Facebook Inc. (NASDAQ:FB) will report Q1 results on Wednesday, May 3 after the market close. MKM Partners expects upside to consensus revenue of $7.8Bn and GAAP earnings of $0.86 per share. User growth and engagement metrics will be important, perhaps more so than in previous quarters given greater focus on Snapchat competition. The stock has outperformed in a strong market this quarter despite uncertain magnitude of deceleration as ad load growth ends in 2H. MKM Partners thinks this is because management’s tone on likely impact appears to have softened. MKM Partners continues to view FB as a secular long and a core holding for growth investors. Reiterate Buy.
For the past three quarters, management has been warning that ad revenue growth “will come down meaningfully” after mid-2017 as ad load will play a less significant role in driving revenue growth. Any commentary on magnitude will be a major focus of the call. As advertisers are still reporting high ROIs on Facebook, auction dynamics should lift pricing as supply becomes more restrained. The company does not think pricing will fully offset the impact that ad load increases have been driving revenue growth. Other offsets to slower supply growth include: Instagram, user growth, growth in advertisers, higher engagement/ time spent, video ramp, ad targeting/ click-through rates, vertical specific efforts (i.e. travel, retail, finance), new ad inventory (i.e. stories).
Whether management adjusts expense guidance is the other major focus. Consensus implies 50% growth in non-GAAP operating expense for this year, compared to guidance of 47% to 57%. The company has under-spent initial guidance in each of the past three years. Only once did management adjust after Q1 (in 2015). This was the year that guidance came a quarter early (in Q3’14), an irregularity related to the WhatsApp merger closing.
MKM Partners thinks messaging will become the next material revenue driver for FB, but thinks it is not likely until 2019 before contribution becomes meaningful. F8 this week offered encouraging updates on Chabot adoption by businesses, user engagement, an expanded set of tools and several positive anecdotes.
With decelerating topline growth, MKM Partners thinks the stock will maintain a P/E/G multiple of around 1.0x until enthusiasm builds for the next major growth cycle which it believes will be messaging. On the firm’s current estimates, this implies about a $150 stock price. The firm sees potential for EPS upside on a more resilient top-line and more stable margins through 2018. MKM Partners is not adjusting estimates or its price target, but will revisit following Q1 results.