Whatever you do, don't sell Facebook now

A stunning surge sets the stage for a bigger rally this summer and beyond.

By StreetAuthority Jul 25, 2013 3:07PM
copyright Photodisc, SuperStockBy David Sterman

How does a company worth $60 billion manage to completely shock investors and deliver a 25% one-day gain? That's the question being asked at traders' desks across the country after Facebook (FB) delivered a rock-solid second quarter that exceeded the most bullish of forecasts.

The answer is simple. Facebook, despite its massive size, had largely been forgotten by most investors. Earlier this month on StreetAuthority, I noted how this once-hot IPO had been steadily falling this past spring, even as the rest of the market was in party mode.

Suddenly, this stock is touching 52-week highs again, and if you were savvy enough to own this stock going into the quarter, then this is no time to be a seller. After a quick move to $33, this stock may be headed toward the $40 mark by year's end.

The great second quarter
Facebook's impressive second-quarter results have been discussed in many other forums, so I'll only recap the key metrics here:
  • Strong advertising revenue (up 63% from a year ago (excluding currency impacts) compared with a 41% year-over-year jump in this year's first quarter) highlights the company's rapidly increasing ability to monetize its massive user base.
  • That monetization, which surged 26% from a year ago to $1.60 per user, is now the highest in the social media landscape. That figure stood at $1.35 just three months ago.
  • Facebook's daily average users, as a percentage of monthly active users, rose to 61% in the second quarter from the previous quarter, reversing recent declines. That rebuts concerns that consumers have grown tired of daily Facebooking.
  • Mobile ad revenues of $657 million were almost 50% above consensus forecasts. The entire analyst community simply didn't see this coming.
  • Facebook generated more than $1 billion in quarterly EBITDA (earnings before interest, taxes, depreciation and amortization) for the first time in its history. The most bullish Wall Street analysts expected EBITDA of around $900 million.
Yet as solid as those numbers are, they don't explain why this stock still has considerable upside. In my recommendation of Facebook earlier this month, I discussed the management initiatives that are still in their infancy and not yet significantly contributing to financial results. For example, the company's purchase of Instagram -- which now has more than 130 million active users -- continues to look like a master stroke, as that division's user growth shows no signs of cooling.

Facebook management has moved slowly to monetize Instagram's user base, wisely preferring to let it grow as large as possible before shifting the platform toward ads. It's a transition that Facebook users now accept, and Instagram users will slowly be weaned into advertising in a similar fashion.

Another growth initiative to monitor: video advertising. Facebook concedes that advertisers are clamoring for more video display ad opportunities and this is likely to be a key focus for management over the next six months. (In the third point I made in my look at the stock a few weeks ago, I also highlighted many other mini-platforms that Facebook is developing.)

The other key trend is very impressive capital management. Facebook's IT team is becoming so much more adept in its hardware and software purchasing that the company was able to pursue all of its growth initiatives with just $268 million in capital spending. That's more than $100 million below consensus forecasts.

Surging revenues and controlled expenses will set the stage for Facebook to post some of the most impressive operating margin profiles of any major tech company. Merrill Lynch believes that free cash flow will exceed $2.5 billion by 2015, up from just $53 million last year. Projected EBITDA of $7.4 billion in 2015 would be roughly triple the EBITDA generated in 2012.

Wall Street sees the light

Wall Street analysts, who tend to move as a herd, have been suddenly boosting target prices at a feverish clip. Here's a quick sampling:
  • Merrill Lynch's target goes from $35 to $40, boosting 2014 and 2015 forward EPS and revenue targets by 20% to 40%.
  • UBS' price target was raised from $30 to $36, suggesting that "there will be upward pressure on advertiser budgets allocated to Facebook as the company improves its ability to demonstrate the (returns on investment) achievable on its platform."
  • Topeka Capital Markets sees shares rising to $40, thanks to "several well defined catalysts over the next two years including monetizing Instagram, launch of auto-play video ads ... and a bigger push into e-commerce."
  • Jefferies' target price goes from $32 to $37, predicting that Facebook will finish the year on a very strong note as current initiatives ripen.
  • JMP Securities upgraded its rating from "market perform" to "market outperform." Its new $38 price target is based on the belief that "Facebook has discovered the formula to begin significantly extracting value from its 1.16 billion global users."
  • Cantor Fitzgerald bumped its price target from $35 to $40, as "the valuation remains compelling for a company growing revenues at 40-plus percent and EBITDA margins at 55-plus percent."
  • JPMorgan has a Street-high $44 price target, suggesting that the just-released second-quarter results "could be thesis-changing for many."
Why should you care about these analysts' price target and views? Because Facebook is about to become a major topic of conversation among these analysts and their hedge fund clients. Analysts tend to "talk up a name" as long as its current price is a reasonable distance from its target price.

Risks to consider: There are a few negatives to the Facebook story. First, the games category continues to underwhelm and is becoming a decreasing part of the sales mix. Second, Facebook's "Graph Search" feature, which was the product of a considerable amount of R&D spending, has not yet become a hit with consumers. And thanks to a rebounding stock price, Facebook could soon be hit by a brain drain as valuable employees cash in their stock options and migrate to smaller, pre-public tech companies where other options bounties await.

Action to take: Shares of Facebook are hitting fresh 52-week highs but remain well below the IPO price. The company burned a lot of bridges with lackluster quarterly results in 2012. Yet it's increasingly clear that management now understands the need to deliver solid financial metrics both now and in the future. That said, it's the probable growth in 2014 and 2015 that should really have you focused on this stock. This week's sharp run for the stock reflects the fresh set of quarterly results -- but the next leg of share price appreciation will come from even better quarters yet to come.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.


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10Comments
Jul 25, 2013 4:07PM
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A non-product leads the way? We are deeply deeply screwed.

Jul 25, 2013 4:02PM
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If MSN is telling me not to sell a stock, I'm selling that stock. I actually just bought some long-term put options against FB.
Jul 25, 2013 3:44PM
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"Whatever you do, don't sell Facebook now"

 

I already did, at a $14/share profit.

Of course you couldn't sell it if you tried, since you don't even own it. 

Jul 25, 2013 4:14PM
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which billionaire  bought up  4 or 5 million shares  to  push it  up.  and will sell out in a few  days .  all manipulation  done  by  billionaires . how else can it be down  almost to the  end  ea  day  and  struggles  back  a few  points  you people do not  understand  how  much is  manipulated  by the  billionaires . just think  if  10 of them set down each  day  and kick in  2 million  apiece  that  is 200 million you can manipulate a lot of that  stock with that  much  money.
Jul 25, 2013 4:09PM
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"Faceplant" is breathing it's last breaths. The latest "explosion" of it's stock price is a ploy to get "zuckers" to buy in so it gets back to its IPO price, and all those so heavily invested in this mirage (including Zuck) can cash out and break even.

 

Check back in a year. You'll see. The house always wins.

Jul 25, 2013 4:37PM
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"Whatever you do, don't sell Facebook"

 

OK, I'll just buy Put options then.

 

Jul 25, 2013 4:21PM
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Sell this donkey.  Facebook has become a haven for political drivel and business advertisement.  It will soon become an o- line version of the yellow pages.  Most people toss the paper version into the recycle bin as soon as they are delivered.
Jul 25, 2013 4:15PM
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I'd call this TERRORISM. Facebook is nothing. It's a virtual business without assets fully reliant on the social mainstream to keep it alive. It promotes counter-productivity, attracts cliques and predators who can go after all the under-aged people who aren't supposed to be on it without parental supervision. We have to be kidding ourselves about this economy-- I'd rather crash every than selective Kool Aid. To be invested in Facebook is to support control, manipulation and New World Order. Do YOU really want those things-- forever?   
Jul 25, 2013 3:36PM
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$$$40.00 by years end....It'll be $35.00 by the end of the day.

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