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Earnings Summary:
Fiscal Year ending Revenue, net ($MM) EBITDA ($MM) Diluted EPS P/E 12/11 3,711 2,296 $0.44 62x 12/12E 5,531 3,385 $0.40 69x 12/13E 7,327 4,411 $0.88 31x
US$27.40
(FB)
Facebook began as an extension to college life but has grown to become the global network of choice for connecting, socializing and sharing with friends. Excluding China, Facebook now connects 49% of the online population and is the dominant network in all but six nations. The companys vision of a social web has triggered a complete re-tooling of how sites are organized, as publishers yearning not to be left behind embrace social networking just to stay relevant. Advertisers have followed in suit, spending ad dollars to start conversations with customers, with little measure of its worth or benefit; in fact, connecting these two dots for advertisers seems to be the one challenge Facebook has failed to conqueras of yet! FY2011 Highlights
Revenue for FY2011 grew +88% Y/Y to $3.7B, with Online Advertising accounting for 85% of total. The remaining 15% was from Payments, which grew 425% due to the success of Zynga. Facebook attracted over 800 MM monthly active users, and it now accounts for 1 in every 7 minutes spent online, worldwide. It is estimated that Facebook delivered 7.8 trillion display ads during FY2011.
27.8x 250%
18.8x -35%
14.4x -16%
17.2x 169%
11.5x 154%
8.7x 138%
Key Risks
1. Competition from existing social networks (Google+, Twitter, LinkedIn) 2. Members accelerate migration towards mobile 3. Advertisers see diminishing value in social ads 4. Members experience diminishing returns from social networking
Valuation
The $27.40 price target was arrived at using DCF analysis with a WACC of 11.15% and assumed perpetual growth of 6%. The key drivers for this analysis include a 4-year revenue CAGR of 32% with adjusted EBITDA margins dropping to 59%. This gives Facebook a market cap of $73B and a resulting FY2012E EV/EBITDA multiple of 19x.
Financial Outlook
The Market for Social Networking
Social networking sites now reach 82% of the worlds online population, or 1.2 billion users. As the reach has proliferated, so has engagement. Since March 2007 when only 6% of the time online was spent on social networking sites, the participation level increased 230% to nearly 1 in every 5 minutes in October 2011, as shown in Exhibit 1 (source: comScore).
15%
Online Advertising Payments
85%
Online Advertising The key drivers for Online Advertising are 1) member count, 2) ad views per member and 3) revenue per thousand impressions, or RPM.
1. Member Count Facebooks MAU-count grew by 39% in FY2011 to reach 800MM+. Exhibit 3 shows the penetration of Facebook by region in terms of existing Internet users. With the total number of Internet users excluding China at 1.6B, Facebook is just short of 50% penetration worldwide.
Exhibit 3: Facebook Penetration of Internet Users by Region
The appeal of social networking has no boundaries. It has grown irrespective of geography, culture, or age group. Even the least tech-savvy age group of 55+ now experiences a penetration rate of 80% worldwide.
Revenue
Facebook earns revenue through Online Advertising and Payments. It currently captures 4% of the $76B online advertising market; the market is set to grow at a CAGR of 12% over the next 4 years. Revenue for Payments is earned by collecting a 30% charge from online purchases within the Facebook platform. Thus far, this market seems limited to the confines of virtual goods, which is estimated at $8.5B. As a platform provider, Facebook faces a market opportunity of $2.6B (30%) for Payments; it currently captures 21% of this market. Exhibit 2 illustrates the composition of total revenue during FY2011.
40% 65% 20% 0% 32% 42% 47% 25% 67% 63% 49%
Aside for China and Iran who both block Facebook, there are only 5 markets where Facebook does not have the largest social network: Japan, Poland, Russia, South Korea, and Vietnam. In all these markets, Facebook has an increasing presence and will stand to benefit from citizens already accustomed to social networking.
Facebook overtook Orkut in India during 2010 and Brazil in early 2012 as the dominant social network in those regions. These two markets alone possess 100 MM additional potential members for Facebook. Capitalizing on these opportunities, and with increased exposure leading to higher adoption rates in smaller nations, I expect Facebook to add 455 MM members by 2015 (207MM were added in 2011 alone). This amounts to a global penetration rate of 81% or 1.3B users.
There is no drop at the moment because of a counteracting force. The 2% growth in ads delivered per MAU shows that the ads lost due to mobile have been absorbed by the ads gained due to higher engagement (perhaps attributable to the ever real-time information supplied from mobile updates!). Even in the U.S. where smartphone penetration is at 44%, the ads delivered per MAU statistic has grown slightly. Now with Sponsored Stories to be presented alongside all Facebook pictures, I expect the growth in ads per MAU to reach a high of 5% in FY2012 before declining to the pressure of mobile and reaching 2% by FY2015. Exhibit 4 shows the resulting 20% CAGR growth in total ads delivered by Facebook into FY2015.
2. Ad Views per Member I have inferred that Facebook delivered an astounding 7.8 trillion display ads worldwide in FY2011, a growth of 42% Y/Y. The number of ads displayed is directly related to the number of ads per page and the page views per member. a) Ads per Page In his letter to investors, Zuckerberg makes it clear that Facebook will not compromise user experience for financial gain. After the re-work to the delivery of ads in late 2010, there have been little changes to the quantity and prominence of ads on the Facebook website. No changes are expected for the foreseeable future. b) Page Views per Member According to comScore, the average Facebook user spent 6.3 hours on the site in October 2011, a growth of 40% Y/Y. However, ads delivered per MAU on an annual basis grew only 2% in 2011, proving that much of that growth has not been monetized. Perhaps mobile is to blame. Mobile remains a bitter-sweet topic for Facebook. An analysis of digital media consumption across a sample of U.S. iPhone and iPad owners showed that these devices increased the reach of social networking by 12.5% and the duration spent by 2.8 times (source: comScore). But even while mobile is increasing the potential pie for Facebook, it is also eating into the top line as members forego ads each time they access Facebook from their mobile. In December 2011, 425 MM or just over 50% of the members accessed Facebook through mobile. Furthermore, mobile MAUs are expected to grow faster than overall MAUs due to the growth in popularity of smartphones. This will effectively lead to a drop in ad delivery per MAU.
Trillion
CAGR 20%
11.4 10.0 7.9 5.5
12.7
13.9
2010
2011
2012E
2013E
2014E
Facebook will not introduce ads into mobile in the conventional manner. The company would rather incorporate ads such as Sponsored Stories directly into the newsfeed so as not to detract from the user experience. This method of delivering ads, however, is new and will need to be proven at the website level before being deployed to mobile. Therefore, I do not expect ads to appear on mobile in the foreseeable future and have not included any such revenue into my model.
3. RPM Facebook does not report this statistic, and the current RPM of $0.45 is based on my own marketing campaigns on Facebook in the U.S. market. (This amount falls in the ballpark estimation by Trefis, a financial community that associates trends with market price.) This RPM is a stark contrast to LinkedIn display ads which earn a RPM of $5.27. 3
2015E
To date, Facebook has compromised innovating on the ad front in order to grow its member base and page views. However, both these aims have a growth ceiling. RPM, on the other hand, is boundless and only limited by the innovation Facebook is able to introduce into this newly developed market for social ads. Therefore, this third criterion is where Facebook has potential to grow its top line. There is substantial room for improvement, but Facebook is currently limited by the inability of brands to associate a financial benefit to social ads. It would seem that Facebook has waited too long to tackle this issue. The latest said innovation on delivering ads is Sponsored Stories, which is just a play onto the Sponsored Tweets originated by Twitter. It would have been easier for Facebook to test the success of this and other ad innovations before the IPO, but now every attempt will be scrutinized by the public and deemed a failure if modest results are not immediate. I predict only a steady growth in the RPM over the next four years, fuelled by minor improvements in the delivery of ads. The RPM will reach $0.60 by FY2015, which is still more generous than the $0.52 estimated by Trefis. Exhibit 5 summarizes the key drivers for Online Advertising over the four-year horizon, with revenue reaching $8.3B by FY2015.
Facebook in order to thrive is social games, with the most successful company being Zynga. Revenue from Payments is expected to increase at a 53% CAGR from FY2011 to FY2015 resulting from the continued forecast success of Zynga. At $3.1B of revenue in FY2015, this gives Facebook 57% of the market share for Platform providers to virtual goods.
Expenses
The lines between search and social are disappearing, and Google is in fact the biggest competitor to Facebook. They operate at a comparable scale and have a similar core business model of providing valuable content to attract viewers and advertisers. As such, I have modeled Facebooks expenses to converge towards the ratios currently experienced by Google. Gross Margin: The companys gross margin in FY2011 was 77%, which is substantially higher than the 66% recorded by Google. For Google, cost of revenues consists primarily of traffic acquisition costs through AdSense which enables Google to advertise on other sites. Much of the traffic acquisition for Facebook, however, is free as sites choose to integrate with Facebook to enhance the experience of its own viewers. Therefore, the gross margin should remain steady at 77% for the foreseeable future. Sales and Marketing: Facebooks Sales and Marketing expense at 12% of revenue was equal to that of Google in FY2011, and will remain steady at this rate.
2011A MAU Count (MM) Growth Y/Y Ad Views per MAU RPM ($) Revenue from OA ($MM) 845 39% 9,303 0.40 3,154
Product Development: This expense was 10.5% of revenue in FY2011 but has shown a rising trend in the last three quarters. The need to innovate in order to compete will grow this expense to Googles level at 13% of revenue by FY2014. General & Administration: This expense has been comparable to that of Google, floating between 6-8% of revenue in the last two years. It will continue to be at 7% for the foreseeable future. Tax Rate: There is a vast discrepancy here with Google paying a 21% effective tax rate in FY2011, compared to 41% for Facebook. This is most likely attributable to the fact that Google earns substantial income in countries that have lower statutory tax rates. Currently, Facebook earns most of its revenue from North America and Europe, but the majority of growth in the future will 4
Payments Revenue from Payments is directly related to the ability of companies to collect revenue from members on the Facebook platform. The Open Graph, however, makes it possible for companies to collect revenue on their own site while still accessing the social richness of Facebook. The only business that seems to require the contours of
come from international revenue. Therefore, this gap should begin to narrow, and Facebook is expected to pay an effective tax rate of 25% by FY2015.
Exhibit 7 shows the calculation of the price target at $27.40. At a market cap of $73B, Facebook would trade at 14.4x FY2013 EV/EBITDA and at a price-to-earnings multiple of 31x on FY2013 EPS estimates.
Management
The executive team balances well around the young creative founder. Zuckerberg, aged 27, may seem young to be at the helm of the worlds largest network, but he does have the experience and record success of leading the company this far. He also has the benefit of Sheryl Sandberg as COO and David Fischer as VP of Marketing; both formerly holding the title of VP, Global Online Sales & Operations at Google. Management seems to understand and appreciate the sensitive divide between members and investors. In his letter to investors, Zuckerberg highlights that Facebook is not focused directly on maximizing shareholder value, but rather on earning money as a means to deliver better services. This is a welcomed stance for a company whose members are literally one-click away from the do no evil mantra held by Google. Facebook simply cannot afford to alienate its members for the sake of short-term gains.
Weighted Average Cost of Capital % Assumed Perpetual Growth % Undiscounted Terminal Value ($MM) Net Present Value of Free Cash Flow to Enterprise Plus: Cash and cash equivalents Less: Net Debt Less: Minority Interest Implied Equity Value ($MM) Fully Diluted Shares Outstanding (MM) FAIR VALUE per Share
Exhibit 8 highlights that under this valuation, Facebook would trade at a 138% premium to comparables based on the EV/Sales multiple of 8.7x for FY2013.
Valuation
The $27.40 price target was arrived at using a DCF model with a discount rate of 11.15% and a terminal growth rate of 6%. Exhibit 6 shows that revenue grew at a CAGR of 32% from FY2011 to FY2015, with 73% of the FY2015 revenue being earned from Advertising. EBITDA margins are expected to decrease by 267 basis points from FY2011-15 as Facebook invests to compete with Google in a future where companies may see little difference between search, mobile, and social networking.
Exhibit 6. DCF Analysis
Average of Selected Internet Companies Average of recent IPOs Overall Average of Comps
Facebook Premium (Discount) Vs. Average of Selected Internet Companies Average of recent IPOs Overall Premium (Discount) Vs. Comps 285% 79% 169% 218% 90% 154% 188% 85% 138%
FY2011 Revenue : $MM Y/Y growth rate Adj EBITDA EBITDA - % of Revenue Cash taxes Capital Expenditures Change in Net WC FCFF ($MM) 3,711 88% 2,296 62% (695) (606) 5 1,000
4Y-CAGR 32%
31%
25% 42%
Exhibit 9:
Description Class A common stock outstanding before IPO Class A common stock issued for IPO Class B common stock outstanding before IPO Class B common stock from conversion of Preferred Class B common stock from vesting of pre-2011 RSUs Total Class A, B outstanding after IPO Options and other equivalents: Class B options at $0.19 per share weighted avg. exercise price RSUs Shares subject to repurchase Warrants Class B common stock reserved for future issuance Total Class A, B outstanding after IPO Class B options to be vested over time Class B RSU's to be vested over time Diluted total (including all RSUs): MM
Exhibit 10:
2010 Mar-11
Net Revenue Sequential Change Growth Y/Y Costs and expenses: Cost of revenue Gross Profits Goss Margin
$777
$345
$432 25%
$467 8%
$731 57%
$1,974
$731 0%
$895 22%
$954 7%
$1,131 19%
$3,711
$5,531
$7,327
$9,243
$11,412
186%
154%
88%
49%
32%
26%
23%
Sales and marketing Product development General and administrative Operating costs
115 87 90 292
36 25 22 83
44 32 26 102
45 41 34 120
59 45 40 144
68 57 51 176
103 99 76 278
Income (loss) from operations Add: Dep and ammort Add: Share based comp Adjusted EBITDA Adjusted EBITDA Margins Incremental Adjusted EBITDA Margins YOY Other income (expense), net Income (loss) before income taxes Provision (benefit) for income taxes Net income (loss) Less: Net Income Attributable to participating securities Net Income attributable to common stockholders
162
219
216
437
388
407
414
548
1,756 323 217 2,296 62% 64% (61) 1,695 695 1,000 332 668
1,632 481 1,272 3,385 61% 60% 1,632 571 1,061 1,061
3,370 637 403 4,411 60% 57% 3,370 1,011 2,359 2,359
4,160 804 508 5,472 59% 55% 4,160 1,040 3,120 3,120
5,135 993 628 6,756 59% 59% 5,135 1,284 3,851 3,851
Basic EPS Diluted EPS Basic share count (MM) Diluted share count (MM)
$ 0.12 $ 0.10
$ $
Exhibit 11:
Advertising Revenue ($MM) Growth Y/Y Online: Monthly Active Users (MM) Growth Y/Y Online: Daily Active Users (MM) Mobile: Monthly Active Users (MM)
764
340
424
450
655
637 87%
776 83%
798 77%
943 44%
327
483 425
Number of Ads delivered (B) Growth Y/Y Ads delivered per MAU Growth Y/Y RPM Growth Y/Y
1,821
5,536
2,112 16%
9,106
0.36
0.34
0.45 24%
0.40 18%
Payments and Other Fees Revenue ($MM) Growth Y/Y Zynga Revenue ($MM) Virtual Goods Market ($B) FB Share
13
17
76
106 715%
94 1780%
188 147%
3,087 37%
7.0 1.5%
18.2 17.0%
$777
$345
$432
$467
$731
$1,974 154%
$731 112%
$895 107%
$954 104%
$1,131 55%
$3,711 88%
$5,531 49%
$7,327 32%
$9,243 26%
$11,412 23%
Exhibit 12:
71% 1,689
71%
74%
72%
79%
75% 373
77% 614
77% 223
75% 331
78% (132)
77% 180
77% 17
77% -
77% -
77% -
Sales and marketing $ (MM) Sequential Change Growth Y/Y Sales and marketing as % of Sales YOY change in bps
115
36
44
45
59
184
68 15%
103 51%
124 20%
132 6%
427
906 112%
879 -3%
1,109 26%
1,369 23%
60% 15% 10% 10% 10% 8% 9% (548) 9% (113) 12% 132 13% 336 12% 360
Product development $ (MM) Growth Y/Y Prod dev as % of Sales YOY change in bps
87
25
32
41
45
144 66%
57 128% 7.8% 55
11%
7%
7%
9%
6%
7% (390)
General and administrative $ (MM) Sequential change $ G&A % of Sales YOY change in bps
90
22
26 4
34 8 7%
40 6 5%
121
51 11
76 25 8% 247
72 (4) 8% 27
80 8 7% 160
280
532
513
647
799
12%
6%
6%
6% (545)
7% 60
7.5% 142
9.6% 208
7.0% (262)
7.0% -
7.0% -
40%
41%
35%
30%
25%
25%
Exhibit 13:
Balance Sheet Metrics Days Sales in Receivables Prepaid Expenses as % of Total Expenses PP&E as % of revenue Days COGS in Payables Days COGS in Platform Partners Payable Accrued Liabilities as % of Total Expenses Deferred tax liabilities as ratio of IT Deferred revenue as % of total 69 9.3% 29% 21 56 15% 5.6x 2% 54 7.6% 40% 27 73 15% 5.1x 2% 54 7.6% 35% 27 73 15% 7.2x 2% 54 7.6% 33% 27 73 15% 8.4x 2% 54 7.6% 32% 27 73 15% 6.3x 2% 54 7.6% 30% 27 73 15% 6.1x 2%
10
Exhibit 14:
11
Exhibit 15:
Facebook - Comparables
P/E 2012 2013 95x 14x 16x 14x 17x 31x 52x 12x 13x 12x 14x 21x EV to EBITDA 2011 2012 2013 37x 11x 8x 13x 16x 17x 27x 9x 7x 11x 12x 13x 19x 8x 6x 9x 10x 10x EV to Sales 2011 2012 2013 1.7x 3.4x 2.7x 7.1x 7.4x 4.5x 1.3x 2.9x 2.4x 5.8x 5.7x 3.6x 1.0x 2.6x 2.1x 4.9x 4.5x 3.0x EBITDA Margins 2011 2012 2013 5% 32% 36% 55% 47% 35% 5% 32% 36% 54% 46% 35% 5% 33% 36% 54% 47% 35% Revenue Growth 2011 2012 2013 43% 27% 33% 33% 49% 37% 34% 18% 15% 23% 30% 24% 29% 13% 12% 18% 25% 19%
Company Internet Companies AMZN Amazon.com EBAY eBay Inc. ACOM Ancestry.com GOOG Google 700-HK Tencent Average Recent Internet IPOs GRPN Groupon LKND LinkedIn ZNGA Zynga Average Overall Average
$ $ $ $ $
123,776 $
12
Exhibit 16:
Revenue Sequential Growth rate CAGR Adj EBITDA EBITDA as % of Net Revenue Cash taxes Capital Expenditures Change in Net Working Capital Unlevered Free Cash Flow
FYE 2012 5,531 49% 49% 3,385 61% (571) (942) 78 1,950
FYE 2013 7,327 32% 41% 4,411 60% (1,011) (1,120) (61) 2,219
FYE 2014 9,243 26% 36% 5,472 59% (1,040) (1,344) 15 3,103
FYE 2015 11,412 23% 32% 6,756 59% (1,284) (1,458) 11 4,024
DCF Valuation (in $MM) Weighted Average Cost of Capital % Assumed Perpetual Growth % Undiscounted Terminal Value Net Present Value of Free Cash Flow to Enterprise Plus: Cash and cash equivalents Less: Net Debt Less: Minority Interest Implied Equity Value Fully Diluted Shares Outstanding (MM) Implied Equity Value per Share $ 11.15% 6% 82,833 63,718 8,908 0 0 72,626 2,651 27.40 $ 27.40 10.15% 10.65% 11.15% 11.65% 12.15%
Perpetuity Growth Rate / Terminal Value at 11.15% WACC 5.0% 68,710 5.5% 75,146 6.0% 82,833 6.5% 92,172 7.0% 103,762
Equity Value Per Share 5.0% $28.03 $25.78 $23.91 $22.31 $20.94 5.5% $30.40 $27.71 $25.50 $23.64 $22.07 6.0% $33.34 $30.05 $27.40 $25.21 $23.39 6.5% $37.09 $32.95 $29.70 $27.09 $24.94 7.0% $42.03 $36.65 $32.57 $29.37 $26.79
13