Facebook Falls Short
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
By Simon Osipov
Behind the face of Facebook
Although the company is not even ten years old, Facebook (NASDAQ: FB) is a household name. In fact, statistically speaking, you probably have a Facebook page open as you read this article. Facebook is the home to more than 750 million active users, 50% of who log on every single day. There are 900 million objects that people interact with, be it pages, groups, or events. People spend over 700 billion minutes per month on Facebook, outperforming all of Facebook’s rivals up to 20x.
The numbers don’t look so hot, though, for Facebook’s profitability. During first quarter of 2012, Facebook had its first quarterly revenue decline of over 6% to $1.06 Billion. The fall was largely pulled down by the decrease in advertisement revenues of over 7%. Looking at the same pre-IPO stage for Google (NASDAQ: GOOG), however, the company had revenue growth of over 35%.
In March 2012, Facebook reported that 54% of monthly active users were mobile users. But Facebook is not monetizing on them because of the lack of physical space on the application platform. A partial solution for this was the hastily executed acquisition of Instagram, which only builds a potential for ad revenue in the future. Facebook does not need more users – it has plenty. It needs a higher concentration of monetized users.
For a company that makes its money from ads, Facebook’s future is uncertain. It has gone the distance to extend space for advertisements, but there is little real estate left. Recent premium ad offerings, which allow for sound and video capability, were a one time revenue boost that couldn’t even put the first quarter earnings growth into positive territory. Moreover, Facebook’s transition into its new platform called “timeline” was not welcomed by users, to say the least. Even worse, timeline offers less ad space and fewer clicks per page, which may hurt Facebook’s top line. Facebook’s new users are also primarily coming from developing countries, which are difficult to monetize since most big brands focus ad campaigns on first world countries.
At a $100 billion valuation, Facebook is pricing itself at 108x its earnings in the last 12 months. Putting this into perspective, the average multiple for the overall market is 14x and for Google it was 18x. Revenue multiples are extreme as well. Facebook’s valuation yields an 18.6x revenue multiple for 2012 forecasted revenues of $5.4 billion. Typical valuations for Google, Yahoo!, LinkedIn, and Yelp were 5-10x. Using a 9x multiple, which many investors agree is a lot more fair and accurate, the intrinsic price of Facebook should be $24, 50% lower than the IPO price of $38. Although the share price may rise in the short term due to media attention, many analysts agree that the long-term fair value price is around $25 per share.
It is not uncommon for a growing company like Facebook to price itself at enormous valuations because these prices are expected to encompass future earnings. Facebook’s business model, though, is not clear-cut, even when compared to other tech giants like Google. Facebook prides itself on its hundreds of millions of users, however Professor Aswath Damodaran of New York University, says “It’s like a Chinese company that says it’s worth a lot because there are a billion people in China.” Facebook’s plan to reach into its unpaid customers’ pockets is not completely clear. “Facebook has a great product,” Damodaran says, “but it is not a great company yet.”
First Public Day
Facebook’s first day of trading on the NASDAQ was not a smooth or successful ride. At 11 AM, the lead underwriter of the IPO, Morgan Stanley, requested a delay in trading. Such an event is very unusual and confused traders even more when they were first informed the trading price was $42 per share but trades could not go through. Facebook opened at $42.05 but many trades haulted because of confusion. Morgan Stanley did not, thankfully, let Facebook end the day below the asking price, which would have made it a “busted IPO.” MS did have to buy shares to keep the stock from falling into negative territory for the day. The stock closed only 23 cents about its $38 IPO as more than 570 million shares changed hands on Friday. $800 million resulted in proceeds, although many blame Morgan Stanley for not setting the price lower than $35, which was a more comfortable price point for institutional investors.
Some prominent investors, such as Warren Buffet, are not investing in Facebook. The future of the business is just not clear enough. Even if Facebook is a great company with great management and potential, advertising revenue may not even be a significant source of revenues 5 years from now. The next milestone for Facebook will be its quarterly earnings report during the summer. Until then, investors will be watching the share price closely, hoping to make gains off the social networking giant. For more information on this topic and others, visit WealthLift to connect with a vibrant community of investors and finance enthusiasts.
This article is written by Simon Osipov and edited by Jake Mann. They don't own shares in any of the companies mentioned above. The Motley Fool owns shares of Google. Motley Fool newsletter services recommend 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.