How Facebook "Beat" 2016 Earnings On A $1 Billion Tax Benefit From Accounting Change

Yesterday evening we noted that Facebook's stock soared in after-hours trading after the company announced inline revenue results for 4Q 2016 but blew away street EPS estimates of $1.34 with an actual EPS of $1.44.  But, like with most tech company earnings, a slightly deeper dive into the results reveals that a conveniently timed accounting change created $214 million of extra net income in 4Q and drove about 73% of the earnings "beat" for the quarter.

On an annual basis, the earnings farce is even more drastic.  For the full year of 2016, the tax accounting changes added $934 million in net income to Facebook's P&L, or roughly $0.32 per share.

So what changed?  Well, turns out that the Financial Accounting Standards Board suddenly figures that tech companies should be allowed to run the "excess tax benefits" derived from stock option exercises through their P&L.  Here's how it works per the The Wall Street Journal:

The Financial Accounting Standards Board, which sets U.S. accounting rules, approved the change in an attempt to simplify companies’ accounting for employee stock payments. The accounting is changing in several different ways, but most of the effect on earnings has to do with the tax benefits that companies get when their employees exercise the stock options they’ve been granted.

 

That is a compensation cost to the company, and it is tax-deductible. When options are exercised, it is typically after the company’s stock price has risen, making them more valuable, and so the company recognizes “excess tax benefits”—the deductions over and above those it expected to realize when the options were first granted.

 

Under the old rules, those excess tax benefits go into the company’s shareholder equity. But under the FASB change, they will be recognized on the income statement immediately—and that reduces the company’s provision for taxes, boosting net income.

As an added bonus, the FASB change also boosts Facebook’s operating cash flow, because the excess tax benefits are now classified as cash flow from operations instead of from financing.  Even though total cash flow is not impacted at all, we're sure this is positive in some way.

Just so we're all on the same page, here is how the process works:

  1. Employee is issued stock options
  2. Stock soars (because what else would a tech stock do?)
  3. Employee feels stock is fully valued and exercises options
  4. Bubbly stock price creates "excess tax benefits" upon option exercise and drives earnings "beat"
  5. Earnings "beat" drives stock even higher
  6. Process is repeated quarterly in perpetuity

In summary, bubbly stock price necessarily equals even bubblier stock price.

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For those who missed it, here's our summary of Facebook earnings from yesterday.

So much for worries about tech companies rolling over.

After yesterday's AAPL beat which nonetheless resulted in one of the biggest intraday jumps in its stock in history, sending it highest over 6% today, moments ago Facebook reported results which crushed expectations, and have sent the company higher as much as 3%. The street was expecting $8.81 billion in revenue and EPS of $1.34. Instead it got revenue of $8.81 billion, a 51% increase from 2015 - 84% of which came from mobile - and EPS of $1.44, a 78% increase.

It achieved this with Daily Average Users of 1.23billion, above the 1.21billion expected, up 18% Y/Y, while Monthly active users soared to 1.86 billion, also above the 1.84 billion expected, and up 17% from a year ago. This means that as of this moment more than a quarter of the world's population logs in to Facebook at least once a month.

Putting Facebook's results and unprecedented user growth in context, in one year, Facebook added some 269 million monthly active users, roughly all of Twitter's user base, in just the past year.

Here are the details reported by Facebook.

  • Daily active users (DAUs) – DAUs were 1.23 billion on average for December 2016, an increase of 18% year-over-year.
  • Mobile DAUs – Mobile DAUs were 1.15 billion on average for December 2016, an increase of 23% year-over-year.
  • Monthly active users (MAUs) – MAUs were 1.86 billion as of December 31, 2016, an increase of 17% year-over-year.
  • Mobile MAUs – Mobile MAUs were 1.74 billion as of December 31, 2016, an increase of 21% year-over-year.

Finally, the biggest factor was Mobile monthly users, which soared to 1.74 billion as of Dec. 31, an increase of 21% Y/Y.  Also, if there was any concern about ad revenue slowing down, that too can be ignored for now: Mobile advertising revenue represented approximately 84% of advertising revenue for the second quarter of 2016, up from approximately 80%  in Q4 2015.

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All the record breaking detail in charts (source):

DAUs:

 

Mobile DAUs:

 

MAUs:

 

Mobile Monthly Active Users

Revenue by geography

 

ARPU

 

EPS: GAAP and non-GAAP

 

Income statement reconciliation:

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The stock, predictably, is soaring into new all time high territory, up almost 3% in the after hours session, to new records.

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