By Matt Doiron
Facebook Inc (FB) is currently down slightly from its close on January 30th before the company issued its quarterly earnings report, recovering from a plunge below $30 in after hours trading on that day. Facebook reported a 40% increase in revenue last quarter compared to the fourth quarter of 2011, which was actually a slightly higher growth rate than it had experienced earlier in 2012. However, the social networking company piled up higher costs. To be sure, much of the increased expenses came in the form of share-based compensation, but even excluding that sales and marketing costs were up 55% and R&D expenses more than doubled. As a result, operating income was down slightly (it did rise 13% if we add back share-based compensation in Q4 2012 and Q4 2011).
If we are generous in adding back costs, Facebook earned 17 cents per share for the quarter which annualizes to 68 cents- with the stock currently trading at $31, that is a high trailing earnings multiple for a company whose operating income is growing at only a moderately fast rate. Wall Street analysts are projecting 66 cents per share in earnings for 2013, and 87 cents for the following year. That implies a forward P/E of 36. At that pricing Facebook would have to be on the verge of very high earnings growth beyond that point, and we are skeptical. The company's recent announcement of Social Graph suggested a product which will add some value, but many of its applications- including reviews of local businesses and dating- are offered by public companies whose market caps are much smaller than Facebook's.
JAT Capital Management, a fund managed by John Thaler which tends to invest more than half of its capital in tech stocks, reported a position of 6.2 million shares in Facebook at the end of September (see more of Thaler's stock picks). Tiger Cub funds Tiger Global Management and Viking Global were two other hedge funds which had large stakes in Facebook at the end of the third quarter (find more stocks that Tiger Global and Andreas Halvorsen's Viking Global liked). The most recent data has short interest in Facebook down to 5% of the outstanding shares.
We can compare Facebook to professional social network Linkedin Corporation (LNKD), Chinese social network Renren Inc (RENN), social gaming company Zynga Inc (ZNGA), and local business review website Yelp Inc (YELP). Facebook, despite the high valuation we've discussed, is actually the cheapest of these five stocks in terms of earnings. Renren is not expected to be profitable this year, and Zynga and Yelp are projected to barely break even; analyst consensus is for LinkedIn to earn $1.31, which would be a current-year P/E multiple of nearly 100.
Zynga is particularly worrisome as a business, with revenue up only slightly in the third quarter of 2012 versus a year earlier, though the company has reported over $1 billion in cash on its balance sheet so we would not consider it a short at these levels. Renren and Yelp have been reporting high revenue growth, though their growth rates are not particularly higher than Facebook's and as we've mentioned those companies are not looking good on the bottom line. LinkedIn has also been doing well on the top line, and the stock is up 60% in the last year bucking the trend of falling social media stock prices as the company has a professional cachet going for it. Still, we would not be buying it at its high valuation multiples.
Facebook's fourth quarter was positive for the business, particularly if we make efforts to adjust for the high share-based compensation during the quarter. However, we still don't like the stock's pricing and think that it might still be overvalued until it can demonstrate strong and sustainable earnings growth, which would likely require a completely different monetization strategy.