Facebook: Is This the Beginning of the End? – Part 2

By Umang Patodia - August 2, 2012 | Tickers: BBRY, FB, GOOG, MSFT | 0 Comments

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From $38 (initial offering) to $31.60 (part 1 of the article) to $21 (this week)!!!!! The shares fell from $26.85 to $23.71 (a drop of around 11%) in just one day after the release of the Q2 statement by Facebook (NASDAQ: FB). But is this just the effect of the statement?

Revenue in Q2 did rise by around 32%, touching the $1 billion mark for the first time ever. This might be a good sign for investors after the much hyped $100 billion IPO, but still it is not a convincing one. The main reason for this is that they reported a net loss of around $157 million, creating fear in the market. This wound will take at least some time to heal.

If we analyze the quarterly release statement, we will see much of the loss is reported primarily because of RSUs (restricted stock units). Unlike stock options, restricted stock units give employees shares, plain and simple—there's no strike price, no need to front cash to exercise the options. (There are some less-favorable tax implications, but those are too complex to get into here.)

Here are two things that Mark Zuckerberg played very smart, learning from the mistakes of his arch rival Google (NASDAQ: GOOG) :

1. From his point of view: He announced his salary to be $1, and thus he becomes eligible for only capital gains taxes, which will be enforced when he sells any of his 28.2% share in the company (if he does, which I doubt!)
2. From the employees' point of view: Since 2007, he has given his employees RSUs, which means they will be paying double the tax. This is because in the income tax calculation of RSUs when its cycle ends, the tax is based on a zero value instead of the higher exercise price. For example, if we have to pay taxes on stock options, we pay the difference between the price issued and the price of redemption. But when we are paying taxes on RSUs, then we are paying the tax at the rate of selling price, not the difference.

These are pure and simple strategies that have helped Mark Zuckerberg retain profit in his pocket, signs of how he is planning for the future (in case it’s a disastrous one). In the current quarter, the company did release $1.3 billion towards the RSUs, causing this entire show of falling share prices. It will take at least few quarters to recover.

It is still far ahead of its competitors, however, like Google and Microsoft (NASDAQ: MSFT). Google+, which is trying its best to make marks in the social media world, is having difficulty attracting users. Most of its users currently are people who are getting hooked up from their Gmail account, but when we see the figures of daily active users, they are alarming. On the other hand, Microsoft, even with its acquisition of Yammer, has not shown any signs of creating an impact on its rivals.

The problem for Facebook is not its market share in the social networking world. The main problem is generating more revenue from this model. Now with the fast changing technological world, people have moved to smartphones and other portable devices for most of their Facebook activities. But they have not yet been able to find ways of generating income from such devices. Once they are able to find a way to generate revenue from mobile applications they might be able to attract advertiser to invest in their model.

The other source of income that Facebook is looking to create is a pay user model. Here, if you want your post to be published on all your friends' walls and not just 12% (as happens now) then you would be asked to pay a fee of around $1.  

Also, with the recent announcement of the development of its own smartphone hardware, it has shown investors that it might be expanding into other sectors rather than just relying on the networking media. The ability to produce hardware combined with the connectivity of Facebook in the social media could provide much needed synergy.

You have to be a patient investor in Facebook, having not just a bird’s eye view on its activities but an eye to watch all the things in detail. Many questions linger, like: What if the Facebook fatigue happens just like with Orkut?? What if someone comes up with better social networking media?? Will they be able to generate revenues from mobile technology?? If they shift to a pay user model, will they be able to maintain the same database??

If you are a mid-term investor then you can look forward to buying shares and holding then for some time frame, such as 9-12 months, with a target price of $33-$35. One possibile reason for it lagging behind its IPO price of $38 is that it still has to prove to its investors that it is a $100 billion company.

For now, we can wait and watch the show from the backseat. Looking at its growth model, at least some improvement is expected in the next few months.

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