Thursday afternoon (July 26th), Facebook released its earnings for the second quarter of 2012, and had an earnings call at 5pm that day. Suffice it to say that the markets’ reception was one of disappointment.
On Friday, Facebook shares dropped some 12% to $23.70 per share. On Monday (July 30), the stock dropped further, closing at $23.15 per share. Tuesday (July 31), the beating continued, with Facebook shares trading at $21.80 per share as of the writing of this post.
Clearly, the markets have not received Facebook’s first earnings release well at all. Why?
Shortly after the IPO in May, I wrote three posts regarding the value of Facebook shares. The shares were trading in the $27-$29 per share range. The posts commented on the astounding pricing of the Facebook IPO ($38 per share and a $104 billion valuation) and questioned the sustainability of pricing at even the $27-$29 per share level based on some fairly basic present value calculations and comparisons with the pricing of Google.
In the third post, we looked at consensus analysts’ forecasts for revenue growth, which called for revenue growth on the order of 36% compounded for the next five years. The post provided some fairly basic math to show that if Facebook were to be able to achieve that fairly astounding level of growth for five years, and investors desired returns for their investments of 10% to 15% (i.e., equity discount rates), then Facebook shares had present values in the range of $21-$28 per share. The price at the time was $27.10 per share (June 8).
Needless to say, I was somewhat surprised when Facebook’s shares rose over the next couple of weeks to just over $33 per share (June 22 and June 26). However, I am reminded again and again in the markets that “hope springs eternal.” But that was before Thursday’s earnings release.
The Earnings Release and Result
For a few years in the early part of my career, I was in charge of investor relations for a regional bank holding company. In that capacity I had to write earnings releases. As a valuation guy for more than thirty years now, I’ve had to write about the performance of companies. In both situations, I have learned that it is nice to write so that readers can understand what is being said.
I always read financial disclosure with an eye to understanding the “story” behind what is being said. I have said many times about financial writing and about financial concepts: “If you can’t understand it, don’t stand for it.”
The Facebook press release and the accompanying “Earnings Slides” leave a few things to be desired in terms of transparency and detailing the story of the quarter. For the second quarter of 2012 in relationship to second quarter 2011:
- Revenues rose from $895 million to $1.18 billion, or 32%. Pretty clear.
- The Company reported a net loss of $157 million, or -$0.08 per share compared to net earnings of $240 million, or $0.11 per share a year ago. Ouch!
- Monthly active users (MAUs) were 955 million as of June 30, 2012, an increase of 29% year-over-year.
- Daily active users (DAUs) were 552 million on average for June 2012, an increase of 32% year-over-year.
- Mobile MAUs were 543 million as of June 30, 2012, an increase of 67% year-over-year.
This was the information provided at the outset of the release. The next section provided “Recent Business Highlights.” Under the “Product” category we learn of the release of some new mobile products, a global App Center, and plans by Apple for deeper Facebook integration.
Under “Advertising” we learn about some independent ROI (I assume that means “return on investment”) data and hopes to sell ads for Sponsored Stories.
Then, under “Corporate,” we read about the announced acquisition of Instagram, a settlement of litigation with Yahoo, a new data center, and the election of Sheryl Sandberg, Facebook’s COO, to its board of directors.
But what’s the story for investors? Most of the above was old news, except for revenue growth of 32% and the net loss of $157 million. What do we learn about the growth story that generated an IPO valuation of more than $100 billion just a few weeks ago? The press release actually began as follows:
MENLO PARK, Calif. – July 26, 2012 – Facebook, Inc. (NASDAQ: FB) today reported financial results for the second quarter, which ended June 30, 2012.
“Our goal is to help every person stay connected and every product they use be a great social experience,” said Mark Zuckerberg, Facebook founder and CEO. “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.”
Investors are looking for more. Mr. Zuckerburg can maintain his desires to connect the world and that everyone have a “great social experience” on Facebook. But investors are looking for the growth story that will justify pricing of Facebook shares at pre-announcement levels or better. Facebook shares dropped 12% to $23.70 per share on Friday, July 28th.
To put this drop into perspective, Facebook came public at $38 per share on May 17th. The stock closed at $38.23 per share the next day, which is the only day the stock has closed above its opening price. During the next three weeks, the shares traded down to the $27 per share range (when I was writing the posts referenced above). Then, bucking the tide, the shares rose during June, reaching $33.05 per share on June 22nd. The shares have been under substantial pressure since then.
Since closing at $29.34 per share on July 25th, the shares have dropped 25% to the $22 per share change during the day today.
Neither the press release nor the Earnings Slides nor the Earnings Call helped alleviate investor concerns over Facebook’s ability to execute a growth strategy
More About the Press Release
Perhaps not surprising given the altitude of the IPO pricing, share-based compensation expense related to pre-2011 restricted stock units (RSUs) totaled $1.3 billion for the quarter. That’s a lot of compensation — more than the entire market capitalizations of most public companies.
The non-GAAP operating margin (adjusted for share-based compensation expense) was 43% for the quarter, down from 53% in the second quarter of 2011. What the press release does not say is that operating income was in the vicinity of $500 million, which represented only about a 7% increase from the second quarter last year. That’s a far cry from 36% compounded for a long time in the future. I shouldn’t have to make those calculations to know this — and neither should investors.
We also learn that capital expenditures rose 212% (that’s 3.12x), from $132 million to $413 million, but we didn’t learn much about the why of the increase or the potential for the future upon which they were based.
We do learn that excluding the RSU expenses, net income was $295 million, or $0.12 per share, compared with $285 million, or $0.12 per share in the year-ago quarter. That’s not very exciting news after adjusting for the presumably non-recurring RSU expense. In fact, that is about as flat as can be. There’s no “growth story” here, at least yet.
The markets are looking for a believable growth story from Facebook. Until that story begins to emerge, Facebook shares will likely continue to be under pressure from impatient investors who remember the apparent push to grab the last dollars from the IPO with the last minute boost to $38 per share in May.
Disclaimer. I am approaching the topic of the pricing of Facebook as a business valuation guy. I am not offering investment advice of any kind, but am simply reflecting on valuation in the news as a business valuation analyst.