Why Facebook’s Rockstar Q4 Earnings is Not All Good News

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Strong average revenue per user (ARPU) growth from Facebook in Q4 2016 earnings report
Facebook Chief Financial Officer, David Wehner. Q4 2016 earnings report shows strong ARPU growth

During the third quarter earnings call, which happened in the first week of November 2016, Facebook’s CFO David M. Wehner said we continue to expect that ad load will play a less significant factor driving revenue growth after mid-2017. Over the past few years, we have averaged about 50% revenue growth in advertising. Ad load has been one of the three primary factors fueling that growth. With a much smaller contribution from this important factor going forward, we expect to see ad revenue growth rates come down meaningfully.”

When a company is trading high on expectations with sky high valuation multiples, it’s natural to want to cool things down a bit when you are expecting growth rates to slowly come down. But contrary to what Facebook’s CFO said during the third quarter, Facebook blew every possible metric out of the water, posting a revenue growth of 53% during its fourth quarter that ended in December 31, 2016.

Growing revenues from $5.637 billion in the fourth quarter of last year to $8.629 billion this year was no mean feat, but if Facebook is capable of growing at this pace, then why even bother to try and cool investor sentiment?

To answer that, we need to take a closer look at the “ad load” Facebook’s CFO was talking about.

Ad load is the amount of advertising that you can show at a given point of time within one or a set of web properties. Facebook derives more than 80% of its advertising revenue from mobile. As we know, the screen space is quite small on mobile devices as opposed to desktops. But, more importantly, there is a limit to the number of advertisements that you can show to your user without spoiling your visitor’s experience.

It’s a fine balancing act that any company needs to do, so that it earns what it can, but not to the point that it sacrifices user experience.

One of the metrics relevant to ad load is ARPU, or average revenue per user. This is what Facebook makes on the ads it shows its visitors and the ads that are clicked through. Facebook’s ARPU has been growing at phenomenal double-digit rates for the last several years.

How is that happening?

ARPU can grow if either the rate which Facebook charges its advertisers grows, or the number of advertisements – a.k.a. ad load – increases, or if the user spends more time on the site, which means more ads can be served in that time.

The cost of advertisements cannot keep going up and up, and neither will the average time spent by the user. Both these metrics should have grown at a steady rate, and ad load was a crucial factor in increasing Facebook’s revenue, by its CFO’s own words.

That implies that a large contribution to the ARPU increase was from ad load growth.

Facebook ARPU and growth over several quarters
Facebook’s ARPU and year-over-year growth over several quarters

This metric, as we saw, is not something that can keep increasing for ever. The fact that it grew at double-digit rates is, in itself, a huge achievement for Facebook. It also shows the value the company offers and how the management was able to exploit that advantage.

But if you notice, the rate of ARPU growth has been coming down for the past three quarters. It’s still growing in double digits, which means there is some more juice left in this metric. But investors do need to expect this growth rate to steadily come down – not because Facebook is executing things badly, but simply because it’s the natural progression of a growing business.

Sure, Facebook had a blowout quarter and killed nearly every metric of any importance, but ARPU may have already achieved its growth peak, and we all know what usually comes after the peak. As such, Wehner was merely bringing investors’ attention to that fact.

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