Susquehanna International Group analysts Brian Nowak and Michael Costantini raise Facebook Inc (NASDAQ:FB)’s price target based on positive earnings expectations.
In a sector dominated by multiple expansion, we believe companies posting upward revisions (like FB) are best positioned in 2014. Facebook Inc (NASDAQ:FB)’s ad pitch is improving and resonating well with agencies and advertisers, and we see continued strong ad dollar growth moving onto the platform. We are already above consensus numbers and the addition of video advertising (which FB just began testing in late December) is likely to drive numbers even higher…potentially adding ~$1.1bn (or 8%) on an annualized basis our to revenue expectations.
Facebook’s macro positioning as advertisers
We like Facebook’s macro positioning as advertisers look for ways to spend on “social” and Facebook Inc (NASDAQ:FB)’s ~1.2bn global monthly active users spending an average of ~392 minutes/month on the site make it the largest social network with industry-leading engagement. In all, we see social advertising driving 81% of forward online display ad spend (’13-’17), with Facebook driving 63% of that growth.
Facebook Inc (NASDAQ:FB)’s advertising offering is also steadily improving and we see multiple levers – an improved and simplified ad pitch as a “one-stop-shop,” attribution and ROI progress, higher quality ad units, and “greenfield” opportunities like Instagram – that are resonating well with advertisers and set to drive more dollars onto Facebook.
Facebook’s mobile leadership
Our agency discussions indicate Facebook Inc (NASDAQ:FB)’s mobile leadership (507mn global daily active users) is also helping the company capture a larger share of ad budgets as eyeballs are moving to mobile and advertisers are itching for ways to spend. Facebook’s massive (and growing) mobile audience is giving it to them, and advertisers also like the familiarity of the Facebook mobile ad units as sponsored story ad units are directly transferable from desktop to mobile.
Video ads top the list of potential new ad offerings, as big brands are eagerly awaiting to increase their Facebook Inc (NASDAQ:FB) spending through video. There is no video advertising assumption in our above-Street estimates, but our video ad model demonstrates how video would generate $1.1bn in annualized rev (or 8% upside to our ’15 revenue estimate) even conservatively assuming video ads are sold at an $8 CPM (vs. other online video at $20+) and if 50% of the video ad units are substitutive over existing sponsored stories. Higher pricing or lower cannibalization is even more upside.
Facebook Inc (NASDAQ:FB)’s advertising offerings and pitch are maturing and the levers are in place for continued strong ad dollar growth. We are 4% ahead of Street revenue estimates in both 2014 and 2015 and believe continued ad-driven beats position Facebook to be one of the top-performing stocks in the sector in 2014. We rate Facebook Positive and have a $68 price target.
Catalysts and downside risk
Catalysts: Faster than expected ad growth. Downside risk: We calculate downside risk to $51 using a 13x EV/EBITDA multiple.
For those looking to hedge long exposures in Facebook Inc (NASDAQ:FB), we highlight the very low skew in Facebook options, which can make for attractive stock collar (risk reversal) opportunities. Recall that most equities (along with most ETF and Index products) trade with negative skew (or put skew), meaning that downside puts generally trade at a premium to corresponding upside calls. Much of this is driven by supply/demand dynamics, as demand for downside puts as insurance for long holders causes these puts to trade at a premium. In the case of Facebook though, we see that the skew is quite low, actually trading slightly to the calls. Much of this is likely driven by demand for upside calls by those without positions seeking upside exposure. In fact, 90-Day skew in Facebook is the 4th lowest of any name in the Nasdaq 100 (as measured by the normalized volatility spread between the .25d put and call).
In addition to being low in absolute terms, Facebook skew is also low in relative terms, currently trading in the 9th percentile relative to the last two years of observations. Long shareholders are able to take advantage of this dynamic by using the sale of upside calls to finance the purchase of downside puts at attractive levels. For example, Facebook holders who would be comfortable exiting positions above the $75 level over the next ~6 months could use a sale of the June 75 calls to finance a purchase of the June 46 puts. Based on Friday’s closing stock price of $57.94, this collar could be purchased in the market for a $0.04 credit. We can see the impact of the call skew in the pricing here, where the ~$12 out-of-the-money puts actually trade slightly below the ~$17 out-of-the-money calls. The position would offer downside protection below $46 in exchange for capping upside above $75.
We value Facebook Inc (NASDAQ:FB) by using an 18x EV/EBITDA multiple, based on Google Inc (NASDAQ:GOOG)’s multiple at the same stage in its life-cycle. In applying our 18x multiple to our 2015 EBITDA estimate of ~$8.8bn, we arrive at our $68 price target.
Downside risks to achieving our price target include: 1) user declines or loss of engagement; 2) continued need to spend on capex/opex to support growth; 3) legal/political/reputational risk around privacy and consumer rights; and 4) inability to further penetrate local ad markets given lack of map product.