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Facebook Earnings: Controversy Aside, Ad Revenue Is Skyrocketing

By Evan Niu, CFA - Updated Feb 1, 2018 at 12:39PM

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The social network closed out 2017 with a bang.

There's been an awful lot of controversy lately surrounding the role of social media and its impact on politics, democracy, and society at large. As the largest social network on earth, much of the debate has focused on Facebook (FB 1.29%), although its smaller rivals are still relevant, too. Even Facebook isn't quite sure if social media is good or bad for democracy: The company's product manager for civic engagement, Samidh Chakrabarti, published a blog post on the topic just last week.

Despite all of this, Facebook just reported blockbuster fourth-quarter earnings. Revenue in the quarter soared 47% to $12.97 billion, which translated into $4.3 billion of net income, or $1.44 per share. Analysts were modeling for $12.55 billion in sales and earnings per share of $1.94.

Mark Zuckerberg speaking on stage

Mark Zuckerberg. Image source: Facebook.

The tax hit

Facebook's bottom-line result was adversely impacted by tax reform, to the tune of $2.3 billion, or $0.77 per share. If you back that out, the company would have easily beat on EPS as well. While the bill included a massive reduction in the corporate income tax rate, from 35% to 21%, it also had a one-time mandatory tax on foreign earnings. The company hasn't yet filed its 10-K, which will disclose foreign cash, but at the end of the third quarter it had $12.9 billion in cash held by foreign subsidiaries.

The company pointed out that it must recognize the effect of tax law changes in the period of enactment, which was the fourth quarter.

The headline operating metrics

Daily active users (DAUs) came in at 1.4 billion, and monthly active users (MAUs) surpassed 2.1 billion for the first time. Within the U.S. and Canada -- Facebook's most important market -- DAUs actually declined by 700,000 sequentially. That's the first time DAUs in North America declined, but it's also a very mature market with "relatively high penetration," according to COO Sheryl Sandberg. Some fluctuations should be expected.

Mobile ads comprised 89% of ad revenue, or about $11.4 billion. On a trailing-12-month basis, the mobile ad business is now approaching $35 billion. All of Facebook's growth has been driven by mobile ads in recent years.

News Feed changes "not clearly negative"

Facebook is in the midst of rolling out a major product change: revamping the News Feed to focus more on social content instead of publisher content. That move entails substantial risks going forward. The change was announced earlier this month (after the fourth quarter closed).

But Facebook had already embarked upon emphasizing "time well spent" over just plain old "time spent." It's a subjective distinction, but CEO Mark Zuckerberg apparently doesn't consider viral videos to be "time well spent." In a statement, he noted, "Already last quarter, we made changes to show fewer viral videos to make sure people's time is well spent." People spent 50 million fewer hours per day on Facebook as a result of several changes to its algorithms, according to Zuckerberg.

That spooked investors initially, with shares dipping before the conference call started, but those concerns eased once Sandberg clarified that the changes won't affect monetization, even if time spent declines. "We're not doing this to be positive or negative for revenue, we're doing this because it's the right thing for our community," Sandberg said. "But the impact it has on monetization is certainly not clearly negative."

Hey, big spender

Occasionally when Facebook forecasts a big jump in expenses, investors freak out. The market seems to be wising up though, as there wasn't much reaction to 2018 expense guidance.

Facebook expects full-year 2018 expenses to jump by 45% to 60%, compared to full-year 2017 expenses of $20.5 billion. Capital expenditures in 2017 were $6.7 billion, and next year capital spending is expected to skyrocket to $14 billion-$15 billion. Facebook continues to invest heavily in data centers and network infrastructure. Note that Facebook's 2017 capital spending came in below guidance; a year ago management expected 2017 capital expenditures to be $7 billion to $7.5 billion.

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