At Decisive we invest in companies with a combination of great management and growth potential. Facebook (FB) with 901 million monthly active users and 3.2 billion likes and comments per day fits both these criteria. FB has plenty of revenue growth potential, it earns only $5 per user compared to Google’s (GOOG) $30 average revenue per user. However, in our opinion the most exciting element is not advertising but in the ability to make applications (apps) and the internet more tailored and personalised.
There are more than seven million apps and websites integrated with FB as of December 31st 2011. FB can improve the user experience by making everything more personal and social, as every product or experience seems to be better off with friends. Apps and the internet assume a general one size fits all approach is best for users, given the amount of information on the internet this is not very helpful. Personalised webpages and apps would save much time and effort and would be very valuable to all internet users, app developers and companies.
FB has big plans to personalise the internet. In late May FB quietly announced on their blog a partnership with Bing to bring more social features to search. This partnership makes sense as we typically get input from friends in making decisions. The search engine combines FB friend likes over the web to provide personalised search results for users. This personalisation also extends to company internet sites. FB disclosed an example in their S1 registration statement. A FB user can visit Pandora (free internet radio) and with input from FB listen to personalised music from bands users have liked on FB.
A further example is FBs own app centre. The centre recommends apps based on user interests and apps they and their friends have liked. It will send users to other stores such as Apple’s to download apps and will enable users to “like” iTunes music, TVs and movies. This centre is designed to grow the use of FB mobile apps and gives developers the optionality to monetise through in-app purchases or paid apps. This should offset mobile advertising concerns and showcases the potential FB has to monetise mobile, check out http://www.facebook.com/appcenter.
FB has the further opportunity to personalise not only the internet but products like the iPhone as well. FB will be integrated into Apples new operating system with a single sign in across all FB enabled apps. It also extends to FB birthdays, events and phone numbers which will appear in the phones calendar and contacts. There are no excuses if you forget a friend’s birthday now!
FBs CEO Mark Zuckerberg is young but comes with great credentials. The late Steve Jobs admired Zuckerburg the most in the Valley for not selling out and wanting to create a lasting company, a pretty good reference in our opinion. Mark seems more interested in building great products, focusing on the user experience rather than just making money. These are characteristics which not enough CEO’s seem to show these days.
During the FB roadshow, we were impressed by comments made by the CFO. He commentated about how happy they were internally with their margins as they are in the heavy investment stage of their business, building the foundations for long term success. At 20%+ profit margins would like to see what the margins would be after the heavy investment stage is over!
A FB article cannot go by without a comment on the debacle that was the IPO. The only good thing about the process was it got Europe out of the headlines for a week! The table below compares FB to GOOG at the time of their respective filings.
Facebook
|
Google
| |
Amount Raised
|
$16 billion
|
$1.6 billion
|
Market capitalisation @ IPO price
|
$104 billion
|
$23 billion
|
% of insider selling
|
57%
|
30%
|
Year founded to listing
|
2004-2012, 8 years
|
1998-2004, 6 years
|
Profit prior year to IPO
|
$1 billion
|
$105.6 million
|
What stands out is the size of FB vs GOOG at time of IPO, but also the amount of insider selling which is nearly double that of GOOG. What is more interesting is prior to filing, FB quarterly EPS declined year on year while GOOG was still doubling. (Note GOOG is 6 months ended vs FB 3 months ended, see table below.) Suffice to say the FB metrics are not as favourable. While FB has tremendous growth opportunities and at the right price will provide a good return for investors, its unlikely to see a similar six-fold return in three years like GOOG. It was amazing re-reading GOOG S1 registration statement in 2003, their largest customer was America Online (remember them) they accounted for approximately 16% of revenues!
| FB |
GOOG
| ||||||
In millions
|
Three Months ended March 31
|
Six months ended June 30
| |||||
2011
|
2012
|
% pcp
|
2003
|
2004
|
% pcp
| ||
Revenues
|
731
|
1,058
|
44.7%
|
560
|
1,352
|
141.5%
| |
Net income (loss)
|
233
|
205
|
-12.0%
|
58
|
143
|
146.7%
| |
Net income (loss) per share:
| |||||||
Basic
|
0.12
|
0.10
|
-16.7%
|
0.44
|
0.93
|
111.4%
| |
Diluted
|
0.11
|
0.09
|
-18.2%
|
0.23
|
0.54
|
134.8%
| |
Source: S1 registration documents
One thing that has always struck me about GOOG is that users are searching for some product or interest, therefore any advertising was relevant and useful rather than intrusive. While FB has the benefits of more accurate audience targeting, there is the question of effectiveness. FB users are there to interact with friends and not search for a particular product or interest. This is further compounded by the increasing use of mobile. FB does not generate any meaningful revenue from use of mobile and was a major factor in year on year earnings declining. This is an issue but with FB integrating social features into apps this could change. Offering users more personalised experiences and products should in our opinion increase the future effectiveness of FB advertising.
FB advertising revenues are nowhere near GOOG $30 average revenue per user (ARPU). FB $5 ARPU has plenty of upside optionality as FB has not syndicated its ads across other websites. This would be similar to GOOGs Adsense network. Adsense enables partner websites to deliver GOOG ads relevant to their websites content. As of 31 December 2011 this drove advertising traffic to GOOG and was 28.4% of their revenue as of 31 December 2011.
Assuming in a couple of years FB can close half the $30 gap to $15 revenue per user, assuming 1 billion users and assuming a conservative GOOG Market Capitalisation/ 12 month forward revenue multiple of 4.5x would equal a $67.5 billion market cap or $25 per share (using approx share count of 2,700 including options). FB may have burned a lot of investors, but potential investors should not make the mistake of ignoring the optionality FB has to monetise its large user base. As the stock tumbles, a price below $25 should get a few a more likes by investors.
Disclosure: Decisive has no position in FB
The material in this article is for informational purposes only and in no way constitutes a solicitation of business or investment advice. The material has been prepared without regard to any client's or other person's investment objectives. Before making an investment decision you should consider the assistance of a financial adviser and whether any investment or service is appropriate in light of your particular investment needs.
