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Look Beyond Facebook’s Perceived Value to Find Growth


On October 28, Facebook (Nasdaq:FB) released its third-quarter 2014 earnings report announcing, for the three months ending September 30, that total revenue of $3.20 billion was generated, an increase of 59%, compared to $2.02 billion in 2013 the same quarter. The earnings release also give a margin of operations of 44%, or $1.40 billion, for the third quarter compared to 37%, or $736 million, in the third quarter the prior year, and net income of $806 million, up 90%, from $425 million for the third-quarter of 2013.

Other financial results are as follows:
• Revenue from advertising was $2.96 billion, a 64% increase from the same quarter last year.
• Mobile advertising revenue represented approximately 66% of advertising revenue for the third quarter of 2014, up from approximately 49% of advertising revenue in the third quarter of 2013.
• Payments and other fees revenue was $246 million, a 13% increase from the same quarter last year.

Back in 2012, in one of two posts I wrote on Facebook, I gave an assessment on what I felt as the upcoming dovetail phase in the tech IPO sector and how Facebook, as a newly-forming public corporation, and its stock, would be received in such a market. Since that time period till now, giving the current corporate and market conditions, my views on Facebook – purely as a tradable stock- remain unchanged.

Taken from Facebook’s 2013 annual report, the company’s key matrices are measured based on daily active users (DAUs), mobile DAUs, monthly active users (MAUs), mobile MAUs, and average revenue per user.

At the time of the annual report, according to Facebook, challenges in ascertaining an accurate number of users arise from a large number of online as well as mobile users creating either duplicate accounts (a worldwide estimate of between 4.3% and 7.9% MAUs), user-misclassified accounts (defined as personal profiles created for a business, organization or a non-human entity such as pets representing an estimated 0.8% and 2.1% MAUs worldwide), or by forming “undesirable” accounts, such as spamming, with an estimated 0.4% and 1.2% MAUs worldwide.

Why these figures matter?

Globally-speaking, 757 million people made up Facebook’s daily average number of users in 2013, which was a 22% increase from 2012. Today, that number is 864 million – that’s a lot of ‘likes’ people.

While it’s no secret that Facebook’s revenue is derived from user –based data and has come under scrutiny for its privacy policies, the social networker, along with Instagram (owned by Facebook) and others, received an A grading for using private data in a way that lines up with user expectations.

One major stream of revenue for Facebook (stated in the same annual report) is received through the selling of “advertising placements to marketers.” For 2013, revenue from marketers’ dollars generated $2.34 billion, which represent 89% of $7.87 billion received in total revenue worldwide; along with a 37% operating margin and $1.50 billion in net income, to end out the remainder of 2013.

Transactions carried out via Facebook’s payment infrastructure; from the selling of “virtual and digital goods to [Facebook’s] users on personal computers from developers” is another source of revenue. Developers integrate their products with Facebook’s development tools and application programming interfaces (APIs) to create web and mobile applications for Facebook’s users.

“Currently, substantially all of our Payments revenue is from users’ purchases of virtual goods used in social games on personal computers. We receive a fee of up to 30% when users make such purchases from developers using our Payments infrastructure. In 2013, developers received more than $2.1 billion from transactions enabled by our Payments infrastructure. While mobile applications can also integrate with Facebook, mobile applications do not process transactions using our Payments infrastructure.”

Below is a table to summarize Facebook’s advertising revenue from both marketers and developers and from payments and fees received from developers. From 2011 – 2012, advertising accounted for 36% of revenue and payments and fees received accounted for 45% of revenue. For 2012 – 2013, advertising increased 63% while payments and fees received declined to 9%; which represents a 75% increase in advertising and an 80% decrease in payments and fees received, respectively.
FB21
As far as expenditures, Facebook’s current total expenses for the third quarter amounted to $1.81 billion, up 41% from $1.28 billion for the same quarter last year. Special attention, however, goes to research and development, which more than doubled from $369 million third quarter 2013 to $608 million third quarter 2014. This is important to note because in the past Facebook has struggled a bit with releasing, with the exception of Messenger (a text messaging app) and a handful of others, new and original products.  The spending increase in R&D has helped to launch several made-for-mobile products this year with Paper, an app version of the website’s News Feed feature, Slingshot, a photo-sharing app, and Rooms, a chat room app.

With the assistance of the before-mentioned apps, Facebook is attempting to stake its claim in the mobile arena.  However, the tech power player has not always delivered successfully; from some call-to-action button features, such as a recommended click-to-call button for mobile devices, or from the failed Facebook phone. Nevertheless, considering Facebook’s acquisitions of Instagram for $1B (a photo sharing app, 2012), Parse for $85M (a mobile development tool, 2013), Atlas for $100M (a marketing data tracker, 2013), Oculus for $2B (the virtual reality headset maker, 2014), and WhatsApp at a whopping $22B (a text messaging app, 2014), giving both the low rates of costs of operating and revenue, overtime, the cost of acquisitions should pay for themselves.

Side note – The increase in R&D was also due to, from an accounting method, categorizing the additional talent employed from the acquisitions.

All in all, herein lies Facebook’s continual dilemma: data limitations form an inaccurate number of users; marketers and developers depend on those numbers to be able to appropriately advertise (and pay Facebook); no form of payment infrastructure for applications on mobile devices, which leads to no way to monetize from users accessing Facebook from said mobile devices; and that, in turns, creates a problem in scaling income from operations. For these reasons, it is my assertion that Facebook is not presently a growth tech stock, but, that does not mean that it will not become so later on, or that the company itself -before going public-were not a growth company.

One huge advantage that Facebook does have is its reign over its competitors. Based on the number of monthly active users worldwide, Facebook ranks first place with 1.35 billion (number of DAUs previously mentioned) followed by Google + with 540 million and Twitter with 284 million. Outside of companies that, according to Facebook, develop applications that “provide social functionality, such as messaging, photo-and video- sharing, and micro-blogging,” Facebook’s social power and market share has afforded the tech giant the luxury of standing out above other social networking platforms.

Still, Facebook’s management is well aware that losing the “top spot” is a natural part of doing business despite having a commanding presence. In doing so, Facebook acknowledges that user growth and revenue growth rates are likely to decline overtime as the size of its active user base increases and greater market share is achieved. Furthermore, “As [Facebook] growth rates decline, investors’ perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline.”

From a stock valuation standpoint, many analysts debate on whether Facebook should be treated as a growth stock or a value stock. In comparing Facebook to the S&P500 ETF (Nyse:SPY), Facebook, FB, has a P/E ratio of 86.88 (SPY: 6.24), a profit margin of 24.66% (SPY: 1063.83%), a quarterly revenue growth rate of 58.90% (Est. 5-Year SPY earnings growth: 9.67%), and a return on equity at 16.11% (SPY return on avg. equity: 23.25%). Along with Facebook having – for the third quarter – a net working capital of $21.2 billion and free cash flow of $766 million, there are elements, however, of both a growth stock and a value stock.

Alas, in my last report I pleaded, begged and practically gave a 10-point summary on why the timing of Facebook going public was off, and to think “the Berg” didn’t listen. I guess I’m going to have to “unfriend” him. In the meanwhile, face it (not an intentional pun), whether your personal style of investing is as a growth or value investor is beside the point, instead, the real test, or what is important, is in how Facebook will reinvest and reinvent itself.

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