Shares are still overvalued today, but dramatic expense growth could spook short-term oriented investors and create a compelling entry point in this wide-moat social network, says Morningstar’s Rick Summer
Facebook (FB) reported strong third-quarter earnings, posting 59% revenue growth and 90% growth in GAAP operating income. The largest social network in the world reaches 1.3 billion monthly active users and 864 million daily active users, and our investment thesis for it remains intact. As we adjust our model to account for higher near-term expenses, our long-term model continues to assume operating margin expansion, and we don't anticipate a material revision to our $60 fair value estimate. In our view, the stock is overvalued, and we wouldn't recommend allocating new money toward the name at this time.
The negative effects of recently closed acquisitions Oculus Rift (a virtual reality company) and WhatsApp (a global messaging company) will amplify operating expenses in 2015 versus this calendar year, according to comments made by management. While we currently model revenue to grow approximately 30% in 2015, expenses are now set to grow 55%-75% (50%-70% non-GAAP). We had not previously expected a dramatic compression of operating margins. Management reiterated its intention to invest in projects that may not contribute significantly to revenue or cash flows for the next five years, and the updated expense guidance supports that vision. In our opinion, if public equity investors have a shorter-term time horizon than management's, the stock is likely to trade below our fair value estimate, creating an attractive entry point for investors. Still, we are focused on near-term milestones such as WhatsApp user growth and revenue contribution for the next several quarters, as we aren't fully convinced of the value some recent acquisitions bring to shareholders.
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