Facebook’s New Growth Narrative

As I’m fond of saying, up until very recently there was no single more guaranteed growth story on Wall St. than Facebook. Those who put up bear cases were laughed at and dismissed as loonies. But the reality was Facebook was going to hit a growth wall in new users at some point, but I don’t think anyone thought it would happen so soon. Couple that with the sentiment change in North American and Canadian consumers, Facebook’s most profitable regions, and we arrive in new territory for Facebook. I want to talk about how Facebook now must change their narrative. But before I do that, I want to share a few thoughts on their overall earnings.

• I mentioned Facebook would hit a new user growth wall. Taking the 1000 foot view briefly, Facebook’s potential TAM is around 3-3.5 billion humans. That is approximately the number of humans with a smartphone currently. It is reasonable to assume that not every human will have a Facebook account but it is reasonable that Facebook’s ecosystem, can touch every person on the planet. More on that shortly
• User Growth in North America and Canada was flat. Last quarter, they saw no new user growth, which is slightly better than the decline they saw in Q1 2018. But when you look at the numbers going back to the middle of 2017 North America and Canada user numbers has settled around 185 million people. They have completely saturated North America and Canada, and I would not expect this to change.
• Despite not meeting Wall St. expectations, which is always a silly barometer in which to measure success, Facebook still saw strong YoY growth in all the metrics that matter. ARPU was up, advertising revenue per user was up, total revenue was up. Compared to Q2 2017, Q2 2018 was a solid quarter.

Facebook Will Now Tell a New Story
Despite the YoY growth, Facebook’s stock took a tumble yesterday. Facebook’s stock dropped as much as 25% in after-hours trading and largely driven by Facebook’s weak guidance. Many investors took the profits they had made the past few years and knew the short sellers would move the stock downward. My guess is many of those investors are buying Facebook stock back after the dip since that would be a wise decision.

But the interesting shift of the narrative is what I think stood out most to me on Facebook’s earnings call yesterday. It is 100% clear Facebook’s management wants to take the focus off of Facebook itself and start to tell growth stories around its other assets which include Facebook Messenger, Instagram, and WhatsApp. Instead of using a pure Facebook only user number, they went to great lengths to explain that 2.5 billion people use a Facebook product daily. Zuckerberg acknowledged that as products like Instagram grow, it will take time away from Facebook and therefore he wants investors to look at the bigger picture. Most companies have a product which is a major source of revenue, and inevitably the growth story for that product or service will slow which is when the narrative must shift to other things. Apple, for example, is still in the process of shifting the focus from iPhone in investors minds to the broader Apple ecosystem. Google is similarly trying to shift investors thinking just from Google search and about the bigger story which includes cloud, YouTube, and their growing presence in business. What Facebook is going through is a part of the playbook for when your biggest source of revenue slows. Facebook, however, has been planning for this moment which is where Instagram and WhatsApp and Messenger come into play.

Instagram is Facebook’s Future
While Facebook itself and things like groups, marketplace, and other growing features will help keep Facebook proper stable, the real growth story is Instagram. Instagram will likely be the thing that disrupts Facebook, and Zuckerberg and crew should be happy they likely own the only thing that can disrupt their current cash cow.

While many new users are onboarding to Facebook and Instagram around the world, it is the younger generation that is bypassing Facebook entirely and investing fully in Instagram. It was clear from Zuckerberg’s comments that he believes Instagram can play a role as a part, if not the future of television for this younger demographic. This is ultimate, the key narrative you have to believe in for most social media networks to buy into their upside. Instagram, YouTube, and Snapchat are essentially trying to be the dominant video platforms of the future. Which if they pull off, leaves many reasons to be optimistic about their growth potential.

For Facebook, Instagram is their future and the thing we can expect Facebook to focus their narrative around.

The Reason to Still be Bullish
I fully recognize the challenges Facebook faces around privacy issues, regulation, public sentiment, and more, however, the one thing that stands out to me is how we continually hear from advertisers that their Facebook ad spends outperform most, and in some cases all, other areas they advertise. This point was emphasized by Sheryl Sandberg on the earnings call yesterday as a point for investors to remember. Facebook’s ad units outperform the industry average by 2x in most cases which is substantial. Which means Facebook is in no danger of losing ad dollars and still likely the biggest benefactor of the shift from offline to online advertising across their assets. This single point is the reason Facebook will be fine and continue in their quest to increase average revenue per user and average advertising revenue per user.

This does not mean Facebook does not still have a lot of work to do. They surely can’t just coast, or rest and vest and the valley likes to say. But it appears Zuckerberg and the rest of Facebook’s executive community understands the big challenges they face and are willing to work to solve these problems. Execution is everything, and we will have to see how management executes, but understanding the problem is step one, and it seems Facebook does grasp the scale of their challenges, what they are, and has some general ideas on how to fix them.