Cautious Optimism Ahead of Facebook's Q4 Results

After the most scandal-filled year on record for the social networking giant, Facebook will report Q4 results on Wednesday Jan 30th after market close. Zuckerberg and his execs will also give commentary on 2019.

What to Expect in Q4 Results##

First, we expect user metrics to be mixed. Here are the theses from bulls (positive) and bears (negatives), in our view:

• Bears see the slowdown in user growth continuing. They expect user growth to be under 10% for the second straight quarter.
• Bulls are focusing on how Instagram should continue to be a significant growth driver, offsetting much of the slowdown in core FB growth.

What remains to be seen is if the pace of slowdown will become even slower. We believe analysts expect monthly active users (MAUs) to growth 8% and 7% in 2019 and 2020, respectively.

Next, we think investors will focus on the transition to Stories from Feed:

• Facebook's management is trying to monetize Stories and increase engagement, but they've said Stories currently monetize at lower prices than Feed, explaining the slowdown in average revenue per user (which had grown 30%+ in Q1 2018).
• Analysts seem to think advertisers are finding Stories attractive and will be watching pricing trends.

Of course, we believe regulatory concerns and advertiser perception will be a focus:

• The perception of FB from advertisers doesn't appear to be as bad as the media makes it seem. Users don't seem to be leaving the platforms in droves post the data breaches, especially outside of core FB.
• We believe Facebook still offers access to a high ROI and it's difficult to find a compelling alternative as an advertiser.
• There doesn't seem to be much clarity on what regulatory fines or rulings could come down. We don't think Facebook will be forced to split from Instagram (there's no clear antitrust argument yet).

Lastly, we think expense growth will be closely watched. This is one of the few metrics for which Facebook gives formal guidance to investors:

• On the Q3 earnings call, FB forecasted 40-50% expense growth in 2019.
• The market's current consensus earnings estimates imply 45% expense growth from 2019-23, so FB's guidance already seems "priced in."
• If management was just being conservative and reduces expense growth guidance on the Q4 call, that could increase earnings power.

In terms of sentiment, most sell-side research firms seem upbeat. 82% of firms have a Buy rating on the stock, with an average price target of $185 (+24% upside). In contrast, we've heard many "buy side" firms (e.g. hedge funds) were more balanced/negative on the stock in recent months. Though that could change with the upcoming results.

Takeaway##

Given the lack of user exodus from Facebook's platforms combined with the stock's late 2018 slide, the upcoming results may end up being a case of "better than feared" for investors, even if user growth is weak. Near its lowest valuation levels in history (~20x 2019 P/E on consensus estimates), we wouldn't be surprised.