No room for error in Facebook's debut quarter

By Reuters | Updated: 21 July 2012 14:42 IST

Facebook Inc faces immense pressure to beat Wall Street's financial targets when its delivers its inaugural quarterly earnings report next week, hoping to wash away the bad taste left with investors from a soured IPO.

The No. 1 social networking company's second-quarter report on July 26 will be scrutinised by investors looking for clues on the health of its business, which is experiencing a sharp slowdown in revenue growth and mounting questions about its advertising sales.

With a rich multiple that gave Facebook the distinction of being the first U.S. company to go public with a valuation of more than $100 billion, the company headed by 28-year-old Mark Zuckerberg has little room for error.

"If they miss, it would be catastrophic for the stock," said Michael Binger, a portfolio manager with Gradient Investments.

"This is a very important earnings quarter for them. It will establish in people's minds how they think of the company," said Binger, whose firm does have a position in Facebook.

The bar has been lowered since Facebook warned that a shift in users to mobile devices - where its ability to earn revenue is still nascent - will hinder growth in the short run.

Analysts, on average, expect revenue in the second quarter to grow 28 percent to $1.15 billion. During the same period a year ago, Facebook more than doubled its revenue.

With Facebook's stock still trading at three-quarters its $38 IPO price, executives need to address a litany of concerns about the business, such as the efficacy of its online ads and the company's nascent efforts in mobile advertising.

Investors say Facebook is unlikely to be able to deliver the sort of numbers that can propel its stock back to debut levels, but the risk of triggering a slide if the company disappoints Wall Street is high. Facebook's stock still trades at a rich 57 times forward earnings, compared with Apple Inc's 13 times and Google Inc's 14 times.

"Facebook is probably going to come up with one or two revolutionary streams that are going to bump up its revenue," said Bill Lee, an angel investor who backed companies, including electric carmaker Tesla Motors Inc and social media site Posterous, which was recently acquired by Twitter. But "all the magic they can continue to deliver is already priced in."

Slowing growth
More than half of the 36 financial analysts now covering Facebook rate the company a Hold, Underperform or Sell - disproportionately high given that Wall Street analysts historically favour Buy ratings.

The three lead underwriters of the IPO - Morgan Stanley, Goldman Sachs and JPMorgan - forecast second-quarter earnings per share of between 10 cents and 11 cents, lower than the Street average of 12 cents, minus IPO-related stock compensation charges, according to Thomson Reuters I/B/E/S.

Thomson Reuters StarMine's SmartEstimates suggests that Facebook will post adjusted earnings of 10.4 cents per share.

"It gets back to 'How predictable are these companies' results going to be when I'm forecasting out pretty significant growth to be able to justify the valuation?'" said Ryan Jacob, chairman and chief investment officer of Jacob Funds, who does not own Facebook shares.

Facebook, which generated more than four-fifths of its revenue from advertising in 2011, has stepped up efforts to rebuild its revenue momentum, rolling out a raft of new advertising features and providing more details about the effectiveness of its ads.

TBG Digital, which helps marketers advertise on Facebook, released a study this week that found the average price of Facebook ads had jumped 58 percent since last year. That is partially due to recently released mobile formats, it found.

"Our clients aren't spending 75 percent of their budgets on Facebook," said David Jones, Global CEO of advertising agency Havas. But he noted that "there are very few clients who we are talking to who are negative on Facebook."

Guidance question
With over 900 million users, Facebook is the world's largest social networking company, challenging established Web companies for consumers' online time and for advertising revenue.

For Facebook, the first date with Wall Street will mark an important test for the company's top brass to try to dispel some of the skepticism. Investors will want to hear from Zuckerberg - who wields majority control - but the company has not said if he will take questions on the day.

"A miss is a miss and it wouldn't be good either way, especially for your first quarter out of the gate," said Colin Sebastian, an analyst with Robert W. Baird.

But the context will be key.

"If it's related to shift in mobile, but the mobile monetization is improving, that's different than just a miss because advertisers are leaving Facebook."

And he said that many investors will be particularly interested in the trends the company is seeing as marketers take advantage of Facebook's mobile and other advertising features.

While most expect Facebook to follow the lead of Google and Amazon.com Inc and abstain from offering financial forecasts every quarter, it may address the current concerns about its business by providing additional colour and outlook.

"This first time out, I think they have to give some sort of guidance," said Robert Bacarella, manager of the Monetta Fund, which does not own Facebook shares. "You pacify the near term and say 'Here's where we're going.' But then you set the table up to say: 'We're thinking about whether or not it's wise give guidance going forward."

For all Facebook's efforts to woo Wall Street, the company's biggest job remains building its relationship with advertisers, such as San Francisco's Public Bikes.

"Whenever we have a new bike shop selling our bikes in a particular city, I'll run a targeted Facebook campaign" in that city, said Dan Nguyen-Tan, Public Bikes' vice president of sales and marketing.

The ability to reach specific groups of Facebook users based on where they live and their interests - such as healthy lifestyles or environmental interests - is an important advantage of Facebook's advertising system, Nguyen-Tan said.

But he acknowledged that Public Bikes spends more money advertising with Google, where it is easier for the company to reach people interested in buying a bicycle.

Copyright Thomson Reuters 2012

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