Facebook Beats Second-Quarter Revenue Estimates, But Stock Falls On High Spending

Expectations were high for Facebook going into second quarter results, and the social media giant’s revenue didn’t disappoint. However, an 82% jump in spending weighed on the stock, which fell as much as 3.6% in after-hours trading on Wednesday.

Facebook’s strong mobile ad business helped the company beat analysts’ revenue estimates after the company narrowly missing sales forecasts last quarter. Facebook said Wednesday that revenue for the three months ending on June 30 rose 39% to $4.04 billion, from $2.91 billion in the same quarter a year earlier. Analysts polled by Yahoo expected sales of $3.99 billion.

The company reported second quarter net income of $719 million, or 25 cents per share, down from $791 million, or 30 cents per share, in the same period last year.

Adjusted earnings per share rose to 50 cents a share, up from 42 cents a year earlier, beating analysts’ estimates of 47 cents on the same basis. (See the full results here.) Currency exchange rates lowered Facebook’s revenue by about 330 million, the social network’s CFO Dave Wehner said on the company’s conference call.

Facebook’s revenue was buoyed by a 220% increase in the cost of ads over the second quarter. The social network’s roll out of more targeted ads, new ad formats and better measurement tools encouraged big brands to spend more to advertise on Facebook.

Facebook reported that expenses grew 82% to $2.8 billion. Capital expenditures were $549 million for the second quarter. That was due in part on increased hiring, especially for research and development roles, as well as on investments in data centers, artificial intelligence, virtual reality and a company project to expand global internet access. Facebook said in April that costs and expenses would likely rise as much as 65% this year.

The Menlo Park, Calif.-based company faces increasing competition from younger social players like Snapchat, particularly in the battle for teen users. But user activity on Facebook’s suite of apps continues to grow. Several of Facebook’s other products could also become multi-billion dollar businesses with time. In the short-term, Instagram could become a significant revenue source. And in the long-term, Facebook’s messaging apps, Messenger and WhatsApp, and its virtual reality product, Oculus, could also become large revenue streams.

Facebook’s mobile ad business makes up a growing slice of its overall revenue. In the second quarter, mobile accounted for 76% of advertising revenue, up from 62% a year earlier, while its desktop ad business continues to shrink. Last year, Facebook boosted its share of U.S. mobile advertising 18.5%, up from a share of 14.4% in 2013, according to eMarketer. Google GOOGL +0.26% remains the alpha dog in the mobile ad space, accounting for 36.9% of all U.S. mobile ad dollars last year, said eMarketer.

“We have the best mobile advertising product in the market, and video is making it even better,” Facebook’s COO Sheryl Sandberg said during the conference call. Sandberg added that Facebook’s ad products for small and medium-sized businesses aren’t yet simple enough, but that they are the simplest products available. She noted that about 40 million small and medium-sized companies are on Facebook, but only about 2 million advertise on the platform.

Facebook’s user base growth is also healthy. Total monthly active users were up 13% from a year earlier to 1.5 billion, and mobile monthly active users were up 23% to 1.3 billion. Daily active users were 968 million on average for June, an increase of 17% from a year earlier. Messenger has about 700 million monthly users, Instagram has 300 million monthly users and WhatsApp has about 800 million monthly users.

The large amount of data Facebook collects from users continues to be a key to the social network’s ad business. Facebook’s June launch of a slimmed-down version of its Android app that uses less data, called Facebook Lite, could help bring new users to the app, especially in emerging markets. The social network’s founder and CEO, Mark Zuckerberg, said on the earnings call that 1.5 billion searches are made on Facebook daily.

“This was another strong quarter for our community,” Zuckerberg said in Wednesday’s press release. ”Engagement across our family of apps keeps growing, and we remain focused on improving the quality of our services.”

Instagram’s Promise

Instagram is a bright light for Facebook’s short-term revenue potential, especially after the app announced plans in June to dramatically expand its ad offerings this year. Mark Mahaney, an analyst at RBC Capital Markets, said in a note before the release that Instagram could generate about $2 billion in revenue in 2016. 

On the company’s conference call, Sandberg said Facebook hasn’t noticed any difference in users’ willingness to click on Instagram ads compared to ads on the social network’s flagship app. However, Sandberg said “it’s going to really take time” for Instagram to have significant impact on Facebook’s overall growth.

Like Snapchat and Twitter, Instagram is also dedicating more resources to curating content for users with the goal of making its app more relevant and simple to use. Instagram revamped its Explore page in June, challenging Twitter as a real-time source for tracking events, conversations and trends.

“With Instagram, the continued growth in the size and engagement of the community shows how this is becoming one of the best places to get a real time snapshot of the world,” Zuckerberg said on the conference call.

Video Ad Boon

Video ads are an increasingly important revenue stream for Facebook.  The social network has been scaling up video ads on Instagram and recently launched spherical and embedded videos. Digital video advertising revenue in the U.S. is expected to rise 34% to $7.77 billion this year, according to forecasting firm eMarketer, and both Facebook and Google are eager to take a larger share of television ad budgets.

Facebook now generates about 4 billion video views per day, compared to one billion in September last year. The company rolled out auto-play video ads internationally late last year. Ads account for more than 90% of Facebook’s revenue.

Long-Term Revenue

Heading into earnings, analysts were bullish on Facebook’s ability to turn its messaging suite — Messenger and WhatsApp — and its virtual reality startup Oculus into multi-billion dollar businesses over the coming years.

Facebook added several new features to Messenger during the second quarter, such as video calling, peer-to-peer payments and location-sharing. More importantly, Facebook continues to build e-commerce tools on Messenger since opening up the platform to developers and businesses at F8 conference in March. Facebook also removed the requirement to have a Facebook account to sign in to Messenger, allowing users to sign in with only a phone number.

Mahaney estimated in his preview note that by 2017, Facebook’s messaging apps could generate between $2.2 billion and $4.7 billion in revenue. On the company’s conference call, Zuckerberg said the social network is looking for ways users can have valuable experiences with businesses on Messenger and WhatsApp.

Zuckerberg wants to turn Oculus into a next-generation computing platform. Facebook recently shared figures suggesting it could help the company’s top line within the next few years. Facebook said before that release that it expects the Oculus device to be available to purchase in the first quarter of next year. Mahaney said in a preview note that Oculus could generate more than $500 million in 2017. On the conference call, Wehner said the company hasn’t announced any specific plans regarding Oculus shipment volumes.

“Immersive 3-D content is the obvious next thing after video,” Zuckerberg said on the earnings call. “Oculus is going to be the best VR experience in the world when it launches.”