Quick Thoughts: Resisting Facebook

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–       The Facebook IPO has priced at $38, at the high end of its revised range, representing a market cap of $108.6B, assuming exercise of vested options.

–       The price is about 26 times trailing revenues and 104 times earnings, which discounts 66.2% compound annual growth over the next 10 years.  In comparison, Google grew at a 42.4% CAGR in the 8 years after it hit the $4B revenue milestone.

–       As consumer Internet use shifts decisively toward mobile platforms, Facebook’s ability to monetize their position is constrained by the control that Apple and Google have over 3rd party Apps.

–       GM’s repudiation of its Facebook ads is also troubling, calling into question the efficacy of ads, even on the browser platform.

 

At $38, the outstanding shares of Facebook will yield a market cap of just over $81B, but adding in employee options vested but not exercised adds another $26B to the total, bringing the practical value of the company to a whopping $108.6B.  Revenues over the past four quarters were $4.1B, up roughly 90% YoY, making the sales multiple a healthy 26 times trailing.  This valuation implies a 10 year growth rate of 66.2% at constant margins.  To put this in context, Google passed a $4B annual run rate in mid 2004, and has grown at a 42.4% CAGR in the 8 years since.  Without doubt, the expectations for Facebook are robust, if not realistic.

On the desktop, consumers access Facebook through a neutral browser, opening the site and, typically, keeping it open as a tab for most of the day.  This mode allows Facebook opportunity to extend the set of activities of its users within its own boundaries, track their behaviors, serve them advertising and sell them things.  Unfortunately for Facebook, Smartphones and Tablets appear on track to supplant PC browsers as the dominant access platform for consumer Internet usage.  Unlike PCs, mobile platforms feature Apps to access web-based services directly, bypassing the browser.  For a iPhone, iPad or Android user, Facebook is an App to be opened as needed and closed again when not in use.  This gives the platform master – e.g. Apple, Google and Microsoft– enormous advantages over the 3rd party App publisher.  First, the platform master may decide to integrate some of the functions addressed by the App directly into the OS or to include an alternative App as a default shipped with the device.  Of course platform masters favor their own Apps, or Apps by companies willing to pay a fee for the privilege.  The platform masters will also take a portion of App revenue and may limit the ability of Apps to link to other revenue generating services.  Moreover, the platform masters can address the user FIRST, serving ads and offering services before they click on the App.  Facebook already generates revenues from games and has hopes of extending into streaming media – this will be very difficult to accomplish on mobile platforms controlled by their biggest competitors.

Facebook has acknowledged its difficulty in delivering effective advertising for its Apps, pointing the constraints of a smaller screen size and a more time sensitive user.  General Motors, one of the largest advertisers in the world with sophisticated resources for evaluating its advertising, announced this week that it would discontinue its $10M annual program with Facebook.  Given the tiny size of this program within a multi-billion dollar annual budget, it seems unlikely that GM would go to the trouble to cut it without clear reasons.  It may be that embedding advertising into social interactions is not nearly as effective as tying it to search or to transactions.  If so, Facebook needs to find a mechanism to apply its vaunted social graph to an application that finds users in a mood to shop, not easy when options are constrained by the App model.

This adds to my skepticism over Facebook.  The company has been flirting with investors for a long time and perhaps the thrill of finally consummating a long distance infatuation upon the IPO will be too much for investors to resist.  I’d rather spend my time with the platform masters.

For our full research notes, please visit our published research site.

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