At first glance, all the metrics lined up for Facebook's third-quarter earnings: Daily active users hit the mark, mobile daily active users shot up 39%, and ad revenue jumped 64% to hit nearly $3 billion. Just after the earnings announcement, Facebook's shares rose a bit in after-hours trading.
That bit of optimism didn't last long. It soon became apparent that while growth on several fronts was fine, the cost of keeping that growth going--especially years into the future--is going to be much higher than investors expected. The result: Shares began falling, eventually settling out with a 9% drop--only a bit less bad than Twitter's shares fell after its Monday earnings report.
And make no mistake, investors have good reason to be taken aback by the company's spending forecast. Chief Financial Officer David Wehner said costs would jump by as much as 70% next year thanks to investments in Facebook's fast-growing collection of new projects and acquisitions. In particular, he said, a large chunk of spending will go toward hiring for all of Facebook's acquisitions, such as Instagram, messaging phenom WhatsApp, and virtual-reality goggles startup Oculus Rift. More spending will be to staff up products such as the recently relaunched Atlas ad targeting and measurement system, video, and Internet.org, CEO Mark Zuckerberg's pet project to bring Internet connectivity to the rest of the world. "We plan on 2015 being a significant investment year," Wehner said on the earnings conference call with analysts.
And that investment will mean a big acceleration of expenses even from the 41% in the third quarter, when Facebook gained about 1,200 new employees, up 44% from a year ago. A quarter of the new employees come from acquisitions such as WhatsApp and Oculus.
One thing that may have further spooked investors was the long-term nature of some of those spendy projects. Zuckerberg grouped Facebook's priorities into three time frames--the next three years, the next five, and the next 10. The near-term focus is on its existing community and ad business, naturally. Five years out, Instagram, WhatsApp, messaging, and search should come on strong, and Oculus is the big 10-year priority, a bet on what Zuckerberg thinks will be the next computing platform.
That sounds logical, but investors no doubt look at the evident spending on both five-year and 10-year projects now, and figure there's going to be a lot of spending on them between now and then. Zuckerberg, in fact, said Oculus, which is only in prototype mode, would need to reach 50 million to 100 million units before it's "meaningful" as a computer platform, and said that wouldn't happen in the next few years. Even nearer-term products such as Instagram and search, he said, would take awhile. "Products don’t get that interesting until they have about a billion people using them," he said.
One area that investors don't have to worry about, unlike at
Apart from the obvious impact of higher expenses on profits, which ultimately informs the stock price, investors may have good reason to worry about higher spending on future products and services that depart from Facebook's social networking roots. After years of investor patience,
One good reason for investors' wariness is that despite its dominance of social network ad spending, Facebook still is nowhere near the size of Google. The search giant can spend a lot more than Facebook in absolute dollars on seemingly unrelated, borderline crazy stuff such as self-driving cars, WiFi balloons, and pills to track down cancer cells without unduly freaking out investors.
Facebook? Not so much. Zuckerberg is probably right to invest in long-term projects, because there's no telling how long the social network advertising gravy train will continue. In fact, most analysts are supporting the spending--perhaps one factor in Wednesday morning's more muted reaction. In early trading, shares were down 6%.
"Although guidance should have a negative impact, investors should feel confident that incremental investment should help support sustained growth," Brian Wieser of Pivotal Research wrote in a note to clients. "Comparable investment of the scale that Facebook is contemplating can only be achieved by them or by Google at this point in time, and we see further investment reinforcing their relative dominance in digital advertising for years to come." Likewise, Ben Schachter of Macquarie Securities, thinks the investments are justified given Facebook's "solid fundamentals."
Still, it's clear that not all investors agree. So add this to Zuckerberg's long list of projects: Persuade investors those projects will indeed pay off. That will be a multi-year project as well.
Updated with analyst comment and Wednesday morning stock price.
