Tuesday, April 24, 2012

Facebook Profit Drops Ahead of IPO: 1st Quarter 2012 Results

Facebook yesterday released its 1st quarter results as part of an amended S-1 filing.

Some things of note:

- Net profit fell 12 percent from $233 million in the 1st quarter of 2011 to $205 million in the 1st quarter of 2012.

- Revenue was $ 1.06 billion in the 1st quarter, a 45 percent increase year over year. At first glance that seems just fine but revenue declined 6.5% sequentially in the first quarter of 2012 compared to Facebook's $ 1.13 billion in the 4th quarter of 2011.

Those results are certainly not the end of the world, but seem fairly weak for a company that's expected to go public with a monster valuation by any standard.

From this Reuters article:

"It was a faster slowdown than we would have guessed," said Brian Wieser, an analyst with Pivotal Research Group. "No matter how you slice it, for a company that is perceived as growing so rapidly, to slow so much on whatever basis - sequentially or annually - it will be somewhat concerning to investors if faced with a lofty valuation," Wieser said.

- Total expenses were up roughly 97 percent over the past 12 months far outpacing the 45 percent revenue growth.

- Monthly active users surpassed 900 million in the 1st quarter, up from 845 million in the last filing.

- Facebook is paying $ 300 million in cash for Instagram plus 23 million shares of its class B common stock. Since Facebook says that the fair value of the shares are $ 30.89, that means the 23 million shares are being valued at just over $ 700 million (obviously, anyone can say what they think their shares are worth...whether they are worth that much is another story).  So that brings the total deal value to roughly $ 1 billion for Instagram. Facebook also disclosed it will pay $ 200 million to Instagram if the company's recent deal to buy the photo-sharing start-up for about $1 billion falls through.

All stocks have a bunch of risk factors that must be listed. One risk factor that's listed in Facebook's S-1 is in the Our CEO has control over key decision making as a result of his control of a majority of our voting stock section. From the section:

As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as a result of voting agreements, in his own interests, which may not always be in the interests of our stockholders generally.

Since CEO Mark Zuckerberg owns 58 percent of Facebook stock, anyone who invests has to feel confident that he'll mostly vote in the interest of all stockholders. Who knows, maybe that Instagram deal will make a lot of sense in hindsight. Then again, maybe not.

The initial public offering for Facebook is expected at around $ 100 billion. That looks like a full price to say the least. The New York Times noted yesterday in this article that Google (GOOG) looked stronger than Facebook prior to its initial public offering:

Before Its I.P.O., Google Looked Stronger Than Facebook

The article notes that Google's revenue grew 125 percent in the 2nd quarter of 2004, compared with the same period the previous year then added...

That was much faster than Facebook's 45 percent increase in the first quarter of this year. At the same time, Google increased its earnings by 146 percent as it headed into its I.P.O., not falling like Facebook's profit.

To be fair, Google had lower revenue and earnings compared to Facebook right before it went public (but also a market valuation that was roughly 1/4 what is expected for Facebook).

What I know is I'll never gain or lose no matter how good Facebook's future ends up being. It's just not something I can understand well enough (necessarily unique for each investor). Others no doubt can better judge what it's worth and future prospects. Considering the expected valuation it's not, at least for me, all that interesting though the company's business accomplishments to date are very impressive.

With the benefit of time and hindsight Facebook may prove to be an excellent business. In fact, with what are already formidable advantages in mind, the company won't surprise me at all if it performs very well over time. Yet, for a good long-term investment result (not simply a good trade over several years or less) to happen, it will necessarily depend upon outstanding and sustained business performance. Due to what appears to be a hefty upfront price, it's possible that the long-term investment result -- while not insignificant in an absolute sense -- will end up offering insufficient compensation for investors, considering the risks and compared to alternatives, even if the business itself does very well.
(i.e. Returns may be unsatisfactory considering the wide range of outcomes and unsatisfactory compared to much less risky investment alternatives that have a narrower range of outcomes. Investment performance ends up being not nearly as impressive as business performance simply because of the upfront price.)

My preference happens to be attractive results that can be achieved via merely solid (though maybe somewhat uneven) continued long run business performance.

Generally, that's going to be a rather boring but durable business -- possibly one experiencing some near-term difficulties but with otherwise sound core economics and sustainable competitive advantages -- bought at a very attractive price.

So Facebook may do more than just fine. It's just that there's a limit to the number of investments any one investor can understand.

Beyond that limit unnecessary mistakes end up being made.

Margin of safety must be obvious.

It comes down to opportunity costs. Choosing the best understood investment alternative, at the biggest possible discount, to protect against inevitable future uncertainties is all-important.


Long position in GOOG

Related posts:
Facebook Files for IPO: What the S-1 Reveals
Facebook's IPO: $ 100 Billion Valuation?
Facebook's 1st Half Revenue Doubles to $ 1.6 Billion
Is Facebook Worth $ 100 Billion?
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