge rewards if Facebook beats estimates.

• Launch of video advertisements in the news feed: This ad product launched in the 3rd quarter of 2014, and the money Facebook receives per video ad is likely over $1 million per day, according to Bloomberg. In 2015, Facebook may increase the number of video ads shown per day and the higher prices received per video ad should help ARPU rise in 2015.

• Recent launch of Facebook’s ad network, Atlas: This ad network enables Facebook to deliver ads on other websites, mobile applications, and mobile websites using Facebook’s wealth of data on its users. Crucially, according to the Wall Street Journal, Atlas enables Facebook to increase ad load without cluttering the news feed. This has the potential to substantially increase the amount of ads delivered by Facebook, which can lead to substantial growth in revenue and earnings.

• Continued increase in advertising on Instagram: Usage on Instagram continues to grow, and Facebook has been slow to monetize it up until now. There is a possibility that ads delivered on Instagram will ramp up in 2015 and beyond, potentially adding another lucrative driver of earnings for Facebook. According to Stern Agee, Facebook was expected to ramp up Instagram monetization in 2014. Although this has not come to fruition in 2014, Instagram ads may make a meaningful contribution in 2015.

• Closed purchase of Whatsapp: Whatsapp represents a long-term opportunity for Facebook to grow. Currently, Whatsapp does not generate much revenue, but it has amassed a fast growing user base of over 600 million people, according to a recent WhatsApp announcement. Currently, Whatsapp charges $1 per year to users with the first year’s payment waived. Over time, Whatsapp is likely to reach the 1 billion user mark and generate 1 billion in revenue from subscription fees. Additionally, Whatsapp can incorporate advertising or increase the yearly subscription fee to increase revenue and earnings.

As far as earnings projections are concerned, analysts have consistently underestimated Facebook’s earnings (see below chart). Ideal Asset Management believes that analyst projections for 2015 earnings of $2.04 is undermining the potential EPS for the stock. Taking into account the multiple potential catalysts for growth in 2015, Facebook is likely to earn around $3 per share in 2015 and $4.4 in 2016. Applying a Price-Earnings multiple of 45 times for 2015, and 40 for 2016, our projected stock price for Facebook is $135 for the end of 2015 and $176 for the end of 2016.

Earnings History      September 2013       December 2013       March 2014       June 2014
EPS Estimated          0.19                             0.27                         0.24                     0.32
EPS Actual                0.25                             0.31                         0.34                     0.42
Difference                  0.06                             0.04                         0.10                     0.10
Surprise %                31.6%                          14.80%                    41.70%                31.20%

 

We look forwarding to hearing the results of today’s call and seeing how the stock performs against its current projections.

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