Facebook Inc. (FB) reported flat year-over-year earnings growth in the second quarter of 2012. The social networking platform provider earned 12 cents per share in the quarter that exceeded the Zacks Consensus Estimate by three cents.
However, including stock-based compensation, payroll taxes and income tax adjustment, Facebook lost 8 cents per share compared with earnings of 11 cents per share in the year-ago quarter.
Facebook’s revenue jumped 32.3% year over year to $1.18 billion, slightly ahead of the Zacks Consensus Estimate of $1.15 billion. The year-over-year growth was driven by strong advertising revenue (84% of the total revenue) that climbed 28% year over year to $992.0 million. Facebook generated the rest of the revenue from payments & other fees in the quarter.
The strong upside in advertising revenues was primarily driven by an 18% increase in the number of ads delivered based on growth in the user base and an increase in average number of ads per page from the prior-year period.
However, strong growth in mobile user base continued to hurt Ad impressions, particularly in the US, where number of ads delivered decreased 2.0% year over year in the quarter.
Average price per ad increased 9.0% year over year, primarily aided by a 20% increase in CPMs in US due to the roll out of sponsored stories in news feed during the quarter for PC and mobile users. Price per ad growth was also strong in Asia and rest of the world, which fully offset a decline in Europe.
Monthly Active Users (:MAU) improved 29% year over year to 955 million at the end of June 30, 2012. Mobile MAUs surged 67.0% year over year to 543 million at the end of quarter. During the same period, Daily Active Users (:DAU) increased 32.0% year over year to 552 million.
Average revenue per user (:ARPU) was $1.28 in the quarter, up double-digits in the US, Asia and rest of the world. ARPU grew 8.0% in Europe in the quarter.
However, this healthy growth in revenue and user base was partially offset by higher costs and operating expense in the quarter, particularly due to stock-based compensation, which totaled $1.3 billion in the quarter. Excluding this effect, operating expenses shot up 60.0% year over year to $669.0 million, driven by headcount growth and costs incurred related to infrastructure development.
Facebook’s operating income increased 8.0% year over year to $515.0 million. However, including stock-based compensation and payroll-tax expenses related to share based compensation, the company reported an operating loss of $743.0 million.
Net Income was up 3.5% year over year to $295.0 million. However, including stock-based compensation, payroll-tax expenses related to share-based compensation and income tax adjustments, the company reported net loss of $157.0 million in the quarter.
Facebook ended the quarter with cash & cash equivalents of 10.19 billion. The company generated $242.0 million as cash flow from operations in the quarter.
Facebook expects operating expenses to increase at a much faster rate compared to the second quarter in the second half of this year. The company expects steep rise in research & development expenses mainly due to continued investments in product development for mobile segment and infrastructure.
We believe that Facebook has significant growth opportunities from increasing online advertising spending as compared to traditional formats. Facebook’s massive user base and its ability to track personal details over time make it a formidable force in the online ad market. Facebook can use this massive database to help advertisers target relevant ads going forward.
However, increasing competition is the primary headwind for Facebook over the long term. Besides competition from Google+, Twitter, Orkut in its core markets, Facebook is also competing against small regional platforms, which not only limit its expansion opportunities but also hurt its profitability.
Facebook is facing significant competition in the display advertising market from Google (GOOG). Rising concerns over the effectiveness of Facebook ads as compared to Google’s AdSense has been a headwind lately. As per eMarketer, Google is set to grab the #1 position in the display ad market by the end of 2013. We believe that Google’s increasing popularity has the potential to limit Facebook’s ad revenue growth going forward.
Further, Facebook’s popularity is based on the engaging apps from its third-party developers, particularly Zynga (ZNGA). However, Zynga’s narrow product portfolio has been primarily blamed for a waning interest in social games on the platform. Zynga’s low-paying customer base and stiff competition from other established players are also hurting its top line. This does not bode well for Facebook, as the company earns the majority of its non-ad revenue from Zynga.
Apart from increasing competition, lack of visibility around mobile monetization remains a concern. Although Facebook has made a number of acquisitions (such as Snaptu, Instagram) to enhance its mobile offerings, we believe that lack of adequate ad coverage for the mobile platform will continue to hurt its revenue earning capacity going forward. Moreover, continued investments to expand mobile offerings are expected to hurt margins in the near term.
We remain Neutral over the long term (6-12 months). Currently, Facebook has a Zacks #3 Rank, which implies a Hold rating in the near term.
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