Quick Thoughts: Facebook’s Annual January “Surprise” Announcement

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– Facebook shares are up 22% YTD, with 10% coming since last week’s invitation to Tuesday’s mystery event.  Speculation is rampant, amongst expectations that 4Q will build on the strong 3Q.

– Some rumors are almost certainly fantasy – an iPhone-like OS, an AWS-like cloud hosting service, or a Google-like search engine would be costly distractions from the challenges at hand.

– Reasonable guesses include: Skype integration, an expanded e-commerce platform, internal social search, a gaming initiative, or an external ad network.  All good ideas, but none likely worth $15B

– A similar event last year yielded a ho-hum social apps announcement.  Another anticlimax would be costly, and 2013 expectations are at risk to Zuckerberg’s Bezosesque indifference to margins.

A blue e-vitation from Facebook hit inboxes this past Monday, igniting speculation and a 10% move up for a stock that had already rallied more than 11% since New Year’s Eve.  FB shares had already been flying on a general consensus that 4Q12 revenues will be strong, expectations that seem well founded.  3Q12 mobile advertising results were a revelation, cooling concerns that Facebook might struggle to sell ads on small screens and highlighting the power of Facebook Exchange to leverage the social graph.  This atmosphere of investor goodwill has been conducive to considerable flights of fancy, as bloggers, journalists and analysts offer speculation as to what it is that Facebook has been building.

I am not shy about adding my own guesses to the pool, or about casting aspersions on the guesses of others, so lets get to it.  First, I do NOT believe that Facebook will offer its own mobile OS.  Not only has Mark Zuckerberg categorically denied interest in his own portable platform, but such a move would be expensive, risky and distracting.  Launching an OS could accelerate future disintermediations by integrated apps on iOS and Android.  Moreover, the Facebook name on a phone is no guarantee of success – just ask HTC.  A Facebook OS would be too little, too late, without an obvious path to critical mass market share.  Better to exploit those billion users and extensive social graph to make the various functions of Facebook irreplaceable to iPhone and Android users.

A cloud-hosting Infrastructure-as-a-Service or Storage-as-a-Service product would make a lot of sense, given Facebook’s investment in a massive, near leading edge, distributed data processing infrastructure.  However, no one at Facebook has ever suggested moving beyond hosting Facebook-specific applications on its infrastructure.  For a company as focused on its core business as Facebook, launching a potentially distracting side business is pretty far afield.

To all of those who have been speculating that Facebook will announce a search engine to attack Google head-on in internet search – LOL!  Internet search is one of the most difficult data processing challenges there is, with huge scale economies and requiring sophisticated processing algorithms built on years of iterative development.  Microsoft has spent a decade and billions of dollars chasing Google, taking less than 10% global share, including searches processed for Yahoo, for its efforts.  Assuming that it would be easier for Facebook is naivety or hubris.  Yes, Zuckerberg has acknowledged an interest in search technology, but it is far, far more likely that Facebook will bring out an internal search product to give its users a much more powerful tool to sort through the mountains of information contributed by its billion users, including product reviews and likes.  This information is not visible to Google searches, giving a social search product a captive audience, and Facebook an attractive context into which to sell adds.  Moreover, a successful and sophisticated internal search product COULD be a bridge to an eventual entry to general internet search , but let’s not put the cart before the horse.

So what else could it be?  Tuesday is also the day that Facebook best buddy Microsoft has chosen to shut down its IM service in favor of Skype, leading some to speculate that the announcement will entail further integration of Skype into Facebook or a new IM platform.  Possible, but unexciting.  Facebook analytics provider Wisemetrics claims that the event will introduce a comprehensive social commerce strategy, expanding upon the well-received Facebook Gifts.  This is a bit more interesting, but a tough, competitive business with a notable low cost leader willing to take razor thin margins in pursuit of extending its scale leadership in all things e-commerce.  The best idea may be the launch of an external ad network, extending the Facebook Exchange’s social graph driven analytics to placing display ads on 3rd party sites.  While there are some issues with Facebook’s unwillingness to abide by the standards of privacy protections generally accepted by the advertising industry, this idea is completely in the company’s wheelhouse but also likely already embedded in most investors’ expectations.

With all of the excitement, the reality may have a hard time living up to the hype, leaving considerable risk that the market decides to sell on the news even though the flashier rumors are bad ideas.  In addition, I’m far more confident that Facebook will deliver strong revenues when it reports its 4Q12 than I am that it will report upside to either earnings or cash flows.  Mark Zuckerberg has a track record of extreme indifference to the interests of his investors, without having earned the benefit of the doubt accorded to Amazon’s Jeff Bezos, and a miss or a guide down in this or the next quarter seems well within the realm of possibility.  Consensus estimates expect Facebook to maintain its 30%+ top line growth rate for the next 5 years and to expand its margins by 1400bp over the same period.  None of the ideas floating around the blogosphere in advance of Facebook’s annual surprise meeting seem to be enough to move the needle against those expectations.

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