Wall St. Speaks Out on FB, Google, Twitter & Yahoo - Pivotal Research

Last week we updated our models and price targets for companies we cover related to internet advertising and digital marketing services Price target changes were primarily a function of changes to costs of capital embedded in our models which we have incorporated across our coverage universe In our valuation framework lower longterm costs of capital driven at this time by falling yields on longterm treasury bonds disproportionately impact companies whose stock prices are disproportionately dependent upon their terminal values Each of Facebook Google Twitter and Salesforcecom remain as Buyrated We continue to rate Yahoo Hold although we note that a majority of its value is dependent upon the value of AlibabaFacebook remains our favorite name in the sector Our YE2015 price target is 105 up from 103 previously Facebook can point to a wide range of factors which will sustain growth through 2015 and beyond as increasing share of spending from small businesses and large brands alike as well as ongoing improvement in focus on performancebased marketers Instagram is proving to be a successful enterprise in its own right and WhatsApp continues to gain traction among consumers around the world although monetization is likely to be modest relative to its user base for an extended period of time Efforts to establish an extended ad network buttressed by LiveRail Atlas and additional acquisitions or internal investments will also provide meaningful growth in the futureThere are other illustrations of the company39s potential to continue growing rapidly in the longrun while Facebook has not captured meaningful budgets that would otherwise have gone to traditional television network owners so far efforts to incorporate mediabrandadjacent video content as illustrated via recent agreements with the NFL and ABC News will help towards these ends over time The establishment of a portal for video content akin to YouTube may also help Facebook given the success that Google has had in monetizing that property with some marginal TVfocused advertising budgets Perhaps the most important factor impacting Facebook39s topline in the nearterm will relate to the degree to which app install ads might remain as a significant contributor to growth Although we have heard much about the notion that many of the earlier app developers might be pursuing uneconomical strategies ie paying to promote installations of apps that get downloaded but rarely used and that therefore the boom in app install ads might face some limits it seems increasingly likely to us that there is more growth to come from this segment of advertisers especially as large brands increasingly develop and promote apps of their ownAcross the whole business our model incorporates revenue growth estimates of 493 for 4Q14 and 443 for FY2015 We presume margin compression during 2015 as management has indicated the year would be one for significant investment but we also expect an eventual resumption of 2014 level margins after 2016 before descending again in subsequent years Our valuation on Facebook on a YE2015 basis is now 309bn or 105share We continue to rate Facebook BUY At Google which we recently upgraded to Buy from Hold many of the negative considerations we have been focused on in recent years have become more widely held among the investment community These include compressing margins investment of capital away from the company39s core competencies and weak government relations among other issues While these concerns are real we believe they are morethan incorporated into the company39s valuation at its current levels More importantly the company isn39t going anywhere along with Facebook Google will maintain a hegemonic position in digital advertising We continue to expect significant cash generation from the company despite its ongoing capital expenditures in and around its core business and few of the threats facing Google are likely to have a meaningful impact We think that currencies will weigh on Google39s topline growth disproportionately in this quarter and for the year ahead with around a 4 headwind on topline revenue growth by our estimates for 4Q14 although Facebook has similar international exposure a several percentage point headwind on total revenues will be more pronounced for Google In total we estimate reported gross revenue growth of 158 during 4Q14At the same time we slightly diminish the longterm mix of revenue we expect Google to generate from third parties such as Mozilla This serves to highlight a key wildcard in Google39s revenue exTAC and line items further down the income statement we believe that the company39s efforts to cull network partners mostly due to partner site quality issues in recent years provides Google with significant flexibility in terms of capturing incremental revenue exTAC in any given period our guess is that a loss of inventory supply has only a limited impact on total demand for Google39s paid search product meaning that if demand remains stable fewer network partners means more revenue operating income and cashflow for Google all else equal Our valuation on Google on a YE2015 basis is 425bn including 79bn in cash or 610share down slightly from 620 previously We continue to rate Google BUYTwitter is another company we recently upgraded to BUY from HOLD Our price target on Twitter is rising both because of the cost of capital changes described above disproportionately impactful on a company like Twitter which will not produce cashflow for many years into the future and also because we think there is a growing basis for positivity around the company39s ability to monetize its platformTwitter is evidently pursuing a more aggressive effort to monetize consumers who visit Twitter properties but do not log in As well Twitter is beginning to monetize its feeds which run on other media properties Further we are mindful of efforts to expand the company39s advertiser base which include enabling targeting by mobile carrier helpful for capturing revenue from carriers and device makers alike given Twitter39s heavy consumption skew on mobile devices As well the launch of Tailored Audiences for mobile apps which should help to monetize spending on app installations from brands and performance marketers alike is illustrative of these efforts too Perhaps most importantly commentary we hear from the advertising community remains overwhelmingly positive as Twitter39s ad sales force continues to perform well deepening relationships with the industry and helping brands find new ways to use the ad products that Twitter has on offerGiven these successes the focus that many investors and the press have placed on the leadership at Twitter seems unnecessary It is clear that Twitter has underperformed on certain key metrics related to user trends at least relative to expectations it caused most of Wall Street to hold And of course there has been turnover in the senior ranks However we think the problem has been that Twitter generally operates like a very large late stage venture funded company rather than a more mature public one This means that we shouldn39t be surprised if the company pursues what might be aspirational goals investors need to decide for themselves how realistic those aspirations are and a quotfail fastquot mentality which produces turnover in the executive ranks For Twitter39s position in the advertising industry this is mostly well and good so long as the company is delivering with its paying customers advertisers We believe it is As Twitter is maintaining its traction we think it is appropriate to increase our revenue estimates on the company for this year and next Following a more than doubling of size this year our estimates previously incorporated a very conservative 20 growth rate in 2016 and beyond or a level slightly above the digital advertising industry39s growth rate from this year39s plateau However we have increasing confidence in the company39s ability to outperform this level by finding new segments of marketers who will find Twitter to be an impactful supplier of advertising inventory and thus our model incorporates slightly higher growth in 2015 and much higher growth in 2016 up to around 40For 4Q14 we forecast revenues of 476mm equal to 961 growth which compares with guidance for between 440450mm Our revenue figure is based upon a multiplier we apply to two quarters39 prior sales and marketing expense as this is the line item and the lag we think most appropriately can be used to drive ad revenue expectations We think that traction in the fourth quarter has accelerated incrementally leading us to use an incrementally higher multiplier vs the multiplier derived for 3Q14 Our valuation on the company39s equity is now 36bn which we apply against 710mm shares on a YE2015 basis to derive our new 50 price target vs 42 previously Half of the increase is due to upwardly revised revenue estimates and half of the increase is due to the aforementioned changes to our cost of capital estimates We continue to rate Twitter BUY Meanwhile Yahoo39s value seemingly couldn39t be more removed from its core business if it tried and the subjectivity associated with valuing its components remains challenging given the range of possible paths forward Alibaba and Yahoo Japan shares are by themselves worth 49 per share if no taxes were ever paid on the disposition of those assets But taxes payable on a straightforward sale amp8211 if one occurred amp8211 could amount to around 40 or nearly 20 per share This is of course behind Yahoo management39s stated intentions to find a tax efficient approach towards realizing value from its ownership of these assets However on the two prior instances during which shares were sold full taxes were paid and specific plans regarding management39s preferred tax strategy has not been forthcoming so far This has led us to incorporate the highly conservative assumption that full taxes would be paid on future dispositions as well Whether because of er quotpromptingquot by the activist investor Starboard or because management had planned to do something around this point in time following the Alibaba IPO all along we expect management will state their intentions around monetizing the Alibaba shares by the time of the 4Q14 earnings call later this month Still despite Starboard39s conveyance of concern regarding reports that Yahoo was considering a cashrich splitoff as a strategy we think something of this nature is probably still on the table as far as Yahoo management is concerned Tax leakage a suboptimal valuation on the Asian assets transaction completion issues and the high potential of further obfuscation of Yahoo39s core business are among the risks associated with a cashrich split But that doesn39t mean it isn39t the preferred strategy for the company39s management It is also possible that Yahoo would decide that a preferred tax minimization strategy is unfeasible at this time for some reason in which case perhaps a small percentage of the company39s holdings in these assets might be sold with full taxes paid in order to raise cash for further buybacks acquisitions or bothOf course anything other than an approach which the investment community broadly accepts as optimal could very well lead to a proxy fight that Starboard would have a good chance of winning And if this were the case a scenario involving a trade of Yahoo39s core operating business to another entity such as AOL seems highly likely and mutually beneficial producing significant value over an extended time frame In short we think there are plausible scenarios where Yahoo will pay a 40 tax rate and there are plausible scenarios where Yahoo will pay next to nothing Taking these and other scenarios into account we think assuming the midrange of this tax rate most appropriately accounts for the range of likely outcomes vs our prior assumption we drive our price target for all of Yahoo up to 54 on a YE2015 basis vs 47 previouslyAlmost as an aside there is positive activity at the core business worth noting Acquisitions of BrightRoll and Flurry last year could generate an incremental 150200mm in net display exTAC revenue and 400500mm in incremental gross revenue during 2015 although at a lower net profit margin than Yahoo39s legacy business As well November39s agreement with Mozilla should several hundred million dollars of gross search revenue and probably some incremental net revenue too although we note that Yahoo39s incremental gains in search query volumes will probably not be matched by growth in revenues as most advertisers will continue to concentrate their search budgets with Google None of these factors will have a meaningful impact on 4Q14 results but we would expect them to be incorporated into 2015 guidance if it is provided during the upcoming earnings call Of course core display revenue is likely still declining and search growth may have otherwise decelerated as prior improvements would otherwise be lapped Still on balance we see these actions as well as the recent hiring of a wellrespected head of ad sales for the Americas as favorable for Yahoo if the business continues to evolve under its current operating and management structure As a subset of the aforementioned 54 valuation for all of Yahoo we continue to value core Yahoo including its operations and cash on its balance sheet as worth 15bn at YE2015 or around 16 per share Our rating on Yahoo remains HOLDLastly we are altering our price target on Salesforcecom to 80 vs our prior 74 figure We are leaving our operating expectations unchanged on Salesforcecom at this time but are instead incorporating new coverage universewide costs of capital which disproportionately increases our valuation of Salesforcecom given the degree to which its valuation is dependent upon the cashflow it can produce beyond our model39s terminal yearWe are mindful that the competitive landscape in marketing technology has come to increasingly favor Oracle and Adobe in recent quarters especially given the recent acquisitions those companies have made While acquisitions are not the beall and endall organic growth is still most important Oracle and Adobe have made more progress in shaping the marketing cloud offerings which we think will be core longterm drivers of CMOdriven technology budgetsWhile we also recognize that most purchases of marketing technologies are bought as point solutions at the same time the market seems to be clearly moving in a direction which favors suites we think this reflects what marketers want too This concern was amplified by last month39s acquisition of Datalogix by Oracle which we expect will be a powerful combination alongside Oracle39s other recent buys at least so long as those assets and key personnel are appropriately integrated Still it is early days for this sector and Salesforcecom should continue to grow at a much more rapid clip than the rest of our coverage universe for an extended time frame as the marketing automation and marketing technology industry continues to offer significant opportunity Further Salesforcecom retains a strong presence in this space given its dominance of middlemarket CRM solutions and from this base the company retains a solid overall positionIn terms of valuation primary among our assumptions is the notion that the company can produce 10bn in gross profit by our terminal year the company39s fiscal 2020 more than double what Salesforcecom should see during fiscal 2016 This should translate into cashflow of around 28bn in 2020 also around double 2016 levels with stillrapid growth ahead from that point on From these figures our valuation on Salesforcecom is 52bn on a fiscal YE2016 basis or 80 per share We continue to rate Salesforcecom BUYREPORT INCLUDING DISCLOSURES CAN BE FOUND HERE Madison and Wall 11615pdfBrian Wieser is a Senior Analyst at Pivotal Research Group where he covers securities which are impacted by the advertising economy including Facebook Google Yahoo Interpublic Omnicom WPP Publicis Nielsen CBS Viacom and Discovery Communications Brian can be reached at brianpvtlcom amp160Read all Brian39s MediaBizBloggers commentaries at Brian Wieser39s Pivotal ReportCheck us out on Facebook at MediaBizBloggerscomFollow our Twitter updates MediaBizBloggerThe opinions and points of view expressed in this commentary are exclusively the views of the author and do not necessarily represent the views of MediaBizBloggerscom management or associated bloggers MediaBizBloggers is an open thought leadership platform and readers may share their comments and opinions in response to all commentaries

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Wall St. Speaks Out on FB, Google, Twitter & Yahoo - Pivotal Research

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