Facebook posted good fourth-quarter results yesterday.
Facebook is a great company, with a great management team, and a big long-term opportunity. Facebook is growing at a very healthy rate, especially relative to most big companies. And Facebook still has lots of “platform” opportunities that may lead to big revenue opportunities in the future.
If investors are willing to bet that, at some point, those platform opportunities will unlock a huge revenue engine that will cause Facebook’s revenue and earnings to skyrocket, then investors can certainly buy the stock at this price (just north of $30).
But, otherwise, there’s just no obvious reason to do it.
Yesterday, after reporting good Q4 results, Facebook announced that expenses will grow much faster than revenue in 2013.
Facebook’s profit margin will drop.
As a result, Facebook’s earnings will grow at an even less-compelling rate this year than analysts were previously expecting them to grow.
If Facebook’s stock were trading at a low price-earnings multiple, or even a medium price-earnings multiple, this would be totally fine.
But Facebook’s stock is not trading at a low-price-earnings multiple. It’s trading at a high price-earnings multiple–nearly 50X this year’s projected earnings, before factoring in the estimate cuts that analysts are making after yesterday’s news.
Facebook’s 50X price-earnings multiple compares to multiples like these for other (relatively) hot growth companies:
- GOOGLE: 16X
- APPLE: 10X
Yes, there are some hot growth companies that trade at even higher multiples than Facebook, such as LinkedIn and Amazon:
- LINKEDIN: 90X
- AMAZON: 185X
Importantly, however, the profit margins of LinkedIn and Amazon are low and rising, whereas Facebook’s profit margin is high and falling. This means that earnings at LinkedIn and Amazon are likely to grow vastly faster than earnings at Facebook over the next few years. And LinkedIn’s revenue is growing more than twice as fast as Facebook’s, which means that the company deserves a much higher multiple.
(And Amazon’s valuation, especially, is almost inconceivably high. As an Amazon shareholder, I thank those who are loading up on the stock at this price, but I have no idea what they’re thinking.)
Now, there are times when valuation just doesn’t matter. Momentum investors, for example, don’t care about valuation. What momentum investors get stoked about is acceleration and upside surprises. It is the hope for this acceleration and upside surprises that has driven Facebook’s stock up 50%+ in the last few months. And last night, Facebook delivered that acceleration and an upside surprise. It also delivered margin improvement, which means even greater growth for earnings.
But are those trends going to continue?
We might get another couple of quarters of revenue acceleration, thanks, in part, to weak revenue growth in the first two quarters of last year.
But unless Facebook CFO David Ebersman was just sandbagging everyone, Facebook’s profit margin will drop over the next several quarters. That means that earnings growth will be weak. And, by the third quarter of this year, Facebook’s revenue growth will likely begin to decelerate again.
Some other facts to consider:
- Facebook’s non-advertising revenue–payments, Gifts, etc.–is not growing at all. Specifically, payments revenue is declining, and the small revenue from Gifts, et al, are not yet meaningful enough to make this revenue line grow. This means that all of Facebook’s growth has to come from ad revenue.
- Facebook’s mobile revenue is already 23% of Facebook’s total ad revenue–in part because the growth of Facebook’s desktop ad revenue has slowed to a crawl. If mobile ad revenue were a massive green-field opportunity, this wouldn’t matter. But there are signs that Facebook’s mobile ad revenue is already more penetrated than some optimists may think.
- Facebook’s mobile ad opportunity may already be more penetrated than you think. Facebook’s mobile revenue actually fell short of most expectations in the fourth quarter. Facebook also said that 65% of clients are already advertising on mobile. And Facebook is already talking about “tuning” mobile ad revenue, which is not something the company would be thinking about if the mobile opportunity were, say, only 10% penetrated. Yes, Facebook has a huge opportunity in mobile, but the growth of this revenue line may slow more rapidly than some folks are expecting.
- Facebook’s user growth is now coming in emerging-market countries in which there is little to no advertising revenue. The 1 billion users that Facebook already has have most of the money and purchasing power in the world. So the next 2-3 billion users that Facebook adds won’t be worth as much in terms of ad revenue as the 1 billion that Facebook already has. This, too, will likely temper the company’s revenue growth rate.
- Facebook’s other new product lines–Search, Gifts, etc.–generate almost no revenue, and CFO Ebersman threw cold water on the hope that this would soon change. Everyone is waiting and hoping that Facebook will suddenly strike gold with a magical new revenue stream. This certainly could happen, but, as yet, it hasn’t happened. And that’s not from a lack of trying.
The bottom line is this:
Given the price-earnings multiple that investors are paying for Facebook, it appears that the market still views Facebook as an explosive tech-growth story–a company that will blow away analysts expectations for many quarters and years to come.
Two years ago, before Facebook went public, this is exactly what Facebook was–and the stock valuation soared as a result.
In the past two years, however, Facebook’s growth has decelerated, and the company is no longer blowing away analysts’ estimates. This suggests that analysts have a pretty good sense of how fast Facebook is likely to grow and how much money it is likely to earn.
And the truth is that this growth rate just isn’t so compelling that it deserves a 50X earnings multiple.
Facebook is a great company. And Facebook CEO Mark Zuckerberg is doing exactly the right thing by investing heavily now instead of “maximizing profit” quarter after quarter. This long-term approach will almost certainly make Facebook more valuable in 5 years than it would be if Zuckerberg were to kowtow to Wall Street each quarter the way so many other companies do.
Another CEO that invests heavily instead of “maximizing profit” each quarter is Jeff Bezos at Amazon, and Amazon’s amazing success over the past 15 years shows how smart (and rare) this strategy is.
So the fact that Zuckerberg is choosing to do this should come as a great comfort to Facebook investors who are in the stock for the long haul.
But none of that means that Facebook will magically trade at a 50X earnings multiple forever. (No stock ever does). And those who plunge into it at this price should at least be aware of that.
I continue to think that Facebook is in the middle of a long-term “consolidation” process in which the stock’s multiple gradually compresses from a super-high “momentum” multiple to a more reasonable “growth” multiple (say, 20X-25X). That process often takes years. (See Google).
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