I think that it is kind of amusing to see Facebook (FB) adopt a strategy that is similar to twitter in that it will provide hash tagging. It seems like technology companies are all about trying to be more similar to each other rather than trying to be different from one another. Eventually, maybe the only difference between one technology driven product and another is the brands and not the values of the product. Last time I checked, I found fairly similar features between all the mid-sized sedans when it came down to selecting the car I wanted to purchase.
Facebook will secure more of a competitive advantage by providing hash tagging to its users. According to Justin Lloyd-Miller:
Facebook is working to introduce the hash tag system to its program, the same system that made Twitter huge in the first place. The hash tag allows Twitter users to associate their posts under a common theme or keyword. The hash tag would not be the first export from Twitter to Facebook, who also adapted a subscriber tool for its users, largely based on the Twitter model.
The hash tagging system that Facebook is trying to adopt from Twitter could result in two things.
- More user interaction. Higher amounts of user-to-user interaction could go against Facebook policy of only interacting with people you actually know. The only problem with FB's strategy to limit social networking interaction with smaller and specifically defined networks (close friends and family) is that it limits the amount of time Facebook users spend on the social network. This could result in an increase the amount of time spent on Facebook by Facebook users. This could improve the amount of advertising revenue generated.
- Facebook could charge Facebook pages for hash tagging. If the hash tag system is similar to Instagram or Twitter, then the tags will directly link back to the original person who used the hash tag. This is a particularly useful tool for companies, not-for-profits, or groups who want to spread the word. This leads to additional web-traffic for any company. Facebook could charge companies and organizations for using the hash-tagging feature on Facebook pages but leave the hash-tag feature completely free for normal Facebook users. This will result in Facebook being able to balance its profit incentive while being able to maintain an open and free social network.
While the hash tagging system is not exactly rocket science, I sure hope Facebook has something more up its sleeve. Facebook has been spending a lot of cash on research and development. I certainly hope the research and development dollars spent can result in more than just some basic changes made to the Facebook platform. The figure below illustrates this.
Facebook has ramped up its spending on research and development. It increased its spending from $388 million in 2011 all the way up to $1.399B in 2012. I compared this to both Google (GOOG) and Yahoo (YHOO) to make some basic assumptions. First, Yahoo has been spending less and less on research and development in order to manage costs better, whereas Google is ramping up its spending on research and development.
Both Yahoo and Google provide a lot of web based services. My experience has been that the underlying web platforms that these companies have operated over the past ten years have improved, but not by leaps and bounds. Yahoo is cutting back spending and Google is expanding its R&D expenditures. The struggle the two companies are facing comes down to managing growth and investing capital. Clearly Google is extremely good at that, whereas Yahoo has to find its own niche in what is becoming more and more of a crowded market place.
Facebook and Google are both similar in that both dominate their own market. Facebook is the largest social network with Google being the largest search engine. I think that the media is hyping Facebook's expansion of its capital expenditure along with its R&D. Bloomberg even dedicated a video to how much Facebook is spending in terms of money on R&D and capital expenditure. I think it is crucial for a company to manage its costs, but I also believe especially in the technology space, that companies invest aggressively into identifying and exploiting unique market opportunities as they arise.
The company's cash from operations (cash generated by its primary business) has stagnated a little between 2011 and 2012. Facebook needs to identify and exploit actionable opportunities or identify ways to derive added profit from its pre-existing activities. This will result in sustained growth from its operations. I am not anticipating the "next social network" that will replace Facebook. What I am merely suggesting is that Facebook needs to find a better way to leverage its media platform in order to generate added profit for shareholders. Hash tags seem to be a good start, but there could be other things Facebook may have planned for its product road map which is why Facebook is spending so much on R&D related expenses.
Investors could find the recent declines in the price of the stock worrisome. The stock is trading below the 20- and 50- Day Moving Average which could be indicative of future losses in the price of the stock. The stock will recover so as long as analyst expectations is met and the company's management grows cash flows year over year.
Analysts on a consensus basis are anticipating earnings per share figures at around 0.57. This is substantially better than the 0.02 EPS figure for fiscal year 2012. The EPS figures for 2012 were extremely low because of the share based compensation expense based on the below picture.
In the second quarter of 2012, the company's share-based-compensation expense jumped to $1.1 billion. The effects on EPS are likely to be temporary. With 2012 being a special case year for fiscal performance, it would be wiser to focus on the cash from operations which remained relatively flat.
The bigger concern is whether or not the company will be able to generate substantial improvements in cash flow. I anticipate that the company will eventually be able to generate improvements in the bottom and top line performance. I believe that Facebook's management is capable of identifying and exploiting opportunities in the market place that could improve profits. Furthermore, I believe that Facebook will be able to derive added efficiencies from its operations, which would generate higher profit margins going forward. Based on those two assumptions I am willing to maintain a price target of around 30.83 to 42.18 for 2013 and 2014.
Overall I remain optimistic on the future performance of the stock, and I anticipate the stock to trade at a higher valuation so as long as the company is able to execute upon practical and reasonable growth opportunities in its competitive and product environment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.