Is Facebook a Buy?
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After the market laughed off its IPO price of $38 per share, Facebook (NASDAQ: FB) hit $20 in early August and has generally traded between $17 and $23 ever since. Short interest is still fairly high but is now down to 17% of the shares outstanding; daily volume has cooled as well. It seems safe to say that the stock has settled, with much of the hype that has pushed Facebook in either direction taking a backseat to news at other tech companies. Read our news reports on Facebook.
Facebook’s second quarter showed a company making a considerable transition. Revenue was 32% higher than in the second quarter of 2011 and 12% higher than in the previous quarter, but the more interesting change was in the company’s expenses. From Q1 to Q2, Facebook increased R&D investments from $153 million to $705 million; marketing expenses from $143 million to $392 million; and general and administrative costs from $104 million to $463 million. As a result, Facebook turned a $381 million operating profit into a $743 million operating loss as a result of its spending. Our estimate is that about $1 billion of the increased costs reflected share-based compensation, which will not be recurring, but even stripping that out there was a substantial increase in these operating costs.
Per analyst estimates, Facebook trades at a forward P/E of 31. This assumes 62 cents per share of earnings in 2013, which in turn is based on revenue numbers coming in 28% higher than 2012’s. We think that in order to reach that point the company will have to find better ways to generate revenue, as its user growth should start to slow (and the new users it does start to reach should be less attractive to advertisers than current users).
Billionaire Chase Coleman’s Tiger Global Management was one of the hedge funds that got into Facebook in the second quarter of 2012 despite the decline in its share price. Tiger Global owned 2 million shares at the end of June; it was the largest new stock position in the fund’s 13F portfolio (find more stocks Tiger Global owned). Tiger Consumer Management, managed by fellow Tiger Cub Patrick McCormack, also bought shares and owned 1.6 million at the end of the second quarter (see more stock picks from Tiger Consumer Management).
Fellow recent Internet IPOs Groupon (NASDAQ: GRPN) and Zynga (NASDAQ: ZNGA) are down 80% and 75% respectively from their IPO prices late last year, making Facebook look like a strong performer by comparison. Both of these companies are currently unprofitable (Facebook only had negative earnings last quarter due to its share-based compensation), though Wall Street expects both to be in the black next year, and puts Groupon in particular at a reasonable forward P/E of 14. We don’t like Zynga -- we’ve considered in the past that it might only be valuable as an acquisition target -- and despite strong revenue growth in its most recent quarter versus a year ago, we still think that there are serious problems with Groupon’s business model.
We can also compare Facebook to LinkedIn (NYSE: LNKD) and to Google (NASDAQ: GOOG), whose Google Plus social networking offering has been underwhelming but is nonetheless a peer in the sense that it draws its revenue from monetizing its traffic through ads. LinkedIn’s revenue growth has been very strong, but it still trades at 90 times forward earnings estimates (and a five-year PEG ratio of 3.4), as the market is considerably more optimistic on the company than the sell-side. We don’t think it is a good value either. Google, despite reporting disappointing earnings, is a better value. If we annualize its lates quarterly EPS of $9, we get a forward PE of 18. This is mostly based on its earnings from the search business. Google is investing heavily in several other businesses and has tremendous growth potential. We think a PE of 18 is a bargain.
We will keep an eye on Facebook's operating expenses in its next earnings report. If they continue to rise, then we would have to see continued revenue growth or a very attractive paid product offering to justify the current valuation, let alone a higher one.
InsiderMonkey has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook, Google, and LinkedIn and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Facebook, Google, 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.If you have questions about this post or the Fool’s blog network, click here for information.