Romney, Obama Elect Winner in Social Media

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Since its historic initial public offering on May 18, 2012, the story of Facebook (NASDAQ: FB) has been far less than perfect. In its six-month history as a public company, Facebook managed to hold onto its elevated $38 IPO price for a single trading session before embarking on a seemingly endless decline in market value. On September 4, shares reached an all-time low of $17.55, representing a 54% decline in share price and a stunning $50 billion in lost market capitalization. I consider the Facebook IPO to be an outright tragedy on multiple levels, and the botched offering served to further erode retail investor confidence and trust in the stock market. All parties involved should have been held to a certain degree of responsibility, including Facebook management, Morgan Stanley as the lead underwriter and its unapologetic CEO, as well as the sell-side analyst community, which initially supported the ridiculously high valuation only to come down to Earth by lowering their price targets in the months to come.

As of this writing in early December, Facebook shares have recovered to the $28.00 level based on Wall Street’s perception of improving fundamentals, and the supply/demand balance seems to be finding equilibrium. Consider the following insightful SWOT analysis dedicated to Facebook if you are appraising an investment in the social media giant.

Strengths

1)   Pessimism surrounding Facebook seems to be decreasing. The company reported Third Quarter 2012 results on Oct. 23 and the stock reacted favorably, rising nearly 20 percent from $19.50 to $23.23 during the following trading session. Investors had been concerned regarding the monetization of mobile going into the quarter, and Facebook delivered, reporting that 14 percent of Q3 revenue is attributable to mobile. Facebook grew to $153 million in mobile ad revenue during the third quarter, compared to only $20 million during the second quarter. Overall, earnings came in ahead of expectations, with adjusted EPS at $0.12 vs. consensus $0.11 and revenue of $1.26 billion vs. consensus $1.23 billion. The positive earnings release caused multiple upgrades from the sell-side analyst community.

2)   The majority of lock-up expirations are behind us. A lock-up occurs when early-stage investors are prohibited from selling their ownership interest before a specified date. 271 million shares owned by investors became eligible for sale on Aug. 16, increasing the amount of shares eligible to be traded by 60 percent. Subsequent lock-ups have occurred on Oct. 31 and Nov. 14, with 234 million and 773 million shares available for sale respectively. At present, only two minor lock-up expirations remain, with 156 million shares coming unlocked on Dec. 14 and 47 million shares on May 18, 2013. These future lockups represent no more than a 10 percent increase in the current float (shares outstanding) of 2.2 billion.

3)   Sheryl Sandberg, the Chief Operating Officer of Facebook, understands the performance demands of Wall Street and remains focused on monetization and revenue growth. Sandberg is gaining the appreciation of investors as a Google (NASDAQ: GOOG) alumnus, previously serving as Vice President of Global Online Sales and Operations at Google. Investors are hopeful that Facebook will be able to experience a similar growth rate to Google in mobile advertising. Google's mobile ad revenue represented approximately 6.2% of the company's $42 billion in revenue during 2011, however mobile advertising grew to 9.3% of Google's $47 billion in revenue during 2012. Analysts forecast that mobile advertising will represent 25% of Google's revenue within the next four years.

Weaknesses

1)   Facebook's current valuation versus other technology companies such as Google, Microsoft (NASDAQ: MSFT), and Yahoo! (NASDAQ: YHOO) is extreme. While Facebook’s forward-looking price/earnings to growth ratio appears reasonable, the company has only earned several hundred million dollars in total as a public company, yet its market capitalization is north of $60 billion. Past profitability will need to dramatically improve in order to maintain the current valuation going forward.

<table> <tbody> <tr> <td> </td> <td><strong>Facebook</strong></td> <td><strong>Amazon</strong></td> <td><strong>LinkedIn</strong></td> <td><strong>Google</strong></td> <td><strong>Microsoft</strong></td> <td><strong>Yahoo!</strong></td> </tr> <tr> <td><strong><span>Price/Earnings</span></strong><span> (TTM)</span></td> <td>260.27x</td> <td>3368.75x</td> <td>703.08x</td> <td>21.88x</td> <td>14.38x</td> <td>5.69x</td> </tr> <tr> <td><strong><span>Price/Sales</span></strong><span> (TTM)</span></td> <td>13.09x</td> <td>1.99x</td> <td>13.89x</td> <td>4.83x</td> <td>3.10x</td> <td>4.47x</td> </tr> <tr> <td><strong><span>PEG Ratio</span></strong><span> (TTM)</span></td> <td>9.76x</td> <td>98.72x</td> <td>9.69x</td> <td>1.39x</td> <td>1.46x</td> <td>0.49x</td> </tr> </tbody> </table>


Trailing twelve month. Data provided by Thomson Reuters.


2)   Staying power among marketers: On May 15, 2012 word broke out that General Motors, with iconic brands such as Buick, Cadillac, Chevrolet, and GMC, would cease advertising on Facebook because the company didn’t find a significant return on investment. Since this time, competitor Google has capitalized on Facebook’s relative weakness, launching advertising campaigns for their own AdWords product with lines such as “Google Ads Just Work.”

3)   Unresolved securities arbitration claims related to the challenged IPO offering in May: While Morgan Stanley and NASDAQ would likely be responsible for paying any damages, Facebook could receive bad publicity as the result of any form of negative verdict. A New Jersey man is seeking $1.9 million in damages, and the outcome of his case could set a precedent for others.

Opportunities

1)   Romney, Obama campaign spending should help drive Facebook’s earnings results for the fourth quarter. Facebook operates on a calendar year basis, and spending activity from both parties during the Oct. 1 – Nov. 4 period will be reflected in upcoming earnings results. How significant could Governor Romney’s former peak of 12 million likes be for Facebook’s bottom line? Only time will tell, but I expect political ad spending to move the needle and push Facebook’s results past consensus estimates. On a personal note, even after I chose to like Governor Romney’s official Facebook page, I was still presented with a Sponsored Story featuring one of several personal friends who decided to endorse the page as well. This became a daily occurrence, being greeted by Governor Romney as I opened the Facebook application on my iPhone 5 during October and early November.

2)   Investors seem to be overlooking the fact that Facebook is all but guaranteed to join the S&P 500 index in coming months. This will cause at least 20 percent of the outstanding float to be purchased by index funds, causing a definite rise in share price. Standard & Poor’s states in their index methodology that “initial public offerings should be seasoned for 6 to 12 months before being considered for addition to an index.”

3)   Facebook is no longer restricted to develop original gaming content for its platform beginning on March 31, 2013. Currently, Facebook has a developer agreement in place with Zynga (NASDAQ: ZNGA), the social game creator of perennial favorites such as Farmville and Mafia Wars. On Nov. 28, 2012 in a Form 8-K filing with the Securities and Exchange Commission, Zynga provided to investors that its agreement with Facebook has been amended and that it will be subject to Facebook’s standard terms of service beginning on March 31. This development is a huge positive for Facebook and neutral at best for Zynga, which basically lost its preferential status with its long-time supporter. While Zynga does have strong name recognition among Facebook users, I would not expect its user base to maintain loyalty if its former partner is able to develop better content.

4)   Facebook is making a quiet entrance into the job search market. A joint initiative between Facebook and the US Department of Labor was announced last fall, however the idea took time to develop and only recently went live on Facebook’s website. The jobs application has more than 1.7 million job listings, including a segment of which already listed on Monster and LinkedIn (NYSE: LNKD). The sell-side analyst community does not view Facebook as a concern for LinkedIn, stating LNKD has “distinct advantages” over FB and FB will not be a legitimate competitor.

Threats

1)   Founder and CEO Mark Zuckerberg previously stated he would not run Facebook in strict accordance with the needs and wants of Wall Street. However, the addition of Google alumnus Sheryl Sandberg to Facebook’s management team should serve to moderate Zuckerberg’s comments going forward.

2)   Emergence of Twitter as a competing platform: While Twitter remains a privately held company, it has made significant strides in the past year with revenue growth and monetization through its Promoted Accounts, Tweets, and Trends offerings. Twitter enjoys a who’s who list of companies among its marketers, including American Express, Delta Airlines, Porsche, Samsung, Volkswagen as well as both Presidential candidates during the recent election. Even Microsoft has advertised on Twitter.

3)   Despite its significant revenue growth, Facebook may be unable to sustain consistent profitability. Consider the case of Amazon (NASDAQ: AMZN), which has annual sales revenue upward of $50 billion and yields an operating profit margin of 0.93 percent and net profit margin of a meager 0.28 percent. Founder and CEO Jeff Bezos continues to earn a free pass among investors, even though his company is barely profitable. Shares of Amazon trade at 100 times their price-to-earnings growth rate. Why does Amazon earn the free pass? The company ships physical goods to millions of customers worldwide, and Bezos is making an argument for continuing to build Amazon’s impressive infrastructure in order to achieve further efficiencies and economies of scale. Unfortunately, Facebook does share the same luxury as Amazon, as the company is fully reliant on its massive user base and advertisers in order to sustain its revenue growth and profit potential. It is likely that Wall Street will not offer Zuckerberg the same free pass as Bezos, and therefore Facebook’s share price could suffer as the result of any hiccup.

4)   The Yahoo! Bing Network advertising coalition seems to be gaining traction among both large and small businesses as an alternative to Google's AdWords product. According to data from comScore, Microsoft and Yahoo! share a combined 28.7% of the US search market, with a total of 152 million unique searchers in the USA. ComScore also states 45.3 million unique searchers on the Yahoo! Bing Network specifically do not use Google. Finally, comScore provides that searchers on Yahoo! Bing Network spend 7.4% more than Google searchers. How does this relate to Facebook? Without any hard data, I suspect that Facebook users, including millions of teenagers and college students, are much closer to the Google demographic in that they have less buying power than Microsoft searchers. Ultimately, the continued success of the Yahoo! Bing coalition could lure hard earned advertising dollars away from Facebook and towards Microsoft.

Personally, I believe Facebook shares could rise following its fourth quarter and full year 2012 results, which will be released in late January. I suspect the company will exceed analyst expectations, in part due to the enormous campaign spending by Governor Romney and President Obama I alluded to earlier. Having said that, as a long-term investor I remain cautious on Facebook based on the company’s current valuation and its unproven ability to sustain profitable growth. I would much rather be invested in Yahoo!, which is gaining traction under new CEO Marissa Mayer. LinkedIn is my preferred stock within the social media sector, as I feel its career-minded user base will allow the company to develop a long-term competitive advantage. These are topics for future articles.

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johnmacris has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Facebook, LinkedIn, and Microsoft and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Amazon.com, Facebook, LinkedIn, Microsoft, and Yahoo!. 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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