Facebook Stock Is Destined to Rise!

Adrian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When I first wrote this article on Nov. 27., (or report I may say), Facebook (NASDAQ: FB) stock was trading around $26.26. I still believe there is more room to go, therefore, I want you to read it and get some of my perspective on the fundamentals of the company and why I think it will rise.

OVERVIEW

As a new publicly traded company, Facebook has limited financial data to be able to measure the progress over a long period of time. However, I believe that with the current information available and the trends we are seeing on the industry I can analyze the performance of the company and get an idea of where the stock will go.

Management has indicated three core segments they are focusing on. One “is to build the best and most ubiquitous mobile product” as said by Mark Zuckerberg during the last conference call on October 23. Second is to build a platform that enables the apps to be more social. Last but not least, the monetization issue, where management has given every department within the company the ability and responsibility to be in charge of monetization within their own product lines.

Let’s not forget the fact that Facebook is the leading (by far) social platform in the whole world. This allows the company to be well positioned to monetize this platform in a short period of time. Mobile for example, is barely taking off as far as monetization. During the last conference call, management acknowledged that 3Q12 was the first time ever the company made any revenue on mobile and it did it nicely. Representing a 14% of the overall revenue for the quarter. Should this continue, it will -in my opinion- become the principal source of revenue for the company within the next few quarters.

EARNINGS REVIEW.

Revenue has consistently been increasing over the last 9 quarters (showed by the company on the slides presentation of 3Q12) from 467 million on 3Q10 to 1,262 million on the most recent quarter. This represents an average of about 13% increase (compounded) sequentially, but has decreased to an average of about 3.5% during the last 4 quarters.

When comparing with the same quarter from last year, this has increased by 306 million or 32% y/y. Also, during 3Q12 we saw revenue from mobile that was not present during same period last year. Mobile revenue was about 152 million for the quarter. Without this revenue the company would still be up from last year but a more moderate rate (about 16%). When calculating the growth (on a y/y basis) without the revenue that mobile brought during the quarter and breaking it down in to the two segments the company uses to measure performance, we still have a nice growth rate. Revenue from advertising, which is the main source of income so far, increased 17% year-over-year and revenue from payments and other fees (gaming for example) also increased double digits, 13% year-over-year.

Having said that, the company not only continues to grow on its core business but found a new way to generate revenue. Mobile, is becoming more and more important for every company out there and in my opinion, Facebook is well positioned to take advantage of that by being the creators of their own products and not depending on others to come up with the solution.

Also, there will be a change in the way they recognize revenue from payments as stated by the company on the slides presentation of 3Q12. During the past, the company has recognized payment revenue one month after it actually happens. This was because they have a 30 day period for claims and disputes; it is just common sense they waited those 30 days to recognize true and already earned money. Starting this coming quarter, the company will start recognizing payments revenue as it happens, therefore making 4Q12 a 4-month quarter. This will be possible because now the company has enough information to estimate future refunds and charge backs.

COSTS AND EXPENSES REVIEW.

Here the company has a challenge. Although during 3Q12 they managed to spend less than the revenue, expenses did not go up in accordance with revenue. In other words, revenue increased 32% y/y for the quarter but costs and expenses went up almost twice as much, 63% compared to same period last year.

It is true, that most of the increase in spending has a lot to do with the RSU’s (Restricted Stock Units) that were part of the compensation plan prior to the IPO and are barely being recognized during this fiscal year. However, the head count increased considerably this year making the company more vulnerable to payroll-related expenses such as medical, taxes and other.

This is an area worth keeping a close eye during the coming quarters in order to better understand management and their approach to spending.

SOME METRICS.

Monthly Active Users (MAU’s) 

Unlike revenue, MAU’s have been increasing at a more moderate, but steady, pace during the past 9 quarters as presented on the last earnings release. From 550 million MAU’s on 3Q10 to a 1,007 million MAU’s on 3Q12, averaging 50 million more MAU’s per quarter.

One important fact that I think will affect very positively the monetization of the company, is that mobile MAU’s were 604 million during the last quarter. If we take in consideration that before this quarter none of the revenue was coming from mobile users then we can be sure that this numbers will impact considerably well the following quarters, as the company continues to roll out more mobile products and implement better strategies to monetize mobile users.

Average Revenue per User (ARPU)

Revenue per user has been above the $1.00 mark (per quarter) since the 4th quarter of 2010, and averaging about $1.29 during the last 4 quarters. The 4Q of the last two years have seen the highest ARPU of the year, so we can easily expect to have a stronger 4th Quarter this year. On top of that, if we add the mobile strategy that it's taking place right now I am confident they can surpass or at least hit the $1.40 per user. You may think it is way above the $1.29 average of the last 4 quarters, but it’s only $0.02 above the $1.38 reported during the same quarter last year.

BALANCE SHEET.

Here is a brief explanation and analysis on the balance sheet of the company. Overall I think it is well positioned to grow over the short term by being well capitalized and having little debt on the books allowing management to focus on the business and not on debt management.

Shares Outstanding.

2,166,427,308 shares are outstanding and more than half (1.3B approx.) are floating. I don’t think this is very good to have as many shares as they do. However, if this is used correctly, shareholders can benefit from it, if the company makes good and smart acquisition via shares instead of cash. I will continue to monitor the shares outstanding for signs of further dilution (which will hurt the bottom line) or any improvements such as buybacks or reverse splits.

Book Value.

The book value per share as of the most recent quarter (3Q12) is $6.53 which in my opinion is healthy for a company of recent IPO. This value, gives us a current P/B of 4.02 not bad if we consider the 4.66 that the industry has on average.

Price to Earnings. 

Based on the current stock price, the P/E is 135.93 which I consider to be pretty high. However, the earnings per share during the last few quarters have been affected by the recognition of the stock-compensation prior to 2011 that until the IPO had not been recognized in the books. Once the company finishes recognizing the previous stock-based compensation and return to normal practices the P/E should get to a better level.

Debt to Cash.

Here is something I believe to be very positive. Having a ratio of 0.75 on the total debt-to-cash on hand is quite good for any company. Even if the company does not generate any more free cash in the short term they are still able to pay off the entire debt just with the cash they have on hand as of the last quarter.

Debt to Equity.

Also a positive sign, with a ratio of 0.13 when considering the entire debt to the equity the company currently holds. As long as no more debt is incurred by the company, or if it will take more debt to do it in a responsible way and in proportion to the equity this should be a great sign of the health and gives more confidence to investors.

COMPARISON

<table> <tbody> <tr> <td><strong>Ticker</strong></td> <td><strong>Cash per Share</strong></td> <td><strong>Book Value</strong></td> <td><strong>P/B</strong></td> <td><strong>P/E</strong></td> <td><strong>Debt/Cash</strong></td> <td><strong>Debt/Equity</strong></td> </tr> <tr> <td>FB</td> <td>$1.14</td> <td>$6.53</td> <td>4.02</td> <td>135.80</td> <td>0.75</td> <td>0.13</td> </tr> <tr> <td>GRPN</td> <td>$1.83</td> <td>$1.22</td> <td>3.84</td> <td>N/A</td> <td>1.02</td> <td>1.54</td> </tr> <tr> <td>ZNGA</td> <td>$1.69</td> <td>$2.38</td> <td>1.07</td> <td>N/A</td> <td>1.78</td> <td>0.41</td> </tr> <tr> <td>LNKD</td> <td>$6.30</td> <td>$7.74</td> <td>14.17</td> <td>720.90</td> <td>1.48</td> <td>0.48</td> </tr> </tbody> </table>

As you can see in the chart above, the closest competitors (if we can call them that, because every company has a different business model) are valued different by the investor community.

Groupon (NASDAQ: GRPN) for example is valued similar to Facebook, on a price-to-book ratio, even though Groupon have substantially more debt. Liabilities at this enterprise are a dangerous 1 1/2 times its own equity and let’s not forget they are not reporting any earnings (at least recently).

LinkedIn (NYSE: LNKD) on the other hand is reporting earnings, $0.16 in the twelve trailing months and $0.02 as of the most recent quarter. Although debt-to-cash is not favorable compared to Facebook is not as bad as Groupon. Debt-to-Equity is also manageable and good overall.  

In my opinion, if we take all this in consideration and the fact that companies without growth potential in the short term (like Groupon or Zynga) are valued similar to Facebook, and that LinkedIn, even with its very low EPS it is enjoying a higher P/E multiple, I really think that once the mobile monetization story starts to have a higher impact on the bottom line, Facebook stock will soar.

4Q12 ESTIMATE.

After the analysis of the data I have available and which I have mentioned above. Here are my conclusions and estimates for the coming quarter.

REVENUE.

To be able to give my estimate as far as revenue for 4Q12 I used several pieces of information; Monthly active users (MAU’s), average revenue per user (ARPU), revenue recognition (extra month on payments) and trends on such items.

Monthly Active Users.

As I mentioned before, the MAU’s have been increasing constantly during the past two years at a similar pace of 50 million users per quarter. Since it does not show sign of deceleration on the most recent quarters, I will assume Facebook will have at least 1,060 million MAU's during the quarter.

Average Revenue Per User.

Here, I will be a little more conservative. We know that during the last quarter of the year is when the company has a higher ARPU than the rest of the year. $1.40 per user is quite conservative, based on the fact that during the 4Q11 was $1.38 and even though there was no revenue coming from mobile.

There were 432 million mobile users during 4Q11 and based on the last report of 604 million mobile users during 3Q12 I can assume that we will see at least 625 million mobile users. This, and the mobile monetization that started during the last quarter makes me confident that the $1.40 ARPU mark can be reached on 4Q12.

Payment Revenue Recognition.

On the slides presentation for 3Q12 an explanation was given to investors that this quarter will see an extra month of payment revenue. I think it will be safe to take the average of 62 million (based on the last 12 months of payment revenue the company has reported) and add it to the revenue as part of the extra month of payment revenue to be recognized. I have not given any increase (growth) on this figure due to the uncertainty of the outcome because the decrease on payments from Zynga the company reported during last quarter.

Revenue

<table> <tbody> <tr> <td><em>Concept</em></td> <td><em>Amount $</em></td> <td><em>Comment</em></td> </tr> <tr> <td><strong>MAU's</strong></td> <td>1,060 M</td> <td> </td> </tr> <tr> <td><strong>ARPU</strong></td> <td>$1.40</td> <td> </td> </tr> <tr> <td>Revenue</td> <td><strong>$1,484 M</strong></td> <td>Before Extra Month of Payments</td> </tr> <tr> <td>Pmt Revenue</td> <td>$62 M</td> <td>Extra month expected to be recognized</td> </tr> <tr> <td><strong>Total Revenue</strong></td> <td><em>$1,546 M</em></td> <td>Estimated</td> </tr> </tbody> </table>

Note: The $1,546 million in revenue I’m estimating is just based on the numbers we currently have and considering nothing more than the ability of the company to maintain its performance but not adding any revenue or estimates from new products such as mobile monetization other than the 2 cents I've explained above. If the numbers are kept and mobile revenue becomes reassuring, then it can easily beat my estimate by at least 200 million.

COSTS AND EXPENSES.

The method I used to calculate the following figures are only based calculating the average from the numbers reported by the company during the last few quarters (except where noted) that I was able to obtain publicly. Also, it has been given to us the estimate of share-based compensation that the company expects to incur during this quarter ($190 million) which I will add to the end of my estimates.

Cost and Expenses Estimates

<table> <tbody> <tr> <td><em>Cost of Revenue</em></td> <td>$386 M</td> <td> </td> </tr> <tr> <td><em>Marketing & Sales</em></td> <td>$170 M</td> <td> </td> </tr> <tr> <td>Research & Development</td> <td>$139 M</td> <td> </td> </tr> <tr> <td><em>General & Administrative</em></td> <td>$124 M</td> <td> </td> </tr> <tr> <td>Share-Based Compensation</td> <td>$190 M</td> <td>As Expected per Management.</td> </tr> <tr> <td><strong>Total Costs & Expenses</strong></td> <td><strong>$1,009 M</strong></td> <td> </td> </tr> <tr> <td><em>Operating Income</em></td> <td>$537 M</td> <td> </td> </tr> <tr> <td>Interest Income/(Expense)</td> <td>($4) M</td> <td> </td> </tr> <tr> <td>Income Tax</td> <td>$220 M</td> <td>41% Tax Rate Estimated</td> </tr> <tr> <td><strong><em>Net Income</em></strong></td> <td><strong>$313 M</strong></td> <td> </td> </tr> <tr> <td>EPS</td> <td>$0.14</td> <td>Per Share.</td> </tr> </tbody> </table>

In my opinion, there are a lot of opportunities for Facebook to keep generating money and add new forms of revenue in the short term. For example, they can start generating revenue through advertising in Instagram (the newly acquired company that is attracting more and more users every month) or by referring to people to sites where they buy products or service and charging a fee or percentage of the sale, the Amazon way.

Just based on the numbers we have and without a new source of revenue I can easily see Facebook generating $6,616 million in revenue during 2013 and earnings per share (EPS) of $0.61. Increasing its book value to $7.20

 

Updates will be made after each earnings release unless I consider adequate to do it before.

If you like my work and want to receive updates or new posts about other companies I follow please follow me here at The Motley Fool.

You can also visit my personal blog at http://adriangomezinvestments.blogspot.com


adriano22 has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Facebook, and LinkedIn and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Amazon.com, Facebook, and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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