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Facebook - high costs weigh on profits

Sophie Lund-Yates, Equity Analyst | 30 January 2020 | A A A
Facebook - high costs weigh on profits

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Facebook Inc Com USD0.000006

Sell: 224.42 | Buy: 224.56 | Change -0.37 (-0.16%)
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Revenues for the full year rose 27% to reach $70.7bn, with fourth quarter revenues up 25% to $21.1bn, which was better than the market expected. However, within that advertising revenue in the US was below expectations.

Total costs and expenses rose 51% over the year, including higher research and development spend, meaning operating income for the full year fell 4% to $24bn.

The shares fell 7.1% in pre-market trading.

View the latest Facebook share price and how to deal

Our view

Facebook is an advertiser's dream. More than a quarter of the world's population use Facebook's social networks every day, bringing shed loads of data with them. Marketing teams pay handsomely for this, helping them to cater ads and content to individuals. And that revenue stream is Facebook's bread & butter.

Revenue has compounded up at an average rate of over 40% in the last five years, and a comparatively low cost base means profits have come along for the ride. However, change is in the air.

All that data gives Facebook great power, but with that power comes great responsibility, and responsibility is expensive. The Cambridge Analytica scandal intensified regulatory scrutiny, and data security and fighting against fake news means costs are rising. As does increased investment in other growth opportunities, like VR capabilities. Then there's sprucing up tougher to monetise, but increasingly popular, personal messaging features like WhatsApp and Messenger.

All-in-all, the shopping list is getting longer, and the rapid pace of revenue growth has slowed a bit lately. That's a tough combination for profit margins. These have fallen well below last year's level, and they aren't expected to move past the mid-thirties for a while.

We can understand the rationale. You've got to invest to stay ahead in tech, and making sure Facebook provides what users want and trust is crucial. But uncertainty around the transformation brings risk.

Still, for all the bluster and negative PR, Facebook looks well placed to us. It remains an invaluable resource for advertisers. With user numbers and revenue per user both still growing, and growth platforms like Instagram driving forward too, operating profit is expected to start growing again from next year. Not bad for a company whose shares currently change hands for 23.9 times expected earnings, some way below the longer run average of 33.

Like many tech giants Facebook's balance sheet is packed with cash. But unlike say Amazon, some of that cash is coming back through share buybacks. Investors shouldn't expect a dividend yet though, the transformation remains the focus for now.

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Full year and fourth quarter trading details

Revenue from advertising increased 27%, reaching $69.7bn, although growth was slower in the fourth quarter at 25%. Average revenue per user now stands at $8.52, compared to $7.37 last year.

The number of daily active users averaged 1.66bn for December 2019, an increase of 9% year-over-year. Monthly active users averaged 2.5bn, reflecting an increase of 8%. These were both broadly in line with expectations.

Total costs and expenses were $46.7bn, including $13.6bn of research and development spending. As a result, operating margins fell to 34% from 45%.

Despite the lower profitability, free cash flow increased 34.5% to $20.7bn. That reflects the legal costs associated with the Federal Trade Commission settlement being delayed.

Find out more about Facebook shares including how to invest

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