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Facebook (FB) Tops Q1 Earnings, to Create Class C Shares

Facebook, Inc. FB reported impressive first quarter 2016 results driven by strength in mobile advertising and consistently growing user base. Adjusted earnings per share (accounting for stock-based compensation and other non-recurring items) and revenues of 57 cents and $5.382 billion crushed the respective Zacks Consensus Estimate of 44 cents and $5.234 billion. Shares of Facebook were up over 9% in aftermarket trading to close at a high of $118.78.

New Share Class Announcement Steals the Show

The robust quarterly results were somehow overshadowed by the company’s announcement of the creation of publicly listed but non-voting new Class C shares, which will solidify Facebook Chief Mark Zuckerberg’s position in the company. Facebook, at present, has a double class structure.

Class C shares will have the same other economic rights as Class A and Class B shares. Notably, Class B shares have 10 times the voting rights of Class A shares. Class B shares aren’t traded and are held mostly by Facebook executives.

The idea behind the creation of this new class of shares is to allow Zuckerberg to hold his sway over the company while continuing his charitable work. In December, Zuckerberg had said that he and his wife plan to give 99% of their Facebook shares, valued at $45 billion then, over their entire lifetime, to the Chan Zuckerberg Initiative LLC, a limited liability company for betterment of the society.

Facebook will issue the non-voting class C shares through a stock dividend to the existing shareholders of the company’s Class A and Class B shares, which will effectively be same as a three-for-one stock split. The proposal is subject to approval from shareholders at the annual meeting on Jun 20.

Analysts point that this technique was earlier used by Alphabet Inc. GOOGL and more recently by Under Armour Inc UA to maintain the so-called “founder led approach”. However, Google was severely criticized when it tried to push for the creation of a new class of shares.

However, it seems Zuckerberg might just be able to pull it off given that investors remain impressed with Facebook’s phenomenal performance in back-to-back quarters, driven by his sheer business acumen. Moreover he outlined a very ambitious and envious roadmap for the next 10 years that aims at building the company into something much bigger than just a social media platform.

Quarterly Numbers in Details

Facebook’s non-GAAP earnings were 77 cents in the quarter, up 83.3% year over year. Revenues increased 52% year over year. Excluding the impact of year-over-year changes in foreign exchange rates, revenues increased 58% year over year.

Facebook’s consistently expanding user growth has been one of its biggest growth catalysts.  At a user base of 1.65 billion (up 15% year over year) monthly active users (MAUs), Facebook continues to be largest social service platform. In addition, Mobile MAUs were 1.51 billion at the end of the quarter, representing 21% year-over-year growth. Daily Active Users (DAUs) were 1.09 billion, reflecting 16% growth year over year while Mobile DAUs are inching closer to the 1 billion mark. In the quarter, mobile DAUs grew 24% year over year to an impressive 989 million.

Breaking down revenue components, advertising revenues came in at $5.201 billion, surging 57% year over year. Excluding the impact of changes in foreign exchange rates, revenues from advertising increased 63% year over year. Advertising revenues were driven by increasing mobile engagement, higher number of marketers, continuing investment in new products and robust performance of its news feed ads. Facebook has over 3 million active advertisers and over 50 million active SMBs and about 80% of those active on mobile.

Mobile ad revenues in the quarter were $4.2 billion (up 75% year over year), contributing 82% to total ad revenues. Ad impressions grew 50%, driven by surging mobile ad impressions. Average price per ad increased 5% from the year-ago quarter.

Payments and other fees decreased 20% year over year to $181 million in the reported quarter owing to a reduction in payment revenues related to PC games.

On the cost front, cost & expenses grew 29.2% to $3.373 billion, driven by increases in workforce and marketing expenses. However, stellar revenue growth provided enough cushion to operating margins. Non-GAAP operating margin grew 300 bps year over year to 55%

Balance Sheet & Cash Flow

Facebook exited the quarter with cash & cash equivalents and marketable securities of $20.62 billion, up 11.7% year over year. The company generated nearly $2.98 billion of cash flow from operating activities in the quarter compared with $1.70 billion in the year-ago quarter. Free cash flow was $1.85 billion compared with $1.19 billion in the year-ago quarter. The company incurred capital expenditure of $1.13 billion in the first quarter.

Guidance

Facebook said that ad revenues will continue to grow but will now face tougher year over year comparisons in the current year. Also, Payments & Other fees revenues will continue to decline despite contribution from Oculus Rift. Moreover, as it continues to ramp up investments, the cost will hover at higher levels. Non-GAAP expenses are projected to increase in a band of 45% to 55% while capex is now expected at the high end of the earlier guided range of $4 billion-$4.5 billion. Stock based compensation is estimated in the range of $3.1 billion–$3.3 billion. The company expects amortization expenses in 2016 to be within $700 million–$800 million.

Final Word

At its F8 developer conference concluded recently, Facebook has more than ever clearly highlighted its ambitions of becoming more than just a social network. The social media giant outlined its plans for the next decade, which is all about going full throttle with AI and AR/VR technology. Messenger was again the key topic of discussion at the conference with talks of chatbots and “conversational commerce”. We believe CEO Mark Zuckerberg will eventually bring “conversational commerce” to WhatsApp as well.

Facebook stumbled a bit with the initial shipments of its VR headsets, Oculus Rift, hitting a roadblock. However, this is unlikely to deter it from its ambitious plans. An analyst observes that Rift has the potential to “handsomely” pay off the $2 billion investment that Facebook made for acquiring Oculus two years back. He expects Facebook to sell 600,000 units this year and another 2 million plus units, thereby generating over $1.6 billion in revenues in 2017.

As of now, all of these appear to be terrific growth engines but it will be one Herculean task for the company to actually make all of them work. Moreover, intensifying competition for users & ad dollars from the likes of Alphabet and Twitter Inc TWTR and increasing investments threaten to thwart its growth prospects.

At present, Facebook carries a Zacks Rank #1 (Strong Buy).

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UNDER ARMOUR-A (UA): Free Stock Analysis Report
 
FACEBOOK INC-A (FB): Free Stock Analysis Report
 
ALPHABET INC-A (GOOGL): Free Stock Analysis Report
 
TWITTER INC (TWTR): Free Stock Analysis Report
 
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