Quick Thoughts: Facebook Lights the Way for Twitter

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–          FB and TWTR revenues are driven by the same things – how many user visits can you attract and how much advertising can you get them to view?

–          FB spooked investors on the first driver by showing decelerating user growth and engagement, and by noting that young teens, in particular, were spending less time.

–          FB continued to deliver more ads at better prices, driving 66% ad sales growth, however, management noted ad density could be near the practical limit.

–          TWTR is much, much further from saturating its potential user base, its user engagement and its ad density. FB’s strong results are a glimpse of its future

First things first. Mea Culpa. I was wrong on Facebook. I thought that user growth and engagement would level off much sooner than this and that the density of advertising in the news feeds couldn’t be pushed to the current levels without triggering a serious backlash from users. Nope. Monthly active users were up a healthy 18% YoY, with the quicker rise in daily average users an indication of continued robust engagement growth. Average revenue per user (ARPU) was up 33%, as Facebook placed more ads directly into user newsfeeds and getting higher prices as a result. The newsfeed ad strategy also drove greater efficacy of the company’s advertising for mobile users – important, since mobile is already 49% of Facebook’s ad revenues. So, good job Mark, Sheryl and company, I’m surprised and impressed.

Next up: Where do we go from here? Facebook has run long and hard over the last 3 months, and a few comments from management during the call have spurred investors into taking their profits off the table. First, CFO David Ebersman called out a minor weakness in engagement amongst the teen demographic in the US. Combine this with an inevitable slowing of the still strong pace of growth in users and their engagement, and investors started seeing clouds behind their silver linings. Second, and about 5 minutes later, Ebersman shared another doozy, stating “However, as we think about the future, we do not expect to significantly increase ads as a percentage of News Feed stories beyond where we were at the end of Q3.” Given that increasing that percentage has been a massive revenue growth lever for the company, this counts as a significant item of financial interest.

So the growth in the number of users – now 1.19B on a monthly active user basis – is almost certain to keep decelerating, given the law of large numbers. The engagement of those users could be facing a similar deceleration, a scenario given credence by the conference call shout out for deteriorating activity amongst US teens. Ad density, at least within the newsfeeds, is getting a stop sign. The only drivers left would be ad pricing – which clearly can keep going up – and new services – of which Instagram, with advertising around the corner, is an obvious example. I’m not ready to call it over for Facebook – I suspect there is some sandbagging in the CFO’s prepared remarks, and the law of large numbers hasn’t been that much of an obstacle since the company came public with over 900 million monthly active users. Don’t be surprised if Facebook posts another big upside surprise in January.

The Facebook results also show Twitter in a favorable light. Twitter is a few years back of Facebook in most of the drivers of revenue – it has less than 20% as many users, its users visit far less often, and it serves far fewer ads to them – but has been posting prodigious growth in all of them. That Facebook can still put up 60% YoY sales growth at its size should give comfort to investors as they peruse the Twitter prospectus.

For our full research notes, please visit our published research site.

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