Facebook crushes forecasts with 11 year old feature

Once again, Facebook cried ‘wolf’ ahead of its quarterly report, and once again, sellers rushed in immediately after the release, only to discover there was no discernible bad news to sell.

Facebook shares dived some 3% moments after the group’s second-quarter results on Wednesday night in one of the stock’s frequent bouts of post-earnings volatility. It then swiftly bounced into the black. Headline results alone made the sharp dip look incongruous. Earnings per share of $1.32 smashed The Street’s $1.13 view, and $9.321bn revenues were comfortably above the average expectation of $9.1bn.

The ad load that keeps giving

Some traders may have been expecting evidence that backed Facebook CFO David Wehner’s reiterated warning in May that mobile ‘ad load’ was approaching critical levels. As a consequence, ad revenues would supposedly decline significantly into the rest of 2017. Such a fall was nowhere in sight in Q2 though that didn’t discourage Wehner from doubling down on such warnings in Wednesday’s conference call. Advertising revenue growth “will come down” as the year progresses he said, having voiced similar concerns in February and November.

A smattering of industry data in the first quarter suggested ad load was beginning to pressure prices by crimping inventory. But with mobile revenue expanding to 87% of Facebook’s total advertising sales in Q2, from 84% the same quarter last year, the group’s resourcefulness in uncovering new pockets of untapped demand is trumping its caution for now. The CFO even contradicted his own reticence on the ad outlook in Wednesday’s call: “We’re seeing more and more ad dollars getting allocated to mobile, and we think that trend will continue”.

News Feed eats ad demand

In Q2, the ongoing maturation of News Feed, now about 11 years old, was the “biggest driver” of growth. It follows one of Facebook’s most subtle (official) tweaks to the module about three years ago. Instagram’s contribution was developing too, Facebook said, though the group stressed the channel was not yet a significant revenue generator. That suggests another source of ad revenue growth will be available if or when Feed’s potential has been maxed out. This illustrates one thread of the group’s essential strategy: incremental monetisation—which also applies to Messenger—enabling FB to maintain potential replacement revenue sources in reserve for years, ready to step in as mature features plateau.

Under such circumstance, investors are likely to keep discounting the group’s prudent cautions for the foreseeable future. These include a new warning that the ramp in mobile video may have a cannibalistic effect on News Feed, and drag on ad impression growth. Again, whilst all metrics keep moving in the right direction, not least the 17% rise in monthly active users to the milestone of 2 billion in June, it’s too early to expect much more than moderate consolidation in Facebook stock.

Too tolerant?

In some ways though, investor tolerance, though predicated on impressive growth on myriad fronts, looks blind. For instance, Facebook’s near-total dependence on advertising is a key vulnerability, connecting it to cyclical realities regardless of its proven ability to grow by innovation. The group won’t escape a significant global advertising downturn like the one that may be brewing now, with so-called ‘old media’ feeling the pain first. A spending drive that has not yet peaked is a related exposure, with expenses up 33% in Q2 and Facebook projecting a rise for the year of 40%-45%. This is coinciding with the emergence of a hawkish attitude against giant American Internet companies among global regulators.

Still, Facebook stock last closed two straight months lower in November and December 2016.  A 44% rise followed in the year to date. It seems only an unusually severe internal setback or even a geopolitical shock can break investors’ Facebook habit right now. FB’s uptrend (so far the stock’s only trend) looks likely to extend its most recent leg that commenced in December.

If main market trading mirrors the eventual rise overnight, a new record high could be in the bag for Thursday. That would take the stock to the brink, or possibly above one of the few upside reference points available for uncharted territory above the last official record high—$166.17, on 24th July. The 161.8% Fibonacci extension in close proximity may offer some resistance. A small rising wedge pattern--traditionally bearish--that formed over the course of this month may also presage temporary difficulties on the upside. Given FB's unequivocal rising trend however, we would not expect a significant correction to ensue, though what constitutes 'significant' for you after a 5-year uptrend is a question worth considering. Buyer anxiety is unlikely whilst the stock remains above $156.5, support that was also the kick off point of this month's up leg and former resistance at the end of June.