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Facebook revenues and earnings came in at $1.18bn and a loss of 8 cents per share vs the streets estimates $1.15bn and $0.12. The loss mostly came from a one off increase in costs, consisting mainly of stock compensation charges due to its IPO, which if stripped out leave a relatively healthy figure in line with expectations $0.12 or 1 cent growth y-o-y. Even so the stock took a tumble to $23.83 in after hours trading from a close of $26.85.
The debacle that was the IPO has left a black stain on the investment banks, Nasdaq and Facebook after only favoured friends (clients) were allegedly told of analyst revisions in the days prior to the listing . Unfair dealing springs to mind. Although the analysts seem to have been right to temper the exuberance of their initial expectations as Facebook has hit an impasse in converting users to cash resulting in slowing growth. Or maybe Facebook is just manoeuvring for bigger things?
Another problem for Facebook has been its tie in with Zynga, who make games such as Farmville, Mafia wars etc where the player invests time to progress or alternatively spends cash to rank up more quickly by buying extras. Zynga posted losses on Wednesday that were well below expectations and the stock dropped 40%. This had a rollover into Facebook as Zynga accounts for 10% of FB revenues, pretty much the balance of what’s left over after advertising revenue. It just seems as if Zynga’s model has run its course, building a farm on your computer or controlling cities in a murderous mob manner is old hat (maybe some read across to Blizzard and Diablo 3). Facebook announced that they have stopped Zynga’s products from ranking favourably in their searches giving priority to newer games and apps. They have clicked the de-friend button – hitting another nail into Zynga’s coffin.
So where are the battle-lines being drawn in the land of the tech giants, who’s flirting with who and who’s ignoring whom. Apple has the product, Facebook has the users and Google gets the users to where they want to go – each is the big boy in its own territory. But Google seem to have given the finger to both Facebook and Apple in recent times by stepping into their territory – to Facebook, by starting their own social network, Google+, which hasn’t worked, and to Apple by starting their own phone operating system, Android, which has. In a first act of revenge Apple has switched its mapping software to Tom-Tom, giving them a well needed shot in the arm. Facebook’s move is slower but looks to be in sync with Apple, where an Eden-like walled garden of product and user are causing Google’s founder, Sergey Brin, to whinge that the liberty of the internet is under threat. He has a point – knowledge could be what you are fed by Apple and Facebook.
So Where do We Come From? What are We? Where are We Going?
Google and Facebook both compete in online media. Traditional media, such as television print and radio, accounted for roughly $363 billion or 62% market share in 2010, with online media at 11% or $68 billion. This gives Google a 50% share of a market that is expected to almost double by 2015 to $120 billion. Facebook’s market share for 2010 sits at around the 3% mark.
Comparing the two companies last year, Facebook’s 2011 revenue came in at $3.7 billion, up 88% Y-o-Y, with an operating profit of $2 billion, a 100% Y-o-Y increase, whilst Google’s revenue and profit increased 30% to $38 billion and 20% to $11.6 billion respectively. It is clear to see that Facebook is growing more quickly and taking a larger piece of the pie – estimates put their market share at 7% this year.
The story plays out differently in terms of reach. Google can access 80% of the global online audience, whilst Facebook only 51% – however the time spent on Facebook is four times higher. This is where the real difference comes in, as the number of impressions (or adverts) served is potentially much larger for Facebook.
Google, which generates 96% of its profit from advertising with finance led campaigns leading the charge at 10%, does so by allowing companies to bid on ‘keywords’ that they consider most relevant to bringing customers, who are going to buy, through their online shop front door. Facebook’s approach is more exacting in that it allows companies to target the specific interests of the individual, or via social impressions, whereby a friend is targeted through one of his connections –the idea being that you’re much more likely to be influenced by a friend’s purchasing patterns and interests.
Does this advantage and knowledge of targeted individual actually make sense and make returns for advertisers? General Motors, the third largest US advertiser, didn’t think so after pulling its Facebook campaign just prior to the IPO with rumours of unimpressive Click-Through-Rates (CTR’s) and campaign returns (ROI’s). However, the model of Facebook advertising doesn’t lend itself to large luxury purchases – considering pictures are 80×110 pixels, taglines are limited 125 characters and headlines to 25.
The model lends itself to direct response, and in a sense, Groupon-like discounts. Companies can capitalise on offers that they know their targets will be interested in immediately – rather than the long drawn out consideration that takes place before a hefty purchase. For example, Casino’s with their “deposit £20 get £10 to play with free”. Other issues highlighted by advertisers are the level of false accounts and false interests which can be targeted (although these will only distort the reach and impression figures, not the return metrics), alongside the ability for campaigns to saturate after time i.e. click –to-reg rates to tail off as the targeted market becomes familiar with the deal. In all – advertisers are still working out if it works for them.
Another threat is the rise of mobile as a platform for advertising – a $1.5 billion market that is expected to grow at 64% each year. Facebook’s prospectus clearly highlighted this as a potential risk as there simply isn’t space to advertise on a four inch screen in the style they are used to. In fact this has been the bugbear haunting Facebook’s share price. For example, in India, the user base has increased from 8 million in 2010 to 50 million now with the majority using the mobile version. These users are completely non cash convertible at present. With the model of advertising and level of local knowledge it seems India will see a gradual adoption of the Facebook method to reach customers.
In 2011 Facebook generated advertising revenue of 56% from America compared to 62% in 2010. This adjustment was mainly due to the faster growth rate of international users in the Western Europe, Canada and Australia. Brazil, Russia and some of Europe still remain relatively untapped with penetration rates of less than 30%, allowing for further revenue growth feeding through to the bottom line – so room to expand is there.
Facebook is clearly relying on this ability to grow in new markets and is planning to use the funds raised in the IPO to expand customer support services and increase its own-brand servers in these areas. Call centres in each major market should increase ARPU’s for the presently heavily understaffed European operations, but still the major problem of the user shifting to mobile devices remains. How are they going to do this?
Rumours that Facebook’s escape plan would involve its own brand phone were quashed by Zuckerberg in the results call yesterday, but he did highlight the plan to more heavily integrate itself into systems that people use. Has the Apple dropped yet? Well the signs are there with Apple engineers hopping over to Facebook, the new Mountain Lion operating system including a Facebook button (set for this fall) and the safari browser taking a more chrome-like functionality. Could there be a swap on the cards? Perhaps a Facebook button in Apple and a Safari search in Facebook bypassing all the pay-per-click advertising – an attack at the heart of Google’s money making machine and a market share of PPC for themselves?
Considering Facebook’s growth and potential lets assume a 30% market share of online advertising revenue by 2015 or revenues of $36 billion (a bit of a quantum leap) – and assuming margins stay the same this would mean a forward 2015 PE of c.6.5 compared to Google’s present PE of 18 – which could be called cheap. But with risks to a long term monetizing of mobile users, doubts from advertisers as to the validity of the method and users going AWOL, there is clear downside risk at these present valuations of 60x earnings, still much better than 100x plus at flotation. It looks like this could be an entry point appearing, whilst sentiment is negative, and before Facebook shows what it has up its sleeves.
