Facebook - Why Shares Are Cheap If The Company Can Boost Its Annual Revenues Per User

| About: Facebook (FB)

Today was the first time in its corporate history that social networking website Facebook (FB) reported its quarterly results as a public company. Shareholders initially reacted favorably to the report, but in after hours shares trading shares lost up to 12%.

Second Quarter Results

Facebook reported a 32% increase in quarterly revenues to $1.18 billion, coming in slightly ahead of analysts expectations of $1.16 billion. Advertising revenues rose 28% to $992 million, while revenues from payment and other fees rose to $192 million. In comparison, the company generated $1.06 billion in total revenues for the first quarter of 2012.

The company reported an operating GAAP loss of $743 million for the second quarter compared to a $407 million profit in the second quarter last year. Non-GAAP operating profits rose from $477 million to $515 million. On a non-GAAP basis the company net lost $157 million, compared to a net profit of $240 million in 2011. Net income on the GAAP basis came in at $295 million, or $0.12 per share. This beat analysts consensus by a penny.

Losses were driven by exploding share-based compensation expenses which are incidental to this quarter. The company spend roughly $1.1 billion in variable compensation, a figure expected to drop to $180 million for the third quarter of the year.

CEO and founder Mark Zuckerberg commented, "Our goal is to help every person stay connected and every product they use be a great social experience. That's why we're so focused on investing in our priorities of mobile, platform and social ads to help people have these experiences with their friends."

Additional information

Facebook ended the quarter with 955 million monthly active users. This is a 29% increase compared to last year's 739 million users and compares to 901 million users at the end of the first quarter. Daily active users came in at 552 million, up 32% on the year, and up 26 million compared to the first quarter. Mobile users came in at 543 million, up 67% on the year, and up 55 million from the first quarter.

The company is still growing reasonably fast in Asia and the rest of the world while North America and Europe have already transformed into mature markets. The company generated average revenues per user of $3.20 in North America for the quarter. ARPU (average revenue per user) in the rest of the world came in much lower. ARPU in Europe came in at $1.43, Asia at $0.55 and the rest of the world at $0.44. On a global scale ARPU was $1.28 per user.


Facebook ended its second quarter with roughly $10.2 billion in cash and marketable securities as a result of the $6.8 billion in net proceeds from the public offering. The company operates without any debt, leaving a net cash position of roughly $10 billion.

For the first six months of 2012 the company generated $2.24 billion in revenues on which it reported a net income of $48 million, or $0.02 per share. Non-GAAP income for the first six months came in at $582 million. At this rate the company is on track to generate annual revenues between $4.5-$5.0 billion on which it is expected to earn around $1.0-$1.5 billion on a non-GAAP basis.

Factoring in another 12% decline in after hours trading, the market values the firm around $50 billion, or $40 billion for its operating assets. This values Facebook at about 8-9 times 2012s expected annual revenues and around 35 times its expected non-GAAP earnings.

Investment Thesis

Shares of Facebook are hitting fresh lows in after hours trading. With shares trading below the $24 level, shares have lost some 40% from their public offering level of $38 per share in May. In their regular trading session shares already traded with losses of 8% after online game producer Zynga (ZNGA), which derives 90% of its revenues from Facebook, fell 40% in today's trading session after warning for disappointing results.

The firm has little room to grow as already one seventh of the world's population has an account. The close to 1 billion user base represents roughly half of the world's online population. From this point in time growth could come from more engagement. However users already spend more than 6.5 hours on the social networking website every month according to research company ComScore (SCOR).

Add to that the pressures the company is facing from the fact that more users access the website from their handset devices. Facebook is struggling to deal with advertising on mobile handsets and the devices have less screen room for advertisement. To improve the customer experience on a mobile handset the company acquired popular photo app-maker Instagram earlier this year. The key for Facebook is to increase its global ARPU, while making a successful monetization effort to service its mobile users.

While Facebook is extremely expensive from a "traditional" valuation standpoint it has plenty of room to grow. Soon the website will have over 1 billion members but it only manages to generate revenues of $5 per member, per annum. This is not a lot given that the average US Facebook user already spends some 80 hours per year on the website. Furthermore sophisticated information stream tracking could result in highly targeted marketing efforts surpassing effectiveness of TV advertisement or other forms of online advertising.

The main challenge for Facebook is to boost its global ARPU. If all users generate $3.20 in quarterly ARPU as they did in the US, the company is on track to generate $15 billion in annual revenues. Most likely the company will report billions in dollars of profit, making today's valuation of $40 billion for the operating assets look dirt cheap.

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