Analyst: Instagram Video Ads Will Benefit Facebook Top-Line

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The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

Facebook (NASDAQ:FB) will report Q2:13 (ending June) results after market close on Wednesday, July 24, and host a conference call at 2pm PT (dial-in: 866-554-3009, conf. ID: 99420501, webcast: http://investor.fb.com/results.cfm).

We expect Q2 results slightly above consensus. Our current estimates are for revenue of $1.62 billion and EPS of $0.15, compared to consensus of $1.62 billion and $0.14, respectively. Facebook did not provide guidance. We expect top-line growth to be driven by mobile ads (up to roughly $374 million in Q1:13 from just over $300 million in Q4:12 and $0 in Q2:12) and payments (up 12% in Q1) as Facebook diversifies its developer base beyond Zynga (NASDAQ:ZNGA). EPS growth will be driven by the top-line strength and operating expense growth that lags full-year guidance.

We do not expect Facebook to adjust limited FY:13 guidance. Management expects FY non-GAAP opex to increase by ≈ 50 percent. Actual Q1 expenses were $895 million (up 56 percent), implying to us that expenses will rise more modestly, and implying y-o-y growth of 44%. We do not expect expenses to rise as high as Facebook projects, allowing it to regularly exceed EPS expectations.

Facebook recently introduced Video on Instagram, which allows users to record 15-second videos and apply 13 filters to adjust the appearance of the content. We expect Facebook to attach interstitial video ads in coming quarters to improve the app’s monetization without alienating a large percentage of viewers. We believe many Internet and mobile device users have become accustomed to seeing ads before, during, or after accessing video content.

We expect the streamlined ad products portfolio to benefit long-term top-line growth. On June 6, Facebook announced it would lower the number of ad units offered by over 50 percent. Among the key changes will be a more consistent look for ads and the automatic addition of social context to ads, eliminating the need to also purchase sponsored stories. A streamlined ad portfolio should increase advertising effectiveness, positively impacting prices through increased demand. The automatic addition of social context should appeal to its core small and mediumsized business customers, many of which leverage its targeting tools.

Maintaining our OUTPERFORM rating and our price target of $35. Our price target reflects a value of $60 per MAU at Facebook’s peak MAU level with a conservative monetization assumption of $1 per MAU per month for five years.

Michael Pachter is an analyst at Wedbush Securities. 

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