Facebook (FB) has started its IPO roadshow with a target date of Friday, May 18, as the first day of trading. I have taken the financial numbers from its latest S-1 filing and built a revenue and earnings model through 2014. I am backing out stock expenses since I believe the Street will remove these costs to get a better view of Facebook's operating results.
It can be difficult to project revenue and earnings one to two quarters in the future for mature companies so it is even harder to estimate results for new, quickly growing companies over a two to three year time frame.
I have summarized some of the key observations of the company's financial results and built three models through 2014. There is a base case using recent trend data, one that has revenue growth and margins improving vs. the previous few quarters and lastly one where the revenue growth and margins deteriorate faster than the past few quarters.
Valuation and thoughts on what could happen with the stock
The current price range for FB is $28 to $35. This would result in a market cap of $73 to $91 billion based on my share calculation of 2.6 billion shares. Assuming that the stock's initial price is $35 it would be trading at a 70x PE multiple using my 2011 EPS estimate of $0.50 (expensive but given its potential growth not too bad). Using my 2013 EPS base case estimate of $0.83 the stock would be trading at a 42x PE multiple. Note however that the earnings growth rate will have decreased from 79% in 2011 to 28% in 2013.
PE at $35
There seems to be tremendous demand for the stock from both institutional and retail investors. It would not surprise me to see the shares pop on the first day but keep in mind what the valuation and market cap would be if the stock moved significantly higher.
At $45 the 2013 PE multiple would be 54x and the company would be valued at about $117 billion.
Note that operating income only grew at a 22.5% annual rate in the March 2012 quarter vs. 40.9% in the December 2011 quarter and 87.3% for all of 2011. While it could bounce back to a higher rate with better revenue growth and expenses not increasing as fast they have recently it is a warning flag for slower earnings growth.
Opportunties: Global, Mobile and Payments
Facebook had 901 million active monthly users and 488 million mobile users in the March 2012 quarter. This huge number of users is both good and bad.
It's great that the company has almost 1 billion people that it can advertise to and monetize. However it will be difficult to grow this user base in some geographies (see the numbers on the U.S., Canada and Europe below) so the company will hit a ceiling on users (there are only so many people in the world). The wild card is China since the company is essentially barred from the country so if it can open up this market it would explode this number (but could find it hard to monetize).
The company is finding it difficult (as most companies are) to monetize mobile users. The experience is different using a smaller screen vs. a laptop/desktop so while this segment should grow faster it may not help as much financially.
Payments could significantly contribute to the company's financial results (think of PayPal at eBay) to grow beyond the 18% of total revenue in the March quarter. As with most initiatives there will be a balancing act between how broadly Facebook can expand it, how fast and at what take rate (probably not the 30% that it gets for Zynga's virtual goods).
Summary of key financial and business metrics
While year over year revenue growth is still strong at 88% in 2011 and 45% in the March 2012 quarter, this metric is decreasing and on a quarter over quarter basis was negative by (6.5)% in the March 2012 quarter.
Advertising revenue growth has declined from 102% year over year in the December 2010 quarter ($655 million) to 44% in the December 2011 quarter ($943 million) to 37% in the March 2012 quarter ($872 million).
The quarter to quarter growth rate for its advertising business (revenue of $872 million in the 2012 first quarter) was a negative (8)% vs. a negative (3)% a year ago.
Payments revenue had 98% year over year growth in the March 2012 quarter but revenue of $186 million is only 18% of total revenue and declined 1% quarter over quarter (vs. a positive 24% growth a year ago).
The company is attributing the quarter over quarter slowdown to seasonality but since the growth rates were significantly slower there could be more factors in play.
Note that Google (GOOG) has had only one quarter of revenue declining quarter over quarter. It was from the December 2008 quarter to March 2009 during the teeth of the recession when revenue declined by (4)% from $4.22 billion to $4.07 billion (note the much higher revenue levels than Facebook's). For the subsequent three March quarters (2010, 2011 and 2012) revenue increased 2.2%, 2.6% and 0% quarter over quarter so it has not been experiencing the same advertising weakness that Facebook has the past two March quarters of down (2.7)% and (7.5)%.
Gross margins increased from 2008's 54.4% to 2011's 77.1%. However March 2012 quarter's gross margin of 74.2% was 300 basis points lower than last years March quarter's 77.2% and down 420 basis points from the December 2011 quarters 78.4%. Note that my calculations remove a small amount of stock based compensation expense.
This could be a worrisome trend if it stays at this level or deteriorates through 2012 and beyond.
Operating margins (again removing the stock expense impact) fell from 54.0% in 2011's first quarter and 55.2% in 2011's fourth quarter to 45.7% in 2012's first quarter. This is significant deterioration and is due to a combination of lower gross margins, higher sales and marketing expense and to a degree higher R&D costs.
This is another worrisome trend since combined with revenue growth rates that are decelerating Facebook's EPS growth rate will decrease even faster.
I calculate that Facebook earned $0.50 in EPS for 2011. This is $0.07 higher than the $0.43 that is in the S-1 filing since I have removed the stock based expense from this calculation and adjusted for the tax impact of this. While my model also balances out to the $0.43 GAAP EPS I do believe that from an operating perspective (which more closely matches cash flow over a period of time) that backing out the stock comp expense is a better view of the company's results.
I also calculate that the company generated $0.10 and $0.28 in EPS in 2009 and 2010, respectively which matches the GAAP earnings since there was only a small amount of stock based compensation in those two years.
Facebook generates good cash flows. In 2011 the company generated $1.55 billion in operating cash flow and $943 million in free cash flow. This compares to $1 billion in GAAP net income and $1.14 billion in operating income when stock based compensation is removed.
Users by Geographies
Pay particular attention to the slowing growth rates in the U.S., Canada and Europe. It appears that these geographies are reaching saturation levels.
US and Canada daily active users of 129 million has had very low growth rates of 2% quarter over quarter the past two quarters. It appears that these geographies are becoming saturated as the year over year growth rates could hit single digits in the second half of 2012.
European daily active users of 152 million has experienced 6% quarter over quarter growth the past four quarters. I believe that Europe's active users year over year growth rate will drop to the mid-teens in 2013 and then low double-digits to high single-digits in 2014.
Asia daily users of 119 million is experiencing very rapid growth at 65% year over year in the March 2012 quarter. This part of the world should continue to experience strong growth but as you will see in the ARPU (Average Revenue Per User) section below its monetization is significantly below the US and Europe.
The Rest of the World (ROW) daily users of 126 million is also experiencing very strong growth at 70% year over year in the March 2012 quarter. However, its monetization is the lowest of any of the geographies.
Geography Revenue, Growth and ARPU (Average Revenue Per User)
The U.S. and Canada generated $1.6 billion in advertising revenue last year for 48% year over year growth and 50% of total advertising revenue. However, it was down 9% quarter over quarter in the March 2012 quarter.
The U.S. and Canada generated $331 million in payment revenue last year for 341% year over year growth but off a low base. While payment revenue still had strong year over year growth of 71% to $106 million it only grew 1% in the March quarter vs. the December quarter ($105 million).
The U.S. and Canada total revenue ARPU was $9.36 in 2011 (when analyzed on a quarter over quarter basis). ARPU increased 20% year over year but only 9% year over year in the March quarter and was down 12% quarter over quarter.
Europe generated $1 billion in advertising revenue last year for 81% year over year growth and 32% of total advertising revenue. However, it was down 10% quarter over quarter.
Europe generated $153 million in payment revenue last year for 595% year over year growth but off of a very low base. However, payment revenue decreased (2)% in the March quarter ($54 million) vs. the December quarter ($55 million).
Europe's total revenue ARPU was $4.70 in 2011, an increase of 30% from 2010 but only 11% year over year in the March 2012 quarter and was down 14% quarter over quarter.
Asia total revenue of $363 million increased 145% year over year but was only up 3% quarter over quarter in the March 2012 quarter. Also Asia's total revenue ARPU of $1.77 is significantly below the US & Canada and Europe geographies.
The Rest of the World's (ROW) total revenue of $277 million increased 174% year over year but was flat quarter over quarter in the March 2012 quarter. Also, the ROW's total revenue ARPU of $1.38 is the lowest of all the regions.
BASE REVENUE AND EPS CASE
Revenue growth decelerates from 88% in 2010 to 38% in 2011, 29% in 2013 and 25% in 2014.
Gross margin stabilizes at 75% vs. 77% in 2010 and 74% in the March 2012 quarter.
Operating margins stabilize at 49% vs. 53% in 2010 and 45.7% in the March 2012 quarter.
2011 EPS of $0.50 increases to $0.65 in 2012 and grows to $1.00 in 2014.
UPSIDE REVENUE AND EPS CASE
Revenue growth decelerates from 88% in 2010 to 43% in 2011, 37% in 2013 and 28% in 2014.
Gross margins stabilize at 75.5% vs. 77% in 2010 and 74% in the March 2012 quarter.
Operating margins increase from 45.7% in the March 2012 quarter to 49% in 2012, 50.5% in 2013 and 52% in 2014.
2011 EPS of $0.50 increases to $0.70 in 2012 and grows to $1.20 in 2014.
RISK REVENUE AND EPS CASE
Revenue growth significantly decelerates from 88% in 2010 to 31% in 2011, 16% in 2013 and 12% in 2014.
Gross margin deteriorates from 77% in 2011 and 74% in the March 2012 quarter to 72.5% in 2013 and 71% in 2014.
Operating margins decrease from 53% in 2010 and 45.7% in the March 2012 quarter to 44% in 2013 and 44.5% in 2014.
2011 EPS of $0.50 increases to $0.59 in 2012 and only grows to $0.70 in 2014
As I am able to gather additional information I will update my model and let you know of any major revisions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.