There has been much scrutiny over Facebook (FB) since its mid-May initial public offering (IPO), particularly with the shares down 26% since that offering. As expected and as a group, sell-side analysts at the IPO underwriters -- Citi Investment Research (C), Wells Fargo (WFC), Morgan Stanley (MS), BofA Merrill Lynch (BAC), JPMorgan Chase (JPM), and others -- have a favorable view of the company with a median price target from more than 25 analyst of $39.50. That offers upside of just over 40% from current levels and equates to 77x Street earnings expectations of $0.51 per share this year (2012) and 60x $0.65 per share in 2013. That’s significantly above the 26% earnings growth Wall Street currently expects Facebookto deliver over the 2011-2014 time frame.
Image via CrunchBase
In looking out over that time period, there are several trends that will continue - cloud computing and storage, apps, and _ to name a few - but the one that will impact Facebook’s business the most is the continued shift toward mobile devices, like smartphones and tablets, and away from PCs. Reading through the company’s S-1 filings with the SEC, it becomes clear that Facebook generates the vast majority of its revenues -- more than 85% in 2011 -- from advertising. But that advertising revenue is largely derived from usage on PCs, where Facebook "monetizes usage by displaying ads and other commercial content." In terms of mobile, Facebook admits that currently, it does not generate meaningful revenue from mobile and that mobile as a substitute for use on personal computers may negatively affect the company's revenue and financial results. Even Facebook CEO Mark Zuckerburg has admitted that his hardest job right now is figuring out how to adapt Facebook to mobile devices in part because the user experience is so different than on desktop computers. How can a website or an app offer advertising on a 2-inch by 4-inch screen and still offer a great smooth experience for users?
To be fair, the company is working to develop solutions for mobile advertising and payment solutions. From an investor perspective, the logical question is how much runway does Facebook have in front of it to figure out its mobile business model?
Per the S-1, at the end of March, Facebook had 908 million monthly active users (MAU) of which 488 million, or 54% of total MAUs, used Facebook mobile products. Some simple math and we realize that the vast majority of advertising revenues are generated from those non-mobile users. But the shift toward mobile devices is accelerating at a time when PC demand, particularly in the U.S. is slipping and that does not bode well for Facebook. During Q2 2012 smartphone penetration continued to grow, with 54.9% of U.S. mobile subscribers owning smartphones as of June 2012. This growth is driven by increasing smartphone purchases: 2 out of 3 Americans who acquired a new mobile phone in the last three months chose a smartphone instead of a feature phone. The risk is more people accessing Facebook on the go than at the PC, not a good thing for the company’s PC centric display advertising business model. Meanwhile, estimated quarterly global PC shipments were down 0.1% in 1Q 2012, with shipments in the U.S. down 5.7% year over year according to Gartner. Keep in mind that the U.S. and Canada were responsible for 50% of Facebook’s revenues in 1Q 2012. Not a good one-two for Facebook.
If this trend continues in the U.S. and around the globe, Facebook will need to overhaul its current slate of mobile products in order to meet or beat Street earnings expectations. And that trend of increasing smartphone and tablet growth is expected to continue. Market research firm Ovum is calling for smartphones to grow at a compound annual growth rate (CAGR) of 24.9% for the period 2011–17 to reach 1.7 billion units. Turning to tablets, the latest NPD DisplaySearch forecast calls for tablet shipments in 2016 to top 350 million units, putting them ahead of notebook shipments for the first time. Digging deeper in that forecast, NPD projects that tablet shipments will have a compound annual growth rate of 28% over the next five years as the total number of shipments rises from 121 million in 2012 to 416 million in 2017. By comparison, notebook shipments are expected to grow to 393 million in 2017 from 208 million in 2012, which equates to a CAGR of 13.6% over that time frame.
Viewed through an investors lens, the shift to mobile from desktop is a critical one for Facebook and the inability to overcome it could threaten its long term prospects for its revenues, profits and shares. As it is, the consensus expectation is for Facebook to grow its revenue to $6.5 billion in 2013 up from $3.7 billion in 2011 and any mis-step or set back on mobile could cost the company just the way other missed technology transitions have hurt other companies. Nokia (NOK) and Sony Ericsson (SNE) lost their top tier position in the mobile phone industry as it shifted toward smartphones. HP (HPQ) and Dell (DELL) are transforming their businesses in the wake of slower PC growth as that industry has matured, relying increasingly on replacement demand. Even going back in time, both IBM (IBM) and Digital Equipment Corp. were challenged by the shift in computing toward desktop machines. While there are scads of other examples, one not to be left out is Microsoft (MSFT), which has had a difficult time in migrating its operating system into the mobile arena. Per data from comScore (SCOR), despite all the hoopla of its relationship with Nokia, Microsoft held only 4% of the U.S. smartphone market in May down from 4.4% in January and 5.4% last October.
While there have been on again, off again rumors about Facebook developing its own smartphone, in order to be a real competitor against Apple, Google and its Android related offerings and now Amazon (AMZN), which in view is one to watch in the smartphone bloodbath, Facebook needs more to integrate itself more into the digital lifestyle. This includes not just smartphones and tablets but also the home and that means the TV where Apple and Google are much further ahead.
Where others have failed, Facebook has its work cut out for it and the company is working internally to develop mobile solutions. To help it along, Facebook has made a few acquisitions of late including its most recent - it had acquired Spool, a mobile bookmarking service. This comes on the heals of acquiring both Instagram and Karma, the latter being a social mobile gifting app. But in terms of mobile advertising, Facebook still has to compete with Apple’s (AAPL) iAd offering as well as Google (GOOG), which acquired AdMob some time ago. As with many things in consumer electronics, the vast majority of market share in mobile advertising will likely be held by three players and those two are formidable competitors.
With more than $3 billion in net cash, Facebook has ample funds to augment internal efforts by acquiring those developed by others. Some potential takeover candidates that would help boost Facebook’s mobile advertising include Admoda, recently public Millennial Media (MM) and certain assets at Comverse (CMVT).
Two sayings come to mind. First, if your standing still, your already falling behind. As a user of Facebook, I hope this isn’t the case; as an investor, the lack of a viable mobile business model is a reason to resist FB shares as the digital consumer continues to increasingly shift toward the mobile world. This brings me to the second saying - don’t confuse the products you love with the company’s stock.
