EQUITY RESEARCH May 3, 2017 It s Raining Friends Our view: FB reported another strong quarter, with results coming in handily ahead of expectations while key metric growth remains robust. FB maintained its expense outlook while reiterating earlier investment year commentary. We are raising our estimates and PT to $185. Reiterating Outperform. Key points: Very Robust Q1 Results: Revenue grew 49% Y/Y to $8.03B in Q1:17, above RBC/Street estimates of $7.75/7.83B. Ad Revenue (98% of total), grew 51% Y/Y ex-fx, vs. 54% Y/Y growth in Q4. Outperformance was broad across geographies, verticals, and ad-buying segments. GAAP EPS of $1.04 was ahead of the Street s expectation of $0.87, tho new tax provisions positively impacted EPS. We note that going forward FB is no longer reporting non-gaap Operating Income or EPS, which we believe is a positive trend.. We note that the co maintained their 40-50% GAAP expense growth commentary for 17. Quarter Keys: 1. More Friends MAUs up 17% Y/Y (fastest growth since Q3:13.um, that s over 3 years ago) to 1.94B. 2. Engagement DAU/MAU ratio (engagement measure) at 66.3%, up 36 bps Y/Y. However, DAU/MAU in the U.S./Canada declined 15bps a small amount, but worth noting given that it was the first decline since Q4:12. 3. Monetization ARPU up 28% Y/Y to $4.23, slight decel vs. 30% in Q4. 4. Strong FCF Generation And Share Repos $3.8B in Q1. FB also had $228MM of share repos in Q1 of the $6B that was authorized in Q4. 5. More Mobile Mobile Rev grew 57% Y/Y (vs. 61% in Q4) to $6.68B (representing 85% of total Ad rev), above the Street s estimate of $6.52B. 6. Ad Impressions/Pricing Impressions growth decelerated to 32% in the Q (down from 49% in Q4), but was offset by 14% pricing growth (up from 3% in Q4). We view this as a noisy metric. 7. U.S./Canada Revenue Decelerated to 47% from 56%, a modest negative though every other region either held its growth or accelerated. Raising Ests & PT: 17 Rev increased 3% to $39.9B, with GAAP EPS up 17% to $5.29, in part due to lowered tax rate expectations. $185 PT (from $175 before) is based on 26x 18 GAAP EPS of $7.11 and 17x 18 EBITDA (incl. SBC) of $28.9B. RBC Capital Markets, LLC Mark S.F. Mahaney (Analyst) (415) 633-8608 mark.mahaney@rbccm.com Andrew Bruckner (Analyst) (415) 633-8651 andrew.bruckner@rbccm.com Sector: Outperform NASDAQ: FB; USD 151.80 Dylan Haber (Senior Associate) (415) 633-8527 dylan.haber@rbccm.com Jim Shaughnessy (AVP) (415) 633-8560 jim.shaughnessy@rbccm.com Price Target USD 185.00 175.00 WHAT'S INSIDE Rating/Risk Change Price Target Change In-Depth Report Est. Change Preview News Analysis Scenario Analysis* Downside Scenario 100.00 34% Current Price 151.80 *Implied Total Returns Key Statistics Shares O/S (MM): 2,944.0 Dividend: 0.00 Price Target 185.00 22% Upside Scenario 220.00 45% Market Cap (MM): 446,899 Yield: 0.0% Avg. Daily Volume: 15,573,413 RBC Estimates FY Dec 2015A 2016A 2017E 2018E Revenue 17.9 27.6 39.9 53.5 Prev. 38.7 51.6 GAAP Net EPS 1.29 3.35 5.29 7.11 Margin 62.6% 65.6% 62.7% 63.4% P/E Net NM 45x 29x 21x EBITDA 11.2 18.1 25.0 33.9 Prev. 24.4 33.0 Revenue Q1 Q2 Q3 Q4 2016 5.4A 6.4A 7.0A 8.8A 2017 8.8A 9.3E 10.0E 12.5E Prev. 7.8E 9.1E 9.8E 12.2E EBITDA 2016 3.3A 4.2A 4.6A 6.0A 2017 4.9A 5.7E 6.2E 8.3E Prev. 4.6E 5.6E 6.1E 8.1E All values in USD unless otherwise noted. Reiterate Outperform: We are incrementally more positive on FB. Core FB is growing extremely well, with almost unprecedented Ad Revenue growth consistency. More important, we believe that s FB s current low market shares approximately 15% of Global Online Advertising & 5% of Global Total Advertising will help it maintain premium growth for a long time. And FB still has several new large revenue growth drivers (Instagram monetization, Messaging Platform monetization, Camera/AR, etc ). On valuation, we view 21x P/E on our 18 GAAP EPS as highly reasonable, especially for 40%+ EPS growth. Disseminated: May 3, 2017 22:32ET; Produced: May 3, 2017 22:32ET Priced as of prior trading day's market close, EST (unless otherwise noted). For Required Conflicts Disclosures, see Page 12. RBC Capital Markets appreciates your consideration in the 2017 Institutional Investor All-America Research Team survey.
Target/Upside/Downside Scenarios Exhibit 1: 125 Weeks 11DEC14-03MAY17 185 UPSIDE 220.00 TARGET 165 185.00 CURRENT 145 151.80 135 125 115 105 DOWNSIDE 100.00 95 85 75 65 600m 400m 200m 2015 D J F M A M J J A S O N 2016 D J F M A M J J A S O N FB Rel. S&P 500 COMPOSITE MA 40 weeks 2017 D J F M A M Source: Bloomberg and RBC Capital Markets estimates for Upside/Downside/Target May 2018 Target price/base case We value Facebook using a blended average of 26x P/E Multiple and 17x EV/EBITDA multiple on our 2018 estimates. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. For key context, we are estimating 41% EPS & 37% EBITDA CAGRs for FB through 2019, which we believe supports these premium multiples. Our $185 Target Price is also supported by a DCF, assuming a 12% WACC and a 3% Terminal Growth Rate. Our price target supports our Outperform rating. Upside scenario In our upside scenario of $220, we estimate a 50% 2-year Revenue CAGR as user growth and sustained engagement drives Ad Revenue. Higher Revenue growth drives EBITDA margins to 72% by 2017. We apply a 40x P/E multiple and a 28x EV/EBITDA multiple. Investment summary Our Outperform rating is based on several key factors: 1) Very Large, Growing User Base Facebook has more than 1.9B active users and is still growing this in the teens % Y/Y. The large amount of data collected on these users is a unique and valuable asset for ad and content targeting. 2) Engagement Still High Although engagement levels are a constant concern, Facebook's measure of DAU/MAU has remained consistently high on an overall company basis. 3) One of the Most "Underlevered" Companies Facebook still has many growth levers left to pull, not least of which is video advertising. 4) Mobile Overhang Addressed Facebook has, so far, effectively addressed one of the most significant overhangs from its IPO days, the lack of Mobile monetization. Mobile Ad Revenue is now showing significant growth and becoming a material part of the overall Ad Revenue mix (85%). 5) Very High Margins FB currently drives EBITDA margins in the low-60%s. An outlook for increased opex investment should drive these down, but we think that increased investment is actually a positive at this point in the company's growth. Impediments to Our Price Target Include: 1) Broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Downside scenario In our downside scenario of $100, we assume that user growth slows more quickly than expected and that engagement begins to slip in mature geographies. This causes both a deceleration in ad volume growth and pricing pressure as more incremental ads come from lower-monetizing geographies. We apply a 25x P/E multiple and 16x EV/EBITDA multiple. May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 2
Facebook Q1:17 EPS Roundup Metric Trends More Outperformance Where s The Ceiling? Monthly Active Users Monthly Active Users (MAU) grew 17.0% Y/Y up slightly from 16.8% in Q4 on a 1pt tougher comp. This is the fastest growth since Q3:13 with the total reaching 1.94B, slightly above Street estimates at 1.91B. This overall growth rate remains very impressive given FB s massive size and don t forget that FB MAU s don t include Instagram (700MM+ MAUs) or WhatsApp (over 1.2B MAUs) North America Y/Y MAU growth was flat at 5% Y/Y growth in Q1 (vs. 5-6% in Q4/Q3/Q2/Q116); Europe growth decelerated slightly to 6% Y/Y (from 8% in Q4) while ROW stayed flat at 19% Y/Y growth (vs. 19% growth in Q4). The growth driver here? Asia, which accelerated grew 27% Y/Y growth from 25% Y/Y growth in Q4. Our guess is Facebook and its properties probably have over 2B unique users worldwide on a monthly basis (i.e. FB > China), including well, well over 1B users worldwide on a daily basis (1.3B as of Q1). Google is the only other global media company with properties with over 1B users. A few factors helping FB at the margin are product improvements, continued traction of Facebook Lite version for Android phones, the growth of.org and the increase in third-party promotional free data plans in Asia and the rest of the world. Facebook again came in above expectations for user growth and showed very strong user growth metrics. Facebook continues to defy the Law of Large Numbers, by not only maintaining its robust growth, but ACCELERATING (however slightly) its robust User growth where s the ceiling? Very impressive for a company which has well over 2B Unique Users across its properties Exhibit 2: Monthly Active Users and Growth 2,000 1,750 1,500 1,250 1,000 1,936 1,859 1,787 1,654 1,712 1,591 1,546 1,491 1,441 1,394 1,351 1,317 1,276 15% 14% 14% 14% 13% 13% 14% 14% 15% 15% 16% 17% 17% 30% 25% 20% 15% 10% 750 5% 500 Q1:14 Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Monthly Active Users (left) Y/Y Growth (Right) 0% Source: Company reports, RBC Capital Markets Engagement Trends Overall engagement levels in Q1:17 were very strong in terms of the DAU/MAU Metric (Daily Average Users/Monthly Average Users, Facebook s best publicly disclosed proxy for engagement). The DAU/MAU ratio was 66.3% in Q1, up from 65.9% in Q4 and up 36 bps Y/Y. This was also above the Street s expectation of ~66.0% and slightly above our 66.2% expectation. The metric was up in all regions Y/Y except for the U.S. & Canada, where it was May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 3
down 15 bps Y/Y the first-ever Y/Y decline. Two thoughts these are intrinsically high levels, so the 15 bps Y/Y isn t a material negative. Further, the follout of camera-centric and AR (Augmented Reality) features could cause this engagement level to continue to rise in the future. These remain robust trends, especially in Facebook s most mature geographies, and we believe Mobile is a major driving factor, along with ongoing product and feature improvements. Engagement remains robust, with our thesis remaining that Facebook can continue to steadily increase engagement over time and, in turn, attract more ad dollars. Exhibit 3: Engagement (Daily Active Users/Monthly Active Users) Geographic Breakdown 85% 80% 75% 70% 65% 60% 55% 50% 74.3% 74.5% 75.2% 75.5% 76.7% 77.0% 77.0% 77.2% 77.9% 77.4% 77.7% 77.9% 77.8% 70.2% 70.5% 71.6% 72.1% 73.3% 73.3% 74.0% 74.3% 74.8% 74.6% 74.9% 75.1% 75.4% 61.8% 62.0% 62.6% 62.7% 63.8% 63.8% 64.2% 64.0% 64.6% 60.5% 59.0% 59.4% 60.3% 55.4% 55.6% 56.8% 56.3% 57.3% 57.5% 57.5% 57.2% 58.1% 58.4% 58.5% 58.8% 59.6% 45% 40% Q1:14 Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 US & Canada Europe Asia Rest of World Source: Company reports, RBC Capital Markets Global ARPU Global ARPU grew 28% Y/Y to $4.23 in Q1, decelerating 2-pts against Q4 s 30% Y/Y growth though on a flat comp. The increase in ARPU is being driven by Ad Revenue, which grew 29% Y/Y on a per-user basis, compared to a 17% decline in Payments ARPU per-user. Rising ARPU is a positive sign for advertiser traction and the company s ability to monetize incremental users/usage. Going forward, given management s commentary around focus on new ad units and moderating ad load, ARPU will be a key metric to determine Ad Revenue growth. With Google s ARPU still materially above Facebook, we believe there is plenty more monetization runway for FB. May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 4
Exhibit 4: Global ARPU and Growth $5.0 $4.83 60% $4.5 $4.0 $3.5 $3.0 $2.5 $2.0 49% $2.00 40% 40% $2.24 $2.40 31% $2.81 25% $2.50 $2.76 23% $2.96 23% $3.72 33% $3.32 33% $3.82 39% $4.01 35% 30% $4.23 28% 50% 40% 30% 20% $1.5 10% $1.0 Q1:14 Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Global ARPU (left) Y/Y Growth (right) 0% Source: Company reports, RBC Capital Markets Ad Metrics Facebook stated that Ad Impressions in the quarter grew 32% Y/Y (Driven by Mobile Ad impressions), down from the 49% delivered in Q4 and the 50% growth seen in Q3. However, we continue to believe this data point is largely noise, especially with continual ad format changes; the company noted that the emphasis on long-form Video in the News Feed negatively impacted Ad Impressions as well. Further, we note management stated that pricing increased 14% (vs. 3% in Q4, 6% in Q3 and 9% in Q2). We continue to look at the growth in overall advertising revenue as the most important factor for FB, which at 51% Y/Y growth (ex-fx) in Q1 is a positive outcome for a business that did $28B in Revenue in 2016 especially one with 60%+ EBITDA Margins. In fact, Google is the only other platform that comes to mind as being able to do this -- in 2007. We continue to believe Facebook s focus on ad quality is the right strategy, particularly given management s consistent commentary around ad loads being a less significant factor for growth starting in H2:17. We also think Video Ads (especially with general user adoption of Videos), Carousel Ads, Canvas Ads, Dynamic Ads, and Instagram monetization will be key parts of this trend over the next two years. Revenue Results Above Expectations Total Revenue grew 49% Y/Y to $8.03B in Q1:17, above RBC/Street estimates of $7.75/7.83B. The key number here was the Advertising Revenue segment (98% of total revenue), which grew 51% Y/Y ex-fx, vs. 54% Y/Y growth in Q4 but on a flat comp. Mobile continued to drive positive results, growing 57% Y/Y (vs. 61% in Q4) on a reported basis to $6.68B, above the Street s estimate of $6.52B. Looking ahead, management maintained that it expects Ad Load to play a less significant factor for driving revenue growth following mid-2017. The commentary on the Q1 EPS call was identical to that on the Q4 EPS call and the Q3 EPS call. May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 5
Exhibit 5: Revenue Growth Trends ($ MM) Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Total Revenue 3,543 4,042 4,501 5,841 5,382 6,436 7,011 8,809 8,032 Y/Y Change 42% 39% 41% 52% 52% 59% 56% 51% 49% Q/Q Change -8% 14% 11% 30% -8% 20% 9% 26% -9% Advertising Revenue 3,317 3,827 4,299 5,637 5,201 6,239 6,816 8,629 7,857 Y/Y Change 46% 43% 45% 57% 57% 63% 59% 53% 51% Y/Y Change (ex-fx) 55% 55% 57% 66% 63% 63% 59% 54% 51% Q/Q Change -8% 15% 12% 31% -8% 20% 9% 27% -9% % of Total 94% 95% 96% 97% 97% 97% 97% 98% 98% Desktop Ad Revenue 896 918 946 1,127 936 998 1,091 1,381 1,179 Y/Y Change -4% -10% -6% 1% 5% 9% 15% 22% 26% % of Total Ad Revenue 27% 24% 22% 20% 18% 16% 16% 16% 15% Mobile Ad Revenue 2,421 2,909 3,353 4,510 4,265 5,241 5,725 7,248 6,678 Y/Y Change 81% 75% 72% 82% 76% 80% 71% 61% 57% % of Total Ad Revenue 73% 76% 78% 80% 82% 84% 84% 84% 85% Payments & Other Revenue 226 215 202 204 181 197 195 180 175 Y/Y Change -5% -8% -18% -21% -20% -8% -3% -12% -3% Q/Q Change -12% -5% -6% 1% -11% 9% -1% -8% -3% Source: Company reports Exhibit 6: Non-GAAP Operating Margins and EBITDA Margins Margin Trends Still Pressured By Investment Cycle In Q2:16, total GAAP Opex grew 40% Y/Y (vs. 29% in Q4). In Q1, Facebook delivered EBITDA margins of 61%, ahead of our estimate of 59.1% but marking a 90bps Y/Y decrease. Facebook is currently in an investment cycle for both Capital Expenses and Operating Expenses, which generally places pressure on margins. As we have noted in other cases, we believe this is the right step for management to take and are comfortable trading near term margins for long-term growth. Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 GAAP Operating Income 933 1,273 1,459 2,560 2,010 2,746 3,122 4,566 3,327 Margin 26% 31% 32% 44% 37% 43% 45% 52% 41% Adjusted EBITDA 2,118 2,507 2,716 3,875 3,308 4,156 4,552 6,028 4,865 Margin 60% 62% 60% 66% 61% 65% 65% 68% 61% Source: Company reports, RBC Capital Markets Additional Datapoints 2017 Guidance In terms of 2017 outlook, the company continues to expect total GAAP expenses to grow 40-50% Y/Y. The company noted on the Q4 call that they expect 2017 to be an investment year, with the company also planning to accelerate their hiring growth (headcount grew 34% Y/Y in 2016). Facebook also expects Capital Expenditures in the range of $7-7.5B (up 50% Y/Y) as they expand data center capacity and office facilities. Under its new accounting guidance, FB s tax will fluctuate with stock price at current stock prices, the company expects that its Q2 and FY17 tax rates will both be in the mid-teens, up from Q1. The company didn t break out SBC or Amortization expectations, but we d note that on the Q4 call they expected full-year 2017 May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 6
Share-Based Compensation expense in the range of $3.9-4.1B, with $1.3B of that allocated to the WhatsApp acquisition (WhatsApp related SBC ends in late 18) and 2017 amortization expenses of $700-800MM. Lastly, management continues to expect ad Revenue growth to come down meaningfully in 2017 driven by the same factors the company has highlighted before (Ad Load growth at Core Facebook will play a less significant factor in driving Advertising revenue growth in H2:17). The company also expects Desktop Ad Revenue growth rates to slow in Q3 as they begin to lap their efforts to limit the impact of Ad Blockers. Lastly, the company expected FY17 Payments & Other fees revenue will decline compared to 2016. Strong Cash Position Facebook reported Cash and Marketable Securities of $32B at the end of Q1. Free Cash Flow was a very hefty $3.8B. Capital expenditures were $1.27B in Q1 the company expects $7-7.5B of CapEx in 2017. All in, we continue to view Facebook s liquidity position as unusually strong, and continuing to improve. Miscellaneous Notes from Earnings Stories Feature on Apps: Instagram Stories now has more than 200MM Daily Active Users using it, while WhatsApp s Status has more than 175MM Daily Active users. The company also recently rolled out its Messenger Day and Facebook Storeies products, putting Video at the center of all services. We d note that in Q1 the company also launched full screen, sound-on ads in Instagram Stories. Stock Repurchase Program: Facebook s Board of Directors authorized a $6B stock repurchase program in Q4 that begins in 2017 with no expiration date. The company noted at the time that they are currently in a financial position to make opportunistic repurchases of common stock from time to time to offset dilution from equity issuance. In Q1, FB repurchased $228MM of Class A common stock. Businesses: Facebook now has over 70MM Monthly Active Business pages on its platform. There are now also more than 5MM Businesses advertising on Facebook, including 1MM in emerging markets. Messaging Platforms: The company now has 1.2B people using Messenger every month, and at F8 (their developer conference) they launched the second generation of their Messenger platform and introduced the Discovery tab to make it easier to find the best experiences quickly. Facebook Communities: The company noted they have launched Community Help, a tool that helps people give and get things like food, shelter and transport in the wake of a natural disaster. The company also noted that they have 100MM people on Facebook who are in very meaningful groups, such as parenting or rare disease support. Furthermore, over 2017 the company will be adding 3K people to its community operations team around the world (they have 4.5K now) to review the millions of reports they get each week. May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 7
Changes to Estimates Below we present the changes to our 2017 and 2018 estimates. Exhibit 7: Change to Estimates 2017E 2018E ($ MM) Old New % Change Old New % Change Revenue 38,723 39,851 2.9% 51,633 53,506 3.6% Adjusted EBITDA 24,441 25,022 2.4% 33,024 33,873 2.6% GAAP EPS $4.51 $5.29 17.2% $6.29 $7.11 13.0% Source: RBC Capital Markets estimates May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 8
Valuation Methodology We are raising our Price Target to $185 (from $175). Our 2018 valuation framework is based on an average of GAAP P/E and EV/EBITDA methodologies. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. Our P/E Valuation framework applies a 26x Target Multiple to our 2018 GAAP EPS estimate of $7.11 to arrive at our $185 Price Target. For key context, Facebook is trading at 28x 2017E EPS and 21x 2018E EPS. Further, our estimates imply a 3-year 41% EPS CAGR, which we believe reasonably supports a Target Multiple of 26x. Our EV/EBITDA Valuation framework applies a 17.0x Target Multiple to our 2018 EBITDA estimate of $29B to arrive at a $182/share valuation. For key context, Facebook is trading at 19x 2017E EBITDA and 14x 2018E EBITDA. Further, our estimates imply a 3-year 37% EBITDA CAGR. We combine these two valuation frameworks and round the result, leading to our $185 PT. Exhibit 8: Valuation Methodologies ($ in millions, except per share amounts) Current Price (After Market) $148.03 Diluted Shares Outstanding 2,944 Current Market Cap 435,800 Less: Cash and Cash Equivalents 32,306 Plus: Debt 0 Enterprise Value 403,494 Price to GAAP EPS 2018E GAAP EPS $7.11 Current P/E on '17 GAAP EPS 28.0x Current P/E on '18 GAAP EPS 20.8x EPS CAGR '16-'19 41% Target Multiple 26.0x Implied Stock Price on Forward EPS $185 EV to EBITDA (incl. SBC) 2018E EBITDA (incl. SBC) 28,896 Current EV/EBITDA on '17 EBITDA 19.1x Current EV/EBITDA on '18 EBITDA 14.0x EBITDA CAGR '16-'19 37% Target Multiple 17.0x Enterprise Value 491,240 Plus: '17 YE Cash 44,417 Less: '17 YE Debt 0 Equity Market Capitalization 535,657 Implied Stock Price on Forward EBITDA $182 Target Price $185 Source: RBC Capital Markets estimates, Company reports, FactSet; Priced in the after-market as of 7:59 PM EST on May 3 rd, 2017 May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 9
Valuation We value Facebook using a blended average of 26x P/E Multiple and 17x EV/EBITDA multiple on our 2018 estimates. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. For key context, we are estimating 41% EPS & 37% EBITDA CAGRs for FB through 2019, which we believe supports these premium multiples. Our $185 Target Price is also supported by a DCF, assuming a 12% WACC and a 3% Terminal Growth Rate. Our price target supports our Outperform rating. Risks to rating and price target Risks to our price target and rating include but are not limited to: 1) broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Company description Founded in 2004 and headquartered in Menlo Park, California, Facebook is the world s most popular social networking site with more than 1.9B users. Through its flagship website, facebook.com, as well as mobile apps and various other tools, Facebook enables users to connect, share, discover, and communicate with each other. Facebook also provides a platform on which developers can build social apps and integrate their own websites with Facebook, further enhancing interactivity among users. Facebook generates revenue primarily through two channels: Advertising (98%) and Payments/Other (2%). May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 10
($ Millions, Except EPS) 2015A 2016A 2017E 3/15A 6/15A 9/15A 12/15A 3/16A 6/16A 9/16A 12/16A 3/17A 6/17E 9/17E 12/17E 2015A 2016A 2017E 2018E Total Revenue $3,543 $4,042 $4,501 $5,841 $5,382 $6,436 $7,011 $8,809 $8,032 $9,303 $10,028 $12,487 $17,927 $27,638 $39,851 $53,506 Cost Of Revenue 636 646 699 802 816 887 956 1,015 1,125 1,189 1,267 1,314 2,783 3,674 4,895 6,305 Gross Profit 2,907 3,396 3,802 5,039 4,566 5,549 6,055 7,794 6,907 8,114 8,761 11,173 15,144 23,964 34,956 47,201 Operating Expenses 1,974 2,123 2,343 2,479 2,556 2,803 2,933 3,228 3,580 4,076 4,336 4,783 8,919 11,520 16,776 21,788 Marketing & Sales 544 542 622 686 744 804 829 1,020 961 1,116 1,203 1,474 2,394 3,397 4,754 6,207 Research & Development 479 560 663 709 757 826 892 910 1,164 1,349 1,434 1,498 2,411 3,385 5,446 7,116 G&A 223 246 287 312 309 348 373 450 588 679 702 749 1,068 1,480 2,718 3,489 Stock Based Compensation (Incl. Payroll 728 775 771 772 746 825 839 848 867 932 997 1,062 3,046 3,258 3,858 4,976 Other 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 GAAP Operating Income 933 1,273 1,459 2,560 2,010 2,746 3,122 4,566 3,327 4,038 4,425 6,390 6,225 12,444 18,180 25,412 Non-GAAP Operating Income 1,840 2,228 2,410 3,523 2,936 3,764 4,156 5,597 4,384 5,160 5,612 7,642 10,001 16,453 22,798 31,149 Depreciation 278 279 306 352 372 392 396 431 481 531 581 631 1,215 1,591 2,224 2,724 Adjusted EBITDA 2,118 2,507 2,716 3,875 3,308 4,156 4,552 6,028 4,865 5,691 6,193 8,273 11,216 18,044 25,022 33,873 Other Income/(Expense) -1 0-27 -3 56 20 47-33 81 101 121 141-31 90 444 600 GAAP Pre-Tax Income 932 1,273 1,432 2,557 2,066 2,766 3,169 4,533 3,408 4,139 4,546 6,531 6,194 12,534 18,624 26,012 GAAP Taxes 420 554 536 995 328 711 790 965 344 704 773 1,110 2,505 2,794 2,931 4,422 Net Income 512 719 896 1,562 1,738 2,055 2,379 3,568 3,064 3,435 3,773 5,421 3,689 9,740 15,693 21,590 Non-GAAP Pre-Tax Income 1,839 2,228 2,383 3,520 2,992 3,784 4,203 5,564 4,465 5,261 5,733 7,783 9,970 16,543 23,242 31,749 Non-GAAP Taxes 650 791 755 1255 804 963 1035 1414 990 894 975 1323 3,451 4,216 4,182 5,397 Non-GAAP Net Income $1,189 $1,437 $1,628 $2,265 $2,188 $2,821 $3,168 $4,150 $3,475 $4,366 $4,758 $6,460 $6,519 $12,327 $19,059 $26,351 GAAP EPS $0.18 $0.25 $0.31 $0.54 $0.60 $0.71 $0.82 $1.21 $1.04 $1.16 $1.27 $1.81 $1.29 $3.35 $5.29 $7.11 Non-GAAP EPS $0.42 $0.50 $0.57 $0.79 $0.76 $0.97 $1.09 $1.41 $1.18 $1.48 $1.60 $2.16 $2.28 $4.23 $6.42 $8.68 Diluted Shares 2,836 2,850 2,863 2,878 2,888 2,905 2,915 2,938 2,944 2,959 2,974 2,989 2,857 2,912 2,967 3,035 Growth Rate Revenue (Y/Y) 42% 39% 41% 52% 52% 59% 56% 51% 49% 45% 43% 42% 44% 54% 44% 34% Organic Revenue, ex-fx (Y/Y) 49% 50% 50% 60% 58% 59% 56% 51% 50% 45% 43% 42% 53% 56% 44% 34% Revenue (Q/Q) -8% 14% 11% 30% -8% 20% 9% 26% -9% 16% 8% 25% -- -- -- -- Non-GAAP Operating Income (Y/Y) 30% 27% 32% 59% 60% 69% 72% 59% 49% 37% 35% 37% 39% 65% 39% 37% Adjusted EBITDA (Y/Y) 29% 27% 32% 57% 56% 66% 68% 56% 47% 37% 36% 37% 38% 61% 39% 35% GAAP EPS (Y/Y) -27% -17% 3% 118% 233% 180% 161% 124% 73% 64% 55% 49% 17% 159% 58% 34% Non-GAAP EPS (Y/Y) 18% 18% 31% 46% 81% 93% 91% 79% 56% 52% 47% 53% 29% 86% 52% 35% Margin Analysis Gross Margin 82.0% 84.0% 84.5% 86.3% 84.8% 86.2% 86.4% 88.5% 86.0% 87.2% 87.4% 89.5% 84.5% 86.7% 87.7% 88.2% GAAP Operating Margin 26.3% 31.5% 32.4% 43.8% 37.3% 42.7% 44.5% 51.8% 41.4% 43.4% 44.1% 51.2% 34.7% 45.0% 45.6% 47.5% Non-GAAP Operating Margin 51.9% 55.1% 53.5% 60.3% 54.6% 58.5% 59.3% 63.5% 54.6% 55.5% 56.0% 61.2% 55.8% 59.5% 57.2% 58.2% Adjusted EBITDA Margin 59.8% 62.0% 60.3% 66.3% 61.5% 64.6% 64.9% 68.4% 60.6% 61.2% 61.8% 66.3% 62.6% 65.3% 62.8% 63.3% Expenses as Pct. of Revenue Marketing & Sales 15.4% 13.4% 13.8% 11.7% 13.8% 12.5% 11.8% 11.6% 12.0% 12.0% 12.0% 11.8% 13.4% 12.3% 11.9% 11.6% Research & Development 13.5% 13.9% 14.7% 12.1% 14.1% 12.8% 12.7% 10.3% 14.5% 14.5% 14.3% 12.0% 13.4% 12.2% 13.7% 13.3% G&A 6.3% 6.1% 6.4% 5.3% 5.7% 5.4% 5.3% 5.1% 7.3% 7.3% 7.0% 6.0% 6.0% 5.4% 6.8% 6.5% Share-Based Compensation 20.5% 19.2% 17.1% 13.2% 13.9% 12.8% 12.0% 9.6% 10.8% 10.0% 9.9% 8.5% 17.0% 11.8% 9.7% 9.3% GAAP Tax Rate 45.1% 43.5% 37.4% 38.9% 15.9% 25.7% 24.9% 21.3% 10.1% 17.0% 17.0% 17.0% 40.4% 22.3% 15.7% 17.0% Non-GAAP Tax Rate 35.3% 35.5% 31.7% 35.7% 26.9% 25.4% 24.6% 25.4% 22.2% 17.0% 17.0% 17.0% 34.6% 25.5% 18.0% 17.0% Source: Company Reports, RBC Capital Markets estimates May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 11
Required disclosures Conflicts disclosures The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated by investment banking activities of the member companies of RBC Capital Markets and its affiliates. Please note that current conflicts disclosures may differ from those as of the publication date on, and as set forth in, this report. To access current conflicts disclosures, clients should refer to https://www.rbccm.com/gldisclosure/publicweb/ DisclosureLookup.aspx?entityId=1 or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. A member company of RBC Capital Markets or one of its affiliates received compensation for investment banking services from in the past 12 months. RBC Capital Markets, LLC makes a market in the securities of. RBC Capital Markets has provided with investment banking services in the past 12 months. RBC Capital Markets has provided with non-securities services in the past 12 months. Facebook's common shares consist of both a Class A and Class B issue. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Any transfer of shares of Class B common stock will generally result in those shares converting to Class A common stock. Explanation of RBC Capital Markets Equity rating system An analyst's 'sector' is the universe of companies for which the analyst provides research coverage. Accordingly, the rating assigned to a particular stock represents solely the analyst's view of how that stock will perform over the next 12 months relative to the analyst's sector average. Although RBC Capital Markets' ratings of Top Pick (TP)/Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis. Ratings Top Pick (TP): Represents analyst's best idea in the sector; expected to provide significant absolute total return over 12 months with a favorable risk-reward ratio. Outperform (O): Expected to materially outperform sector average over 12 months. Sector Perform (SP): Returns expected to be in line with sector average over 12 months. Underperform (U): Returns expected to be materially below sector average over 12 months. Risk Rating As of March 31, 2013, RBC Capital Markets suspends its Average and Above Average risk ratings. The Speculative risk rating reflects a security's lower level of financial or operating predictability, illiquid share trading volumes, high balance sheet leverage, or limited operating history that result in a higher expectation of financial and/or stock price volatility. May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 12
Distribution of ratings For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - Buy, Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick(TP)/ Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis (as described above). Distribution of ratings RBC Capital Markets, Equity Research As of 31-Mar-2017 Investment Banking Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [Top Pick & Outperform] 843 51.94 285 33.81 HOLD [Sector Perform] 679 41.84 149 21.94 SELL [Underperform] 101 6.22 8 7.92 References to a Recommended List in the recommendation history chart may include one or more recommended lists or model portfolios maintained by RBC Wealth Management or one of its affiliates. RBC Wealth Management recommended lists include the Guided Portfolio: Prime Income (RL 6), the Guided Portfolio: Dividend Growth (RL 8), and the Guided Portfolio: ADR (RL 10), and former lists called the Guided Portfolio: Large Cap (RL 7), the Guided Portfolio: Midcap 111 (RL 9), and the Guided Portfolio: Global Equity (U.S.) (RL 11). RBC Capital Markets recommended lists include the Strategy Focus List and the Fundamental Equity Weightings (FEW) portfolios. The abbreviation 'RL On' means the date a security was placed on a Recommended List. The abbreviation 'RL Off' means the date a security was removed from a Recommended List. Equity valuation and risks For valuation methods used to determine, and risks that may impede achievement of, price targets for covered companies, please see the most recent company-specific research report at https://www.rbcinsight.com or send a request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. Valuation May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 13
We value Facebook using a blended average of 26x P/E Multiple and 17x EV/EBITDA multiple on our 2018 estimates. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. For key context, we are estimating 41% EPS & 37% EBITDA CAGRs for FB through 2019, which we believe supports these premium multiples. Our $185 Target Price is also supported by a DCF, assuming a 12% WACC and a 3% Terminal Growth Rate. Our price target supports our Outperform rating. Risks to rating and price target Risks to our price target and rating include but are not limited to: 1) broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Valuation We value Facebook using a blended average of 26x P/E Multiple and 17x EV/EBITDA multiple on our 2018 estimates. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. For key context, we are estimating 41% EPS & 37% EBITDA CAGRs for FB through 2019, which we believe supports these premium multiples. Our $185 Target Price is also supported by a DCF, assuming a 12% WACC and a 3% Terminal Growth Rate. Our price target supports our Outperform rating. Risks to rating and price target Risks to our price target and rating include but are not limited to: 1) broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Conflicts policy RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. To access our current policy, clients should refer to https://www.rbccm.com/global/file-414164.pdf or send a request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time. Dissemination of research and short-term trade ideas RBC Capital Markets endeavors to make all reasonable efforts to provide research simultaneously to all eligible clients, having regard to local time zones in overseas jurisdictions. RBC Capital Markets' equity research is posted to our proprietary website to ensure eligible clients receive coverage initiations and changes in ratings, targets and opinions in a timely manner. Additional distribution may be done by the sales personnel via email, fax, or other electronic means, or regular mail. Clients may also receive our research via third party vendors. RBC Capital Markets also provides eligible clients with access to SPARC on the Firms proprietary INSIGHT website, via email and via third-party vendors. SPARC contains market color and commentary regarding subject companies on which the Firm currently provides equity research coverage. Research Analysts may, from time to time, include short-term trade ideas in research reports and / or in SPARC. A short-term trade idea offers a short-term view on how a security may trade, based on market and trading events, and the resulting trading opportunity that may be available. A short-term trade idea may differ from the price targets and recommendations in our published research reports reflecting the research analyst's views of the longer-term (one year) prospects of the subject company, as a result of the differing time horizons, methodologies and/or other factors. Thus, it is possible that a subject company's common equity that is considered a long-term 'Sector Perform' or even an 'Underperform' might present a short-term buying opportunity as a result of temporary selling pressure in the market; conversely, a subject company's common equity rated a long-term 'Outperform' could be considered susceptible to a short-term downward price correction. Short-term trade ideas are not ratings, nor are they part of any ratings system, and the firm generally does not intend, nor undertakes any obligation, to maintain or update short-term trade ideas. Short-term trade ideas may not be suitable for all investors and have not been tailored to individual investor circumstances and objectives, and investors should make their own independent decisions regarding any securities or strategies discussed herein. Please contact your investment advisor or institutional salesperson for more information regarding RBC Capital Markets' research. May 3, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 14
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