Pinterest (NYSE:PINS) is another Silicon Valley unicorn that is in the process of filing for an IPO in 2019. It is commonly viewed as another social network similar to Facebook (FB), Snapchat (SNAP), and Twitter (TWTR). Its recently filed S-1 reveals a very different kind of platform with some unique characteristics that set it apart from its more well-known peers.
In this article, I will first present several interesting insights uncovered from the S-1. I will then examine its business model, market potential, and financial performance. I will also discuss some of the concerns and risks related to this business. Finally, I will take a look at its valuation and recommend a course of action for an interested investor.
Note: This article will not focus too much on details of the IPO offering as it has been well covered by other articles. Instead, it focuses more on Pinterest's business fundamentals as a potential investment opportunity for a long term investor.
A Quick Overview
According to Pinterest's S-1, 85% of the users say that they go to Pinterest to start a new project. That makes Pinterest a very different platform than Facebook, Instagram, and Snapchat, where people go to connect and communicate with others, or Twitter, where people go to keep up with the latest happenings.
In Pinterest's own words,
"Pinterest is where more than 250 million people around the world go to get inspiration for their lives. They come to discover ideas for just about anything you can imagine: daily activities like cooking dinner or deciding what to wear, major commitments like remodeling a house or training for a marathon, ongoing passions like fly fishing or fashion and milestone events like planning a wedding or a dream vacation."
Pinterest is a two-sided platform that connects its users, who are looking for ideas, inspirations, and guidance for their own projects, to advertisers and brand partners, who can provide contents, products, and services to help these users get things done. On one side, it provides a visual discovery platform for these users, i.e., creatives, makers, planners, and DIYers, to go from inspiration to action. On the other side, it offers an advertising and commerce platform for advertisers and businesses to reach their target customers, who exhibit strong intentions through the activities they do on the platform. And therein lies Pinterest's business model.
Extracted from Pinterest's S-1, a few interesting insights, some of which may be surprising, may warrant an investor's attention.
1. It is More About Search and Shopping than Being Social
Pinterest lists Amazon (AMZN) and Google (GOOG) (GOOGL) as competitors in the S-1 in addition to Facebook, Twitter, and Snap. This is because a significant part of Pinterest's user experience is about discovery and action, which means search, especially visual search, and shopping. It, therefore, more resembles the Amazon and Google shopping experience. According to Pinterest, over two billion text-based searches and guided searches happen on its platform every month. There are still some social components as people can share their boards and follow others, but it is the discovery experience that is central to the overall Pinterest experience.
Since many people may perceive Pinterest as another social network, the fact that it is more about search and shopping may come as a surprise.
2. Users On the Platform Have Strong Buying Intention
As previously mentioned, many Pinterest users come to the platform to start their personal projects with specific purposes in their minds as they seek ideas and inspirations. Many of these projects will end up needing to buy ingredients, supplies, products, and services as they go through the discovery journey. Quoting surveys done by Comscore and Talk Shoppe, Pinterest says 68% of its users have discovered a new brand or product on Pinterest, and more of them are using Pinterest to find new shopping ideas and inspiration than on other consumer internet platforms. On Pinterest, there is an alignment between the user and advertiser objectives as this quote from S-1 indicates,
"People actively seek relevant commercial content on our service, and advertisers are increasingly providing it. This fundamental alignment between Pinner and advertiser objectives differentiates Pinterest from other services, and we believe the continued growth of our advertising business will improve the core Pinner experience over time."
Another quote from the S-1 is worth noting,
"The majority of pins saved on our service are from businesses. Ads do not compete with the content Pinners want to see - they are the native content."
In other words, Pinterest is perfect for advertising.
3. Pinterest is a Positive (non-toxic) Environment
On today's internet, consumers' digital experiences can be stressful or negative with social media being littered with toxic elements. This is NOT the case for Pinterest because it works hard to keep the platform optimistic and inspirational by actively removing toxic content. According to Pinterest S-1, 91% of its users say that Pinterest is filled with positivity, and 89% of them say that they leave the platform feeling empowered because they can explore new things on Pinterest without worrying about being judged. This is very rare, especially when many of Pinterest's peers have been under fire lately for various scandals as well as security and privacy concerns.
A positive and inspiring platform could be a boon to advertisers and businesses that want to foster positive brand association with their target audience.
4. Pinterest has Desirable Advertising Demographics
Pinterest S-1 also reveals user demographics that can be attractive to many advertisers. Of Pinterest's 250 million monthly active users, two-thirds of them are female. In the U.S., Pinterest's total audience includes 43% of U.S. internet users, including 8 out 10 moms, who are often the primary decision-makers when it comes to buying products and services for their household, as well as more than half of all U.S. millennials. Pinterest is still expanding internationally, attracting similar demographics.
According to S-1, "on average, Pinterest households were 39% more likely to buy retail products, and they spent 29% more than the average household."
Compelling Products and Value Propositions
Pinterest's two-sided platform offers compelling value propositions to both of its users and advertisers. And, they appear to appreciate the value they receive.
For the users, Pinterest offers an immersive and personalized visual discovery and project planning experience via products like product pins, recipe pins, video pins, home feed, search, visual search, and boards (for organizing ideas into collections). With Pinterest's users having created 175 billion Pins that are organized into 4 billion boards, Pinterest is able to aggregate an enormous amount of user intelligence into a taste graph, which powers Pinterest's visual recommendation engine to provide more relevant and personalized content experience specific to each user's taste, style, and preferences. As a result, 82% of users say Pinterest feels personalized to them.
Pinterest has also built features that encourage users to take action once they find what they are looking for, with a special focus on making it easy for people to purchase products they discover on the platform. For example, it offers features like Product Pins, which includes pricing and product info with direct links to the checkout page for easy shopping, and the Shop the Look feature, which uses computer vision technology to identify similar products for sale based on a picture on a user's Pin.
Finally, as mentioned before, Pinterest offers an empowering and positive environment where users can just be themselves, focusing on their interests and getting things done.
Since Pinterest monetizes primarily through ads, it offers advertisers three value propositions. 1) Advertisers can find a valuable target audience on Pinterest with a user base of attractive demographics and engaged users with strong shopping intent. 2) Advertisers can easily foster positive brand association with the target users on a positive platform like Pinterest. 3) With the entire Pinterest user journey from discovery to action, advertisers can put relevant content in front of them at the appropriate stage of their journey that matches advertisers' marketing objectives, including for example increasing brand and product awareness, promoting consideration, and encouraging sales.
With these value propositions, Pinterest's ad platform appears to be able to help advertisers to generate positive ROI from their ad campaigns, and this has encouraged them to spend more. Citing a 2017 study from Analytic Partners, Pinterest claims in S-1 that it has delivered $2 in profit for every $1 spent on its platform and that advertisers have increased their ad spend by 29% from 2017 to 2018, a net cash retention rate of 129%.
Pinterest's S-1 showcases some advertisers who have recognized great value from the platform. For example, Target saw a 10X return on ad spends on Pinterest over the holiday period in 2018, nearly 3X their total yearly goal. Pie Provisions, a small business that sells pie ingredient kits, saw a 600% spike in website traffic as pie lovers discovered the company through its first promoted pin on Pinterest.
Sensible Go-to-Market Strategy
Pinterest takes a measured and deliberate approach to attract users and advertisers, which investors may appreciate.
By initially focusing its resources on developing a robust platform with great user experience, Pinterest is able to grow its global user base primarily through word-of-mouth and organic traffic. This leads to low marketing cost for user acquisition.
To court large advertisers, who typically prefer white-glove services, Pinterest does employ sales teams for customer acquisition and retention. Having learned from serving the needs of these large customers, it has developed and refined its ad products and performance measurement tools. It is now extending these tools and capabilities to develop more robust self-serve tools for the SMBs. By deploying these self-serve tools, it can scale its ad platforms more efficiently and quickly to serve more advertisers without dramatically expanding its sales force, helping it to expand its operating margin. It is also taking what it has learned from the U.S. market and applying those lessons on its international expansion effort. Pinterest is also building capabilities to serve more verticals, helping it to further expand its market and to attract a more diverse group of users.
Pinterest's go-to-market strategy seems to be working well as reflected in its user growth and ad revenue growth numbers.
As the table below shows, Pinterest is able to grow total monthly active users from 160M in 4Q 2016 to 265M in 4Q2018, an annualized growth rate of 29%. While the growth rate in the U.S. has slowed to single digits in 2018, international expansion is still at a high rate of 33%. The slowdown in the U.S. user growth could indicate that Pinterest is approaching the limit in the U.S. and will need to rely more on international expansion for user growth.
Pinterest also shows impressive quarterly revenue growth ranging from 50s% to 60s% since 2016, with a 4Q 2018 revenue of $273M, a 57.8% year-over-year growth comparing to $173M revenue of 4Q 2017.
Profitability In Sight
Pinterest is not yet profitable, but its financials have shown a clear path toward profitability in the near future. Let's take a look at its financials.
As the table above shows, Pinterest achieved significant revenue growth (59% annualized growth) from 2016 to 2018 while expanding its gross margin meaningfully from 46% in 2016 to 68% in 2018.
Pinterest's operating expenses as a percentage of revenue have been steadily decreasing from 2016 to 2018, with R&D dropping from 56% to 33% and G&A shrinking from 18% to 10% while S&M remaining steady at 34%.
The rapid increase in revenue, coupled with expanding gross margin and decreasing operating expenses, has led to narrowing net loss, which has dropped significantly from $188M in 2016 to $75M in 2018.
Such positive trend shows that Pinterest's ad business has strong operating leverage. As it continues to scale its ad business, it will likely expand its profit margin and achieve profitability. In fact, Pinterest was profitable with a net income of $47M during 4Q 2018, the peak period for ad spending.
Note: Pinterest will recognize a large amount of share-based compensation during IPO quarter, which will negatively impact its GAAP earning.
Pinterest also has a solid balance sheet with ample cash and little debt. As of December 31, 2018, it has $628M of cash (including cash equivalents and marketable securities) and $282M of liabilities. With the amount of new equity expected from the IPO (estimated net proceeds of $1.15B - $1.32B), Pinterest will be in an even better financial condition because it will likely significantly reduce its debt.
Pinterest's near profitability and its healthy balance sheet are a reflection of the sensible approach it has adopted in growing its business. Investors should take comfort that Pinterest will likely not rake up a huge amount of loss for the sake of aggressive market expansion like some of the other highflyers do.
Market Potential and Optionality for Growth
The huge digital ads market provides ample room for Pinterest to grow while Pinterest's small share of total ad spendings means many advertisers may be unaware of Pinterest as an alternative platform to reach their target audience. This also implies more growth opportunity for Pinterest if it can successfully communicate its value propositions and demonstrate positive ROI to these advertisers. Here are the details.
The digital advertising market is projected to grow to $423B in 2022 from $272B in 2018, representing a 12% CAGR, according to IDC. With its 2018 revenue of 0.75B, Pinterest is taking less than 0.3% of the market share. A 1% share of the projected 2022 ad spendings will allow Pinterest to grow 5X from its current revenue.
Pinterest's average revenue per user also shows a lot of room for growth. In 2018, Pinterest's U.S. ARPU was $9.04, and international ARPU was $0.25. As a quick comparison, according to Facebook 4Q 2018 Earnings Presentation, Facebook's U.S. ARPU and International ARPU were $110 and $24.6, respectively. Pinterest can grow its ARPU 5X and still not reach half of Facebook's ARPU level.
Additionally, Pinterest has so far been focusing on monetizing through advertising only. Though it has already built some shopping-related features, it hasn't begun to monetize shopping yet. This gives optionality for Pinterest to expand its future revenue streams.
All these factors show that Pinterest has a long runway for growth, though the competition will be fierce.
Carving Out a Defensible Niche in a Competitive Market
Pinterest competes in the digital ads market with powerful companies like Google, Facebook, and Amazon, which round out the top three in terms of ad revenue (see chart below from eMarketer). Even though the market is competitive, it is in a unique position to carve out a defensible niche.
(Source: eMarketer Feb. 2019)
Pinterest can deploy a competitive strategy similar to the one of LinkedIn, which was acquired by Microsoft (MSFT). With LinkedIn, Microsoft is able to take a 4.1% market share to occupy the 4th spot on the top US digital ad companies list. LinkedIn has succeeded in competing for ad spending by owning a niche, professionals who engage in networking and career development activities on its platform, which is attractive to advertisers. In Pinterest's case, it is in owning the entire visual discovery experience for creatives, makers, planners, and DIYers that makes Pinterest attractive to advertisers, and this makes Pinterest competitive.
Pinterest has a flywheel network effect working in its favor to attract user engagement. As Pinterest's users discover, create, and organize their findings in pins and boards, they also contribute to the curation of content on the platform and help enhance Pinterest's taste graph, which in turn increases the value of the platform and attracts more users to join and participate. The entire ecosystem is self-organizing and ever-expanding. This is not any of its peers can easily replicate.
Pinterest is attractive to advertisers with its valuable audience and the way it allows advertisers to reach them natively while they are fully engaged with their activities in discovery mode. This is very different from the normal disruptive ad experience on other platforms. Pinterest needs to harness this competitive advantage that differentiates itself from its peers and continue to develop more tools to help advertisers easily reach its users natively for various marketing objectives while offering more robust measurement tools to gauge the effectiveness of each ad campaign.
Instagram has shown signs of moving into Pinterest's territory with the introduction of features like Collections and Shoppable Posts. Google also has been working on a visual search function. However, at the moment, they both still offer very different user experience and value propositions that attract a different audience than Pinterest. With a visual-based experience, Instagram could potentially post the biggest threat to Pinterest. Hence, investors should monitor the development.
With its unique user experience and strong value propositions, Pinterest has a good shot in securing a niche in the huge digital advertising market with ample growth opportunity. However, this is not without some concerns.
Slowing U.S. User Growth - Pinterest's single-digit user growth in the U.S. market could mean it has reached the market ceiling, leaving it to rely on international expansion for user growth and ARPU expansion for revenue growth.
Strong Competition - Pinterest faces some of the strongest competitors. There is no guarantee that it can successfully defend itself and take more market share. Though investors have reasons to be optimistic (as outlined before), they need to be mindful of this threat.
Reliance on Competitors for Key Functions - Many Pinterest users use their Facebook and Google credentials to log in to the platform. Google also sends tons of organic search traffic to Pinterest. If Facebook and Google make any change in these areas, it may negatively impact Pinterest's operations. Pinterest also uses Amazon AWS for its hosting solution. In addition to the obvious concern that Amazon is a competitor, hosting cost also greatly impacts Pinterest's gross margin as it is one of the biggest variable cost items.
Dual Class Structure - Pinterest's dual class structure will leave class A shareholders with minimal influence. Each share of Class B common stock will be entitled to 20 votes. As per S-1 notes, "The holders of our outstanding shares of Class B common stock will initially hold approximately 99.2% of the voting power of our outstanding capital stock following this offering."
Stock-based Compensation - Similar to many other tech companies, Pinterest relies on stock-based compensation to attract talents. While these are not cash expenses, they are still expenses to shareholders and will hinder the company's ability to achieve GAAP-based profitability, especially for the IPO quarter, when Pinterest will recognize a large amount of RSUs that will become vested. This also means potential near-term share dilution from these newly vested share post IPO.
With 529M shares outstanding post IPO (75M class A shares and 454M class B shares) and a proposed offering price range of $15-17 per share, Pinterest's market cap will range between $8B and $9B. This implies a Price to Sales ratio (P/S) of 10-11, about in line with many of the high growth tech stocks. With 50-60% revenue growth rate and expanding margins, Pinterest could potentially justify the high multiple, even though it is not yet profitable. It is also a discount from the reported $12B valuation of its last funding round. However, it is entirely possible that Pinterest is just being conservative in setting the initial price and may raise its final offering price if its shares are oversubscribed prior to the IPO date.
(Note: Pinterest would be valued as high as $11.3B if we include stock options and restricted stocks that could become vested upon IPO, but the official share outstanding count is 529M shares according to the S-1. This also means investors should expect near term dilution from such stock options and restricted shares.)
Using a 5-year earnings projection model, with the assumptions that Pinterest can grow revenue 30-35% annually for the next 5 years and achieve a 20-25% profit margin, we arrive at a projection of earnings per share of $1.32 by 2023. After applying a P/E multiple of 30 for a high growth business (bull case, 35 and bear case, 25) and a 15% discount rate to account for the high risks associated with a not yet fully proven business, we can derive a base case fair price of $20 (bull case, $28 and bear case, $13). To compute the margin-of-safety price for the value-oriented investors, we can apply an additional 50% discount. This leads to a margin-of-safety price of $10 for the base case (bull case, $14 and bear case, $7).
Note: A valuation model is meant to be used as a reference only because no one can predict the future. It is provided here simply to give a sense of what is possible.
Pinterest is an interesting business with unique and attractive value propositions to its users and advertisers. With the small market share that it is accounting for at the moment, it still has a lot of room to grow so long as it can continue to communicate its value propositions to its users and advertisers. Many advertisers may be unaware of Pinterest as an alternative platform to reach their target audience. They will likely to get onboard if Pinterest can successfully fill the awareness gap and build more robust advertising and shopping tools to help them achieve positive ROI. Though competition will be intense with some of the most powerful players in the field, Pinterest is in a good position to carve out a defensible niche as long as it can continue to amplify its uniqueness. This will enable Pinterest to continue its high growth rate and become profitable. As such, Pinterest deserves to be on the watchlist of a long-term growth investor.
Most IPOs tend to be volatile during the first few quarters in the public market with factors like IPO hype, dilution from newly vested options and restricted shares, expiring lockup period, and more. Prospective investors should be mindful about some of the potential risks and only invest in what they are comfortable with. Long-term investors can take time to observe the performance of an IPO and invest only after the stock meets expectations with a price that they believe is attractive relative to the risks and rewards they are willing to accept.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.