May Idea of the Month: Catching a Falling Star

Looking for growth in a 2011 IPO that lost its zip

No, today’s idea of the month will not be “buy facebook!” Though I’m actually shocked to see it close right around the $38 IPO price on Friday as I finish this note, and I do believe the stock will do well once they find their footing and report some earnings growth quarters. I expect the odds are on the side of facebook figuring out how to more aggressively optimize its advertising offerings to boost revenue over the next few years, which is really what’s worrying investors right now (meaning, display ads for “branding” aren’t going to cut it for facebook right now, as noted by GM’s decision to drop their FB advertising, they need to use their customer data much better to personalize and target offers).

Facebook may well not effectively revamp their ad offerings this year, and the pressure on them to be pushy is limited thanks to Zuckerberg’s social mission focus and controlling vote, but I think they’ll get there and I’d consider buying it around $40 for folks who don’t mind short-term dips and can look out at the horizon. Right now, facebook is valued at about $100 per user, and generates less than $10 per user in revenue in its most profitable markets (that’s the US and Canada) … the number for Europe is about half that, and revenue per user is between $1-2 in much of the rest of the world. If they magically revamp their advertising or other monetization and generate $10 per user in profits (not revenue) in 2014, that would mean that they’re now trading for 10X 2014 earnings (remember, this is magical guessing), about the same as Google or Apple (analysts are projecting a 2013 PE of 64 for FB right now, though there’s no reason to think their forecasts are reasonable yet given the lack of data and guidance).

But no one is projecting that FB will do $10 billion in profits in two years, which would be roughly 1,000% three year profit growth — we really just don’t know. That’s just what it would take for them to be valued similarly to the other tech megacaps, most of which are dirt cheap … comparisons are hard when you’re this big and your peer-sized companies have much better track records of profitability and much lower valuations. Facebook can’t make that kind of earnings number without changing something radical about facebook’s ...

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