Facebook Worth The Wait?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
How I wish that Facebook (NASDAQ: FB) went public 2 - 3 years ago. An IPO in March 2010 would have been compelling. Investors would have been looking at a company with about 431 million monthly active users and roughly $1 billion in revenue. However, that's not how things worked out. While Facebook still has some growth left in its tank, the numbers just aren't as favorable as they once were. Today, Facebook has somewhere around 901 million monthly active users, and generated about $3.7 billion in revenue last year. There are multiple pieces to the Facebook story so let's take them one by one.
Monthly Active Users:
Just to clarify, the 901 million people on Facebook are not necessarily on the site even once a day. In fact according to Facebook's S-1 statement, as of December 2011 about 42% of total users actually used Facebook on a near daily basis. As of January, Twitter had about 462 million registered users, with about 28% of these users being active users. Compare this to the around 100 million total users of Google (NASDAQ: GOOG) Plus service, and you can see that Facebook clearly dominates in both total number and active users. According to the company, they estimate there are about 2 billion global Internet users. This means the company has effectively penetrated 45% of the market. With greater penetration comes slower growth, look at the difference in monthly active user growth over the last several quarters:
You can see the downward slope. Clearly Facebook is unlikely to see the huge user growth that they did in the last several years. Trying to extrapolate this out, the company would near its targeted market of 2 billion in about 2 years. When a company could potentially saturate its market in just two years, you have to be cautious as an investor.
Facebook makes two seemingly contrary statements in its S-1. The first is, “mobile usage is critical to maintaining user growth and engagement over the long term”. The second is, “we do not generate any meaningful revenue through Facebook mobile products.” With an estimated 425 million people accessing their Facebook account through a mobile device, this is a big deal. There are two huge differences between Facebook on mobile versus on a traditional PC or Mac. First, the usability is much worse on mobile because of limitations in the application. Just as an example, on the iTunes store, the Facebook iPhone and iPad app gets a rating of 2 out of 5 stars, mostly due to technical issues. While technical issues are fixable, a bigger problem is, on mobile there is much less screen real estate for the type of advertising that Facebook specializes in. Advertising on mobile is inherently more invasive than on a traditional computer screen. This cuts down on Facebook's value proposition to advertisers.
Facebook primarily makes its money through advertising, 83% of their total revenue at the end of 2011 to be exact. The company believes that it offers a “unique combination of reach, relevance, social context, and engagement to enhance the value of sponsors ads”. However, according to a recent AP poll this might not be the case. USA Today reported that, 57% of Facebook users say they never click on ads, and another 26% say they “hardly ever” do.This same poll found that about 4% click on ads on a regular basis, and that is only slightly better than traditional banner ads at a 2-3% rate. The market for online advertising is expected to grow from $68 billion in 2010 to $120 billion in 2015. When you look at analysts expectations of 20% revenue growth for Google, you know that by 2015 Google could take half of this market. That leaves about $60 billion for Facebook and others to fight over. With 30% growth in revenues, by 2015 Facebook would generate about $11 billion in revenue. For Facebook to reach this goal they would need to take nearly 20% of the remaining market for online advertisements. Considering they only took about 3% of the market in 2010, that is a lot to ask the company to achieve in the next few years.
Most analysts cite the potential for payments as Facebook's future growth driver. It is true that in the last year payments jumped from 13% of revenue to 17% of revenue. Since Facebook says, “substantially all of our payment transactions are for social games for virtual goods”. The obvious question is, can the company move beyond virtual goods? Facebook users don't seem to think so. The same AP poll found that 54% of users said they wouldn't feel safe using the platform for financial transactions like purchasing goods & services. In addition, only 8% said they would feel “very safe” using Facebook for purchases. Customers have already clearly chosen Amazon.com (NASDAQ: AMZN) for online sales with its over $46 billion in revenue last year, and to a lesser extent eBay (NASDAQ: EBAY) with its over $11 billion in revenue. These are two formidable competitors for online payments and I don't see Facebook changing that any time soon.
Valuation & Competition:
Last but not least, Facebook faces two challenges, one of their own making and one that is naturally occurring. The first issue is the stock's valuation. With the stock at $31.75, it currently trades at over 60 times 2012 full year estimates. Even looking at year 2013 estimates, the company trades at over 50 times projected earnings. This valuation represents a clear premium to the company's expected growth rate. Keep in mind we aren't talking about a company that has 5% or 10% of its market, we are talking about a company already engaging 45% of its market. In most industries, when a company begins to get close to 50% penetration, investors usually worry that the fast growth for the company is over. I don't see a reason to believe that Facebook is any different.
When it comes to competition, there are the known and unknown competitors. Facebook says its primary competitors are Twitter, Microsoft, and Google. However, what about newcomers like Pinterest and tumblr.? These two sites have a different way of engaging users. Both sites revolve around a more free form way of sharing information. According to a recent study, 32% of online shoppers have made a purchase based on what they've seen on Pinterest and other image sharing sites. If I'm spending advertising dollars, I want to hear 32% of people buying something they saw rather than 4% clicking on banner ads.
The biggest problem I have with Facebook as an investment is, the company is much larger than it was just a few years ago. As I said before, if this were 2010 I would be all over the stock. The fact that the company is so much larger, makes it just another tech stock to me. Facebook is a great site to interact with friends and family. Facebook is a great place to go if you like online games. The fact that 901 million people already use the site, tells me that Facebook is probably not a great investment anymore.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Facebook, and Google. Motley Fool newsletter services recommend Amazon.com, eBay, and Google. 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.