As a reminder, in May of last year we valued Facebook (FB) at $23/sh. The stock has certainly gone on a wild ride. After an IPO pricing of $38, the stock closed flat at on the first day of trading on 5/18. From there, it went down to $25 and slightly recovered to around $32, but it was downhill after that, as the stock hit an all-time low of $17.55 on 9/4. We were pretty much satisfied with our call given the stock's disappointing performance (disappointing to the ones that marketed it so much). However, unfortunately, even after it went 24% below our valuation, we did not begin pumping it, as the stock has jumped 72% since and closed at $30.10 on Tuesday.
The latest driver of such an upturn was the much-hyped announcement that FB's CEO, Mark Zuckerberg, was scheduled to make on Tuesday. Well, he did, and although the announcement was one of another innovation, it did not provide more color on whether or not the Company has taken steps to increase revenue growth and margin expansion in the short and medium term. Mr. Zuckerberg basically described how FB will continue to invade every user's privacy by allowing 'friends' (as defined by FB) to conduct "graph search" on each other using various dimensions as filters, such as pictures, locations, likes, comments, promotions, and so forth. The search allows FB users to feel like data analysts as they analyze each of their friend's 'movements' within the FB world using tables, charts, and pictures. We think this will certainly help create millions, if not billions, of active FB investigators!
But let's put aside the jokes for a second. This 'unique' idea is very similar to what Google (GOOG) has been trying to do with its Google+ social network. If successful, FB's new service will not only benefit advertisers by helping them target FB users more effectively, therefore possibly increasing returns on their ads, it may also create problems for other social networking service providers such as LinkedIn (LNKD), Yelp (YELP) and even online dating sites, as many others have already reported. This basically takes the 'word of mouth' concept to another level. Of course, we believe that if FB users want to get the same benefits from FB as they do from LNKD, then they better start thinking twice before posting 'non-professional' pictures and comments. And if they do that, then we, and they, may ask "what's the fun in that?" We must also say that such service will certainly up the probabilities of stalking on FB, which is the last thing FB users want to see. The stock declined after the announcement and closed down 2.7%.
The next event that could move the stock is the Company's Q4 earnings announcement, scheduled for Jan. 30, after the close. And this reminds us of a question that we kept asking on Tuesday: why make an announcement about a product that is not yet fully released a couple of weeks before the FY '12 year-end earnings announcement? There are many 'glass is half full' and 'glass is half empty' answers to this question.
Regarding Q4 earnings, we expect total revenues of $1.49bil, up 31.5% Y/Y and 17.7% q/q. The Street is expecting total revenues of $1.52bil. Such growth, we believe, is driven by the seasonal increase (Christmas, etc.) of the number of ads placed, in addition to a bit less tension surrounding macro dilemmas and the question of economic recovery. Regionally, we continue to believe that while the number of users in Asia and other regions will grow faster than those in North America and Europe, ARPU's of those will remain low, therefore the North American region will continue to represent the biggest chunk of revenues. Faster adoption of FB services in the North American region will help grow that region's top-line. In addition, we think North America payments & other fees revenues will surprise to the upside as FB's Gifts and other programs will likely help offset most of the declining revenues from Zynga.
Stock based compensation will represent a big chunk of the Company's operating expenses, likely around $190MM or 18% of opex. We expect GAAP net loss of $63MM or $0.03 per share. Excluding stock based compensation and tax adjustments, we project non-GAAP net income of $368MM or $0.14 per share, a penny below the Street's estimate.
As everyone knows, FB management's comments on mobile revenues are what many will focus on. On the Q3 call, management was very optimistic about mobile revenues. However, while growth in mobile ad revenues could be impressive, we would like to get more color on whether or not such growth is coming at the expense of desktop ad revenues; and if so, can it continue to expand and/or be maintained, or will such cannibalization of desktop revenues prove too costly for the Company?
While generating revenues from mobile ads may satisfy some on the Street, we question whether it can continue. We agree that more and more users access FB from their smartphones, but given the limited space on the screens, and likely less attention span provided by users when on mobile platforms, will mobile ads actually provide better returns for advertisers in the long-run?
In addition, while FB management boasts about the higher clicks that ads placed on News Feed get, we wonder if it is due to the "fat-finger" problem that many mobile users face when clicking or typing on their smartphones, as an analyst suggested on the last earnings call. This sounds a bit unusual, but we think it is a valid question. Also, we wonder where else besides on the News Feed, which is in the middle of the FB page and between all postings of FB 'friends', would FB place the ads? There is no other available space on the mobile platform. In our opinion, this discounts management's exuberance regarding the early returns it has seen on mobile ads.
Regarding the number of ads and their pricing, we hope to see a bit higher price increase along with growth in the number of ads placed during the quarter. We say this because if mobile ads are turning out to be as effective as management has stated, then not only demand for the number of those ads should increase, but so should their prices. In Q3, while the number of ads jumped nicely by 27%, the average price per ad was up only 7%. If this continues, it could be an indication of ad commoditization, which would not necessarily be good news because FB would have to keep upping the number of ads more and more to maintain top-line growth. This could be doable, but it comes at the risk of driving away users. Higher prices will indicate if FB is placing "better ads in the feed" as management claims.
We finally updated our model with FY '12 Q2 and Q3 numbers. We also added FY '17 estimates in order to use a 5-year DCF model to value FB. It turns out that our valuation is still around $23/sh. From a technical standpoint, the stock has jumped more than 20% in two weeks, so we think that gap needs to get filled before it can peak at around $33/sh. While many may continue to hold on to FB, we note that many analysts covering this stock have upped their expectations and valuation, which has created additional risk going into the earnings announcement, again scheduled for 1/30. If the stock does give back some of its gains, the next support level is around $26. Although the stock declined a bit after the announcement, it appears that a very good earnings call is still priced into the stock, which could make the reaction to a disappointing call ... well ... disappointing.
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