Facebook: An Interesting Long-Term Bet

| About: Facebook (FB)

Shares of Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL) are probably better long-term bets than Facebook (NASDAQ:FB), and investors would do well to skip its highly touted IPO, Barron's wrote in its May 14 edition. Facebook shares, if priced at $35, would be at a discount from a recent high of $44 in private trading on SharesPost in late March so could get a pop on the first day of public trading.

At $35, Facebook shares could be discounting $15 billion in annual ad revenues in a few years and $1.50 to $2 a share in profits. A doubling in Facebook's market value may require $30 billion or more of revenue by 2017, five to six times what the company is expected to generate this year. These revenues could produce $3 a share in earnings power and support a $70 stock, according to Barron's.

The company is seeking to raise about $10.6 billion by selling more than 337 million shares at $28 to $35 a share, which would value Facebook at $77 billion to $96 billion. Trading is expected on May 18.

Some Facts and figures

Facebook has more than 900 million active users. If the company were a country, it would be the third largest in the world after China (population: 1.34 billion) and India (population: 1.17 billion).

With 157 million members, the United States has the most Facebook users, followed by India with 45.9 million, Brazil with 45.3 million, Indonesia with 42.4 million and Mexico with 32.9 million.

Facebook is the most popular social network in every country of the world, with the exceptions of China, Japan, Poland, Russia, South Korea and Vietnam.

Last month, Facebook announced a billion-dollar deal to buy the startup behind wildly popular smartphone photo sharing application Instagram, its biggest acquisition to date.

Facebook says it had an average of 526 million daily active users in March 2012, an increase of 41 percent from a year ago. It had registered 125 billion "friend connections" as of March 31 and 3.2 billion "likes" and comments.

More than 300 million photos are uploaded to Facebook per day and more than 488 million active users access Facebook using mobile devices.

"The Social Network," the 2010 film about the origins of Facebook, won four Golden Globes -- including for best picture and best director -- but flopped at the Oscars, walking away with only awards for best adapted screenplay, original score and film editing.

Facebook, which currently employs some 3,500 people, has announced plans to hire "thousands" more over the next year.

Facebook is the leading social networking site of the world. Facebook mission is to make the world more open and connected.

Facebook helps internet users stay connected with their friends, families, and colleagues. It helps them discover and learn more about what is going on in the world around them. It helps them express themselves by sharing their opinions, ideas, photos, and activities. Facebook provides a number of products, free of charge, to its users. These include: Timeline, News Feed, Photos and Videos, Messages (Email, Chat, Text Messaging), Groups, Lists, Events, Places, Subscribe, Ticker, Notifications, and Facebook Pages.

Business Reach and Revenue Streams

Facebook offers a unique combination of reach, relevance, social context, and engagement to the advertisers. Advertisers can engage with users based upon the information shared by users such as age, gender, location, education, work history or specific interests. Facebook offers advertisers an ability to include social context in their ads. Social context highlights a user's connections with a brand or business. Businesses can also create Facebook Pages to engage with interested customers and simulate an ongoing dialog with them.

Facebook offers development tools and APIs that enables developers to easily integrate with Facebook. Developers can use Facebook platform to build apps and websites that are more personalized, social, and engaging. Facebook offers developers Open Graph API and Social Plugins that developers can use build different user experiences, including Apps on Facebook, Desktop Apps, Mobile Apps, and Platform-integrated websites. At the end of 2011, more than 7 million apps and websites had been integrated with Facebook. Facebook offers developers an online payment infrastructure that enables developers to receive payments from the users in an easy-to-use and secure environment.

While advertisements remain a key source of revenue for Facebook, the contribution from payments is increasing consistently. Payment revenues increased from nearly 2% in 2009 to 15% in 2011. Ad revenues contributed 85% to the total revenues in 2011.

Facebook is investing heavily into Facebook-owned data centers. This is to support user growth, increased user engagement, and delivery of new products. Facebook data centers currently store more than 100 petabytes (100 quadrillion bytes) of photos and videos. This is going to increase further in the future as users engage more on Facebook. To support these massive storage and computing needs, Facebook custom designed and built their software, servers, and data centers from the ground up.

To increase the user engagement even further, Facebook has partnered with companies such as Netflix (NASDAQ:NFLX), Hulu, Spotify, Washington Post (WPO) providing online movies, TV shows, music, and news. Their apps help users share what they are watching, listening, or reading with their friends and family.

Gross Margin Levels.

Facebook has even higher gross margins than Google. In fact, they are amongst the highest in the technology industry.

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Marginal Profitability Calculation.

To check whether higher revenues are translating into higher profit margins, you can compare the revenue growth with the operating profit growth. Higher operating profit growth would mean higher marginal profitability.

For Facebook, operating margins were negative during 2007-08, reached a peak of 52% in 2010, and then declined to 47% in 2011. Google's revenues and operating income grew at same pace at 23% CAGR from 2007 to 2011. For Facebook, it is not possible to calculate CAGR number because its operating income was negative during 2007-08. However, Facebook operating margins are very healthy and are higher than Google.

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Facebook revenues grew from $153 million in 2007 to $3.7 billion in 2011 at a 4-year CAGR of 122%.

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Clearly, Facebook has grown much faster than Google over last 5 years. However, if we take a look back into Google's early years, its numbers were better than Facebook numbers today. Google was founded in September 1998. Facebook was founded in February 2004. In its 4th year of operations, in 2001, Google revenues were $86 million. By 2005, Google revenue reached $6.1 billion at a 4-year CAGR of 190%.

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Final Note

Facebook is a very promising company and comparable to Google. I don't share Barron's view that there are probably better long-time bets. Both companies have a big mission that they are after. Facebook's mission is to make the world more open and connected and Google's mission is to organize the world's information and make it universally accessible and useful. These missions are driving scale and innovation in these two companies. The global online advertising market is big and will expand further. Both players are in a good position to capitalize on the global opportunities that will occur.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.