This morning, Facebook
(NASDAQ:FB) announced that it crossed the 1 billion monthly active user mark in September, putting it just behind oxygen and water in terms of importance to human life here on Earth.
But now, the question on everyone's mind: What does this mean for earnings?
Let's break it down.
First, let's look at what a monthly active user ("MAU") is.
From Facebook's S-1:
We define a monthly active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or took an action to share content or activity with his or her Facebook friends or connections via a third-party website that is integrated with Facebook, in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community, which has grown substantially in the past several years.
Sounds good to me.
Given that Facebook crossed the 1-billion mark on September 14, it puts the 30-day measurement window pretty close to the end of the quarter, meaning that we can use it to make assumptions about the company's financial results.
Here's how I break it down.
We'll take one important metric: Quarterly revenue per monthly active user.
Now, since the MAU metric is calculated as of the last 30 days of the date of measurement, I averaged each quarter's reading with the previous one's to try to capture the flow during the whole quarter rather than just the last month. So for Q2 of 2012, I averaged Q1 and Q2's readings. (Note: I also did the math without averaging the MAU numbers; the actual numbers are a little different, but the trend is virtually identical)
So here's how that chart looks over the past six quarters:
According to Bloomberg, analysts expect Facebook to deliver revenue of $1.23 billion for the third quarter.
To earn that much money from 977.5 million MAUs (the average of Q3's 1 billion and Q2's 955 million), Facebook would have to deliver revenue per MAU of $1.26, a number that seems very reasonable based upon recent results. Over the past two quarter, Facebook has averaged revenue per MAU of $1.24. Over the past four quarters, it's been $1.28.
So as much as I'd like to view that 1 billion MAU number as negative relative to expectations (I am short Facebook -- please read on for why), the math just doesn't add up.
Yes, it points to dramatically slowing year-over-year growth in MAUs, as you can see here:
But investing isn't about deciding about what's good or bad -- it's about what's priced in and what isn't, and when people will start caring.
Everyone in the universe already knows that Facebook's user growth has been dramatically slowing, which brings us to the other side of the equation: Monetization.
Facebook hasn't hidden the fact that it's had difficulty making money off of its rapidly growing mobile user base.
But wait! A few months ago, Facebook got busy stuffing ads into users' mobile news feeds in an effort to bring home the bacon to a frustrated investor base. Here's a screenshot from the Facebook app running on my Apple
(NASDAQ:AAPL) iPhone 4S:
See "Sponsored" next to my big red arrow? That means you're looking at an ad. These are actually pretty well-designed because unless you're looking for the "Sponsored" mark, it's very easy to miss on a smartphone screen. Ads on a Google
(NASDAQ:GOOG) search page, for example, are much more obviously ads, in my opinion.
Now let's look at what's happened with Facebook's stock price.
Facebook hit an all-time low of $17.55 on September 4, before bouncing about 25% to the $22 handle at which it's trading now.
Well, the main factor seems to be Mark Zuckerberg's crowd-pleasing turn at the TechCrunch Disrupt Conference on September 11. (See: Wait a Minute! Did Facebook's Mark Zuckerberg Really Say Anything New?
To make a long story short, after months in hiding, Zuckerberg came out swinging on mobile, making the following point:
So mobile is, there are going to be more users, each user's going to use spend more time, and per amount of time that they spend, we're going to make more money than we make on desktop.
As Vincent Vega might say, that's a bold statement.
The problem is, Zuckerberg is notoriously long-term-minded. In fact, during that interview, he specifically mentioned measuring the company's success over a three- to five-year period. He wasn't necessarily talking about this
Nevertheless, investors got pumped big-time, sending the stock up 8% the next day alone.
But here's the problem: He wasn't offering anything new.
Back on July 26, on the Q2 earnings call, Facebook was already bragging about its success in mobile. Here's an excerpt:
By the end of June, Sponsored Stories in News Feed was at a run rate of over $1 million per day in revenue and about half of that is coming from mobile. This is an encouraging start in our effort to generate revenue from the mobile use of Facebook.
Furthermore, let's do a rewind to Monday, when COO Sheryl Sandberg was interviewed by CNBC anchor Julia Boorstin, who asked a great question: “Has the new mobile app you launched in August boosted revenue?”
Sandberg's answer? “The new mobile app is boosting engagement, and engagement always leads to revenue.”
In no way can that be construed as a yes.
Yes, Sandberg may be sandbagging like a vintage Bill Gates, but there's no real evidence that Facebook's mobile business is taking off in a way that justifies the stock's valuation.
And essentially, that's why I'm short.
Note, I am using options to define my downside risk with this trade. I am using a combination of short call spreads and long out-of-the-money puts to bet on total destruction. This strategy is a modified risk reversal. (See: 9 Weeks to Better Options Trading: Risk Reversals.) I am not shorting the stock outright because if Facebook beats, it could easily go to $30 or higher in the blink of an eye. I'd much rather know where I stand in the event I'm wrong, which I've been more than once.
I don't know that Facebook is going to miss. I just think expectations have rebounded enough to give a strong probability of a downward spiral in the share price if it does.
Have you checked out Wall Street's revenue estimates going forward? Analysts are actually expecting an acceleration in revenue growth for 2013. According to Bloomberg data, consensus forecasts call for a 29% revenue gain next year. That's actually an acceleration from the 27% they're expecting in Q4.
If Facebook misses, the Q4 revenue growth forecast will come down, and the 2013 numbers will go below that!
Right here, right now, the stock's trading at 35 times expected 2013 earnings.
Rich valuations are not a problem for a company that consistently puts up big numbers, as you can see with stocks like Salesforce.com (NYSE:CRM), which is expensive as all get-out on any metric you can find. (See: Salesforce.com Provides Lesson on Dangers of Shorting High-Octane Momentum Stocks.)
But they're a huge problem for companies that don't. Like Netflix (NASDAQ:NFLX) back in 2011. (See: Netflix: Double-Costanza Time After the Most Predictable Collapse of 2011.)
So will I be going to Sizzler in celebration of a big drop in Facebook shares?
We'll know on October 23 when earnings hit.
Position in FB, AAPL.
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