Facebook Faces Tough Challenges Ahead

Sep.28.12 | About: Facebook (FB)

By Adam Isaac

Facebook (NASDAQ:FB) is the biggest social media network in the world, with more than 900 million users worldwide. After the IPO, the FB stock has been plunging and currently trades in the lower twenties. While, the stock has been plunging, the biggest challenge for Facebook is increasing its revenue generating capabilities. At the moment, even at such low prices, FB stock does not justify its price multiples. In my previous articles, I have looked at Facebook from different angles. However, the theme has been the capability of the company to generate enough revenues to justify its valuations. I have also suggested some strategies to maximize revenue. In this article, I will look at some potential pitfalls and challenges for FB in the coming six months, and how it can affect shareholders.

Facebook is trying to revolutionize the online advertisement, and with the type of data it has access to, not many would bet against it. However, using this data is a challenge in itself. At present, the company cannot seem to come up with an idea to appease both consumers and advertisers. Just before the IPO, General Motors (NYSE:GM) decided to pull its $10 million advertising budget from Facebook. The main reason was that GM wanted bigger, higher impact ad units. On the other hand, Facebook claims to have the best consumer experience online. Therein lays the main issue and that is a tradeoff between the user experience and the satisfaction of advertisers.

Will Facebook mobile be a success?

Facebook management has pinned all of their hopes on Facebook mobile, and how it is going to augment declining revenue growth. However, a recent survey by Appcelerator and IDC indicates that it may not be easy for FB to generate revenue from mobile users. Appcelerator and IDC surveyed 5,526 Appcelerator Titanium developers from August 22-28, 2012 on their perceptions about current debates in mobile, social, and the cloud as well as their development priorities. It is believed to be the biggest mobile developer survey of its kind. An incredible 66% of mobile developers affirm that it is "likely to very likely" that a mobile-first social startup will disrupt the market for social applications on mobile devices and take market share from Facebook.

It is common in the technology sector for customers to switch allegiance for new technologies. As I mentioned in my previous article, Facebook is no more a novelty and is likely to lose market share to new apps. If Facebook is not able to achieve expected growth in the mobile sector, the firm can be in serious trouble.

Lock-up Release and Hefty Tax Bill

A large number of Facebook shares will become eligible for sales in the next year. As a result, shares may enter the market in a steady torrent, which may cause an oversupply of shares. At the moment, there are only 25% of the total shares outstanding for Facebook, as 10% shares (268 million) became eligible for sale on August 15, 2012. However, by May 2013, 70% of total Facebook shares can be in the market due to the expiry of lock up period. Therefore, an influx of the shares can put a pressure on the price of FB. Although some of the shareholders may be wary of selling the stocks at such low prices, some will surely sell and try to get out. The remaining may want to sell if the stock price increases, and this can create a consistent selling pressure on the stock.

Recently, Facebook director Peter Thiel sold major portion of his stake in the company for almost $400 million. Thiel, one of the earliest investors in the company, sold approximately 20.1 million shares on August 16 and August 17, raising $395.8 million. The sale came after the first "lockup" period expired. As a result of the sale, FB stocks came down to $19.05. At the moment, the stock is trading around $20, and the next lock-up period will expire in mid-October. Facebook stock will see another fall in price, as I believe investors will look to get out. In October, another 247 million shares will be available for sale in the market.

Another problem that Facebook faces is an enormous tax bill related to its employee stock compensation program. Facebook will have to pay around $2 billion to the U.S. government to pay the withholding tax on its Restricted Stock Units (RSUs). However, the company seems to have this issue covered through its cash reserves and credit lines. Facebook established credit lines with the banks it used to underwrite the IPO. Earlier suggestions of a secondary offering have been rejected by the company.


For Facebook, the same questions remain; will the company be able to generate enough revenues to justify its lofty multiples? Even at $20.79, the stock is still trading at 30x-35x next year's expected earnings, as opposed to 12x for Apple (NASDAQ:AAPL) and 13x for Google (NASDAQ:GOOG). Facebook can come down significantly, and the multiples will still look expensive as compared to the leaders in the tech industry. I believe the firm is trying hard to come up with strategies to increase its revenues and allay the fears of its investors. However, it will have to go through another tough six to eight months before it can see any improvement.

Disclosure: I am long GOOG, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.