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Facebook Q3: high growth, but evolution lagging Google and Amazon

Thursday 3 November 2016 | 12:33 CET | Background

Facebook reported better-than-expected results for the third quarter. In a conference call on the results, the company was more cautious about 2017, sending its share price lower after market. While the company continues to grow strongly, it's entirely due to the advertising market. Growth from hardware, such as the Oculus VR headset, or monetising its messaging apps still needs to happen. Compared to its big rivals Alphabet and Amazon, the former has already made the step to diversifying its revenues, and the latter is much more advanced.  

 

Revenues top USD 7 billion

Facebook passed another revenue milestone in Q3, as sales topped USD 7 billion for the first time. Sales have been growing at over 50 percent since the end of 2011. In terms of usage, mobile monthly active users surpassed 1 billion. Monthly mobile users already passed 1 billion in Q2 2016, while total daily users hit the 1 billion mark in Q3 2015. The next 1 billion will need to be found in Asia.

In terms of profitability, the operating margin rose to the highest level since Q2 2014. Capital spending topped USD 1 billion, while free cash flow reached a record USD 2.48 billion. Facebook had USD 26.1 billion in cash at the end of the period, its highest ever. 

Revenue can be broken down in a number of ways:

  • Geographic. North America is worth twice the revenues of Europe and three times more than Asia. Growth varied from 48 percent in Europe to 63 percent in Asia.
  • Advertising and other. The latter includes payments for games, a contracting segment. This also includes the Oculus, but there is little to see from this. 'Other' accounts for just 2.8 percent of revenue, down from 4.5 percent a year ago. The bulk of Facebook's revenue is advertising, which grew 59 percent in Q3. Ad revenue can be broken down in ad impressions (+50%) and average price per ad (+6%). Facebook is focusing fully on video as the most important form of communication, which offers significant room for advertising expansion.
  • Advertising can also be split in mobile and desktop. Mobile has gone from zero at the start of 2012 to 84 percent of revenue in the past quarter. That's up from 78 percent a year ago, but unchanged from Q2, showing saturation is approaching. We estimate from this that mobile ads contributed USD 5.73 billion in revenue and desktop USD 1.09 billion. The latter grew by 15 percent, which Facebook said was in part thanks to success in circumventing ad blockers.

Growth slowdown

The high growth cannot last forever, and Facebook said it expects a slowdown to set in from Q4 2016. While operating costs may come in somewhat less than expected, capex will increase due to investments in data centres, with a seventh site planned in New Mexico. Cash flow will also be negatively affected by taxes on staff stock options.

Strategy

In terms of strategy, Facebook said the following:

  • Innovation is focused on connectivity, artificial intelligence and VR/AR (virtual and augmented reality). This covers a range of products, from Free Basics (zero-rating) to the Telecom Infra Project and Oculus.
  • The three priorities are capitalising further on the shift to mobile, attracting more advertisers and improving the relevance and efficiency of ads. Monetising the messaging apps is an important part of this. Facebook sees three stages of development, with WhatsApp still in the first, Messenger in the second and Instagram in the third. Instagram is now ripe for generating cash, with the launch of new products such as 'shoppable tags'. Instagram has 500 million active monthly users, 300 million DAU and 100 million DAU for the Stories feature.

Diversification

Facebook has achieved a wide geographic spread in revenues, but it remains highly dependent on the advertising market. While this works in its current stage of structural growth, there is still little diversification in its business. New products like the Oculus face stiff competition - such as the cheaper Daydream View from Google.

Alphabet has a similar problem, but is further along in its evolution:

  • Google Advertising: 88.3 percent of revenues.
  • Google Other: 10.8 percent of revenues. This includes Google Play (content), hardware (such as Chromecast and the new products), service fees (cloud) and licensing.
  • Other Bets: 0.9 percent of revenues. This includes Nest (smart home devices), Google Fiber (expansion of which has been suspended) and licensing.

Amazon is a step further. It divides its sales in products (e-commerce) and services (AWS, Prime, other) as well as North America, International and AWS (Amazon Web Services). This shows the following breakdown:

  • Products (e-commerce): 68.3 percent of revenues.
  • Services (e.g. Prime): 21.8 percent of revenues.
  • AWS: 9.9 percent of revenues.

Facebook is for now focusing on advertising, video and communication. In the longer term, it will need to diversify, and with its steadily growing cash position, it has plenty of possibilities. Alphabet already has several irons in the fire, but the real star in the internet sector is Amazon.



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