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Can Facebook Continue Growing Earnings?

By Adam Levy – Nov 18, 2016 at 7:22AM

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Comments from the CFO unnerved investors.

Image source: Facebook.

A couple of sentences from Facebook (META 0.84%) CFO Dave Wehner scared a lot of investors during the company's third-quarter earnings call. "We expect to see ad revenue growth rates come down meaningfully," Wehner said, explaining the impact of saturating the platform's ad load. He went on to say, "We anticipate 2017 will be an aggressive investment year."

It doesn't take a financial genius to understand slower revenue growth and accelerating expenses mean earnings results could suffer considerably. But sussing out what exactly Wehner meant from those comments could help investors determine if the market overreacted to the earnings call, providing a buying opportunity.

Nothing we didn't know already

This isn't the first time Wehner warned investors that ad load could be a problem for Facebook going forward. On the company's second-quarter earnings call in late July, he provided similar commentary, noting, "We anticipate ad load ... will be a less significant factor driving revenue growth after mid-2017."

Importantly, Wehner hasn't changed his tune on how big of an impact the ad load problem will have on Facebook's operations. During the second-quarter call, Wehner said, "Since ad load has been one of the important factors in our recent strong period of revenue growth, we expect our ability to grow revenue will be impacted accordingly." In the more recent call he said, "We expect to see ad revenue growth rates come down meaningfully."

What's more, Wehner did nothing to cast doubt on Facebook's ability to grow revenue through its other products, such as Instagram, Facebook Audience Network, Messenger, and WhatsApp. In fact, he and COO Sheryl Sandberg talked about the success the company is having monetizing Instagram, and CEO Mark Zuckerberg talked about where the company is in its path to monetize Messenger and WhatsApp. Wehner also talked about new and enhanced ad products on its flagship platform that could increase ad prices.

We've heard this before

Wehner's language to describe its step up in expenses sounds familiar as well. In the company's conference call for fiscal 2015, Wehner provided a similar outlook for 2016, telling analysts it "will be another significant investment year for Facebook."

After "significant investment," Wehner expects Facebook's expenses to climb around 30% year over year. He expects capital expenditures to come in at $4.5 billion, up 80% year over year.

Even if expenses climb another 30% or capex climbs another $2 billion, Facebook would have to see a huge slowdown in revenue growth for it to affect earnings meaningfully. For reference, analysts are expecting 35% revenue growth and 28% earnings growth next year, so they were already factoring in some margin pressure for 2017.

Facebook's focus this year is on attracting top engineering talent and expanding its data-center capacity. Engineering talent can help develop new ad products and ways to monetize WhatsApp and Messenger. Data-center capacity is a necessary expense to support the 1.79 billion people using Facebook and its other products every month.

The market's reaction to Wehner's comments seems overblown, and with shares trading around 10% off their all-time high, now might be a good time to buy. As usual, Facebook is taking a long-term view with its expenses, and the negative impact from ad load is already priced in. There's still plenty of revenue growth left in increasing ad prices and engagement on Facebook, the burgeoning market for Instagram ads, the growth and expansion of Facebook Audience Network, and the potential in its other products -- Messenger and WhatsApp. 

Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Facebook. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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