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Facebook Earnings: Expect a Bullish Revenue Decline

Updated from 11:28 a.m. ET with year-over-year comps and Wednesday share prices

NEW YORK (TheStreet) - Facebook (FB - Get Report) is expected to post a quarter-over-quarter drop in total advertising revenue as the growth rate of the company's costs per impressions (CPM's) decline. If slowing engagement and declining ad revenue sound worrying, bullish Facebook analysts seem to have found a way to rationalize it.

Facebook, according to multiple Wall Street analysts, may be in the process of a long-term change to its advertising business that could undermine first quarter results but provide a long-term benefit. Those expectations mean Facebook investors are likely to take quarter-over-quarter ad revenue declines as high as 10% and similarly large CPM declines with a grain of salt.

Since 2013, Facebook has been limiting its advertising load as it tries to show users it is the best online destination for online advertising budgets. That may damper first-quarter earnings results, while setting the stage for long-term revenue gains.

"We see Facebook's strategy to limit ad load (which management began emphasizing in 2Q13) to be a wise move in terms of user experience and believe that rising CPMs can continue to drive upside to consensus forecasts," Goldman Sachs analyst Heath Terry said in an earnings preview.

"Our field work continues to indicate a discernible shift in the way advertisers view the Facebook platform as the burden of proof has been removed and as more and more advertisers start to leverage their vast network," Terry added.

Uptake of Facebook news feed ads will drive CPM's up 88% this quarter versus last, while mobile CPM's may rise 200%, Goldman calculates.

Overall, the firm estimates Facebook will report first-quarter revenue of $2.34 billion and non-GAAP earnings per share of 23 cents. Consensus, according to Bloomberg data, is that Facebook will earn 24 cents in non-GAAP EPS this quarter.

Goldman forecasts total ad revenue of $2.11 billion, a 10% drop from the fourth quarter of 2013, as mobile ad revenue drops to $1.14 billion. The firm, however, said field checks highlight stronger mobile CPM trends then their estimates, suggesting some possible upside in the first and second quarters.

Year-over-year figures still point to strong growth at Facebook. Revenue is still expected to rise 70% from the first quarter of 2013. In the second-quarter, Goldman forecasts a sequential rise in ad revenue to $2.25 billion, indicating a 42% year-over-year rise. Goldman rates Facebook a "buy" with a $78 price target.

Pacific Crest analysts believe Facebook has entered a period of declining ad impressions, softer engagement and greater spending. While those forecasts sound unequivocally negative, Pacific Crest believes Facebook is solidifying its long-term position in the online ad market.

"Facebook's opportunity to use its consumer data to sell ads on other apps and sites diminishes the importance of users spending less time of Facebook. Instead, Facebook, barring any consumer backlash, becomes tied to the activity of its user base across the Web, which continues to grow," analysts at the firm said.

They continue to hold a "sector perform" rating on Facebook and recommend Google (GOOG), LinkedIn (LNKD), and Yelp (YELP) instead.

Expect High Volatility

Options traders are expecting higher-than-usual volatility on Facebook's earnings release, according to Goldman Sachs. Those expectations come even as Facebook already has proven one of the most volatile stocks on its earnings, surging in recent quarters on strong mobile user and revenue growth trends.

Goldman Sachs options strategist John Marshall estimates that Facebook options imply a 15% move higher or lower on the day of its earnings release. That represents a greater than average move.

"There has been an increase in the number of put contracts trading on an absolute basis and relative to calls. While this is not surprising given the decline in Facebook shares over the past month, it suggests that investors are not yet positioning for a rapid rebound in the company's shares," Goldman Sachs said.

Changing Wall Street Models

Credit Suisse, in previewing Facebook's earnings, said it is considering changes to how it forecasts the company's advertising revenue.

"Facebook is on the cusp of a multiyear value creation cycle with the release of new products, including Premium Video, Graph Search, as well as Instagram advertising - we believe that these ad units can be layered on top of existing desktop and mobile ad formats without posing material risk to consumer engagement," Credit Suisse said.

"[As] we explicitly layer in the impact from Premium Video, Graph Search, and others, we begin to diverge more meaningfully from consensus estimates," they added. Credit Suisse believes Facebook will be able to drive revenue growth without lifting ad loads and that long-term estimates are too conservative.

While Credit Suisse's new model indicates a full-year revenue estimate of $11.2 billlion, 1.9% lower than consensus, its 2019 revenue estimate of $44 billion in revenue is 17% higher than consensus. Similarly, Credit Suisse's full-year EPS forecast of $1.17 a share is 7.1% below consensus. Nevertheless, a estimate of $6.82 in 2019 EPS is 21.5% higher than consensus.

Credit Suisse recently upgraded its price target for Facebook to $87 a share from $65 a share.

Facebook shares were falling nearly 2% in Wednesday afternoon trading to $61.90. Shares have gained over 13% year to date.

Bottom Line: Expect greater than average volatility in Facebook's earnings release as bullish investors and analysts try to rationalize declining revenue.

-- Written by Antoine Gara in New York.

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