how is FB describing itself to the financial community?

I think the roadshow video is very instructive.

First of all, it is very expertly and painstakingly scripted and filmed.  A great deal of time, energy and thought went into it, in my view.  Therefore, it should be taken seriously as saying how FB wants to position itself in the minds of investors.

What are the main messages?  I think there are three:

1. FB is as much a social cause as a company.  And, by implication, we all now have a chance to be a part of the movement by becoming owners.

Mark Zuckerberg says both in the video and in a letter in the prospectus that he didn’t initially intend for FB to be a company.  He created it (I think I see a slight change in his delivery as he says this on the video) because it needed to be done.

“Facebook was not originally created to be a company.  It was built to accomplish a social mission–to make the world more open and connected…There’s a huge need and a huge opportunity to get everyone in the world connected, to give everyone a voice and to help transform society for the future…We hope to strengthen how people relate to each other,” he writes.

2.  FB is in a unique position among internet companies. 

Everyone else has succeeded only in creating the “raw tools” that FB is cementing together into a comprehensive communications network.  Because of this unique position, future applications developers will doubtless build their products on the FB infrastructure, giving the company huge profit expansion potential.

3.  FB is only at the start of its “rewiring” of the way people communicate with one another.

There’s very little discussion of current operations in the video–despite the fact it’s a half-hour long.  You’ll see why below.  To me, the implication is that the concept of a possible future is much more important than the present.  It’s a sort of “If you build it, they will come” message.

what about current operations?

Here are the numbers I find most interesting:

users

As of March 31, 2012, FB had 901 million registered users worldwide who have interacted with Facebook in some fashion at least once over the prior month.

As of the same date, it was averaging 526 million registered users who have some interaction with Facebook on a given day.

Of monthly active users, 83 million use mobile devices exclusively to interact with Facebook; 405 million others use both computers and mobile devices.  This is a big change.  Mobile usage grew by 69% over the past year.  It contributed most of the gains shown in North America.

Overall user growth was 33%.

geography

FB breaks out active users into four geographical areas:  US and Canada, Europe, Asia, and Rest of World.

US/Canada

20.7% of all users

average quarterly revenue/user = $2.86, up 14% year on year

user growth was +91% two years ago, +46% last year, +15% this year

biggest boost to growth appears to have been through mobile devices

Europe

27.9% of all users

average quarterly revenue/user = $1.40, up 18% yoy

user growth +94% two years ago, +46% last year, +20% this year

Asia

25.5% of all users

average quarterly revenue/user =$.53, up 23% yoy

user growth +268% two years ago, +93% last year, +47% this year

RoW

26.9% of all users

average quarterly revenue/user = $.37, up 19% yoy

user growth +137% two years ago, +58% last year, +33% this year

what these figures mean

To me, they suggest that the North American market is maturing rapidly and that Europe may be only a year or so behind.  Not surprising, given that Facebook users in North America already outnumber non-users.

The two regions make up three-quarters of FB’s revenue.   So, if it isn’t already, emphasis in North America has got to shift away pretty soon from grabbing as many new users as possible (to prevent rivals like Google+ from snatching them us) to raising revenue per user.  How that will go is unclear (to me, anyway).

income statement

FB has two sources of revenue:  advertising and payments, the latter mostly generated by microtransactions in games. During calendar 2011, FB collected $3.154 billion in ad revenue and $557 million as its share of payments (the lion’s share of that from Zynga).  That was an 88% yoy gain.  Net income was up by 66%.

For the latest quarter, however, net was down yoy, despite a 45% yoy rise in revenue to $1.058 billion.  How so?

Expenses rose by 97% yoy during the period.  R&D was up by 168% to $153 million, marketing by 134% to $159 million, spending on infrastructure by 65% to $277 million.

I interpret this as FB’s recognition that to continue to grow it has to do so in a new way.  It either has to sign up a whole big bunch of low-revenue users outside the US and Europe, or find new ways to raise average revenue per user in its more affluent, but more mature markets in North America and Europe.

It’s conceivable that during this transition time, eps growth will be nothing to write home about.  It’s also not 100% clear FB will be successful, although it is in a very powerful position in the social networking arena.

conclusions

FB’s IPO materials tell two different stories.

–one, portrayed in the video, is of a unique company with boundless potential in an increasingly interconnected world.

–the other, from the numbers in management’s discussion of operations in the prospectus, is of a company that has already picked most of the low-hanging fruit and which is ramping up spending to fend off slowing revenue growth.  The price of this ramp may be lackluster profit growth for at least a while.

Which story to believe?

Here I have no strong opinion.

On the plus side,…

…good growth companies tend to reinvent themselves every few years.  For example:

–Microsoft was originally the PC operating system company.  Then it was the Windows graphical interface company.  Then it was the corporate Office productivity suite company.  Then, a dozen years ago, it stopped growing.

–Apple was the iPod company.  Then it was the “halo effect”/Apple Store company.  Then it was the iPhone company.  Now it’s the iPhone/iPad/iCloud company.

–Amazon, which I think FB resembles the most closely, was originally an Internet “concept” company that sold books in cyberspace and didn’t make much money.  Then it “pivoted”, expanded the range of products it sold itself and began to act as an online sales conduit for third parties.  Profits exploded.

What could go right in this fashion for FB?

Let’s say that corporate advertising on Facebook could double–I’m not sure whether this is an aggressive assumption or an underestimation–over the next two or three years, while FB maintains something like its current cost base.  If so, earnings would rise by about 150%.  Companies would arguably shift ad dollars to FB because it’s cheaper and because customer targeting is better.

Or something really good that’s unexpected by the investment community could develop, as happened in all the cases I’ve cited above.

On the minus side,...

…the valuation, based on current profit levels, is high at 96x earnings per share.  That’s not necessarily a deal-breaker.  LinkedIn, which I don’t think is as promising a company, trades at 686x.  Amazon trades at 186x, with a similar story of heavy investment in new product development.

Priceline.com, clearly a more mature company, trades at 30x.

An “old” warhorse like Apple, where the price earnings multiple has been contracting for the past several years, trades at 14x.

Microsoft, which hasn’t shown any innovative spark so far this century, trades at 11x.

what will professional investors do?

Value investors will hold onto their MSFT and not touch FB with a ten-foot pole.

Growth investors will probably take all the FB they can get in the IPO.  Knowing that the stock will very soon be part of the NASDAQ index, I think they’ll try to build their positions to the point they have only slight underweights and then await further developments.

For me, the stock would be a roll of the dice–something I try to avoid.  It’s not simply a question of valuation. If I thought FB’s earnings in three years would be close to triple the current level, as a doubling of revenue/user would achieve, I’d be very happy to buy it.  I don’t know the company well enough to have that conviction.  But I believe this is the key question potential investors should have an answer to.

Note:  Since I  wrote this post, two new pieces of information have come out:

–FB amended its prospectus to reflect what was apparently a management answer to a question posed during the roadshow.  FB said that some users were switching to accessing Facebook through mobile devices rather than through computers.  This has a negative effect on revenues, since FB runs fewer ads through mobile devices and advertisers pay less for them.

–apparently demand is strong enough for the issue that FB is talking about raising the IPO price to $34-$38.