If you thought Facebook Inc.’s first year as a public company was tough, get ready for a demanding Year Two.
In the first year, the company faced the challenge of generating significant revenue, and it succeeded: In the first quarter of 2013, sales rose 38 per cent, to nearly $1.5-billion (all figures U.S.).
The cash flowed from a shift in the company’s focus – away from trying to attract more and more users to its social media site, where people post updates on their lives, and toward squeezing more money out of this massive user base, which now stands at 1.1 billion people.
These revenues are still largely driven from desktop computer advertising, though Facebook has been diversifying. As more its users have moved to accessing their Facebook accounts from their smartphones and tablets, the company has increased mobile advertising, which now accounts for 30 per cent of sales.
But however successful Facebook has been in turning dollars out of users, it still faces a daunting task: It has to justify the chasm between its share price and its earnings.
This has been a sticking point even among observers who appreciate the company’s business model and accept that Facebook’s enormous popularity makes it virtually unassailable by upstarts. Its trailing price-to-earnings ratio is more than 1300. The P/E multiple on the Nasdaq composite index is 25.
With earnings growing rapidly, Facebook’s P/E ratio is expected to shrink fast. According to analysts’ estimates, Facebook this year should generate earnings of 57 cents per share after accounting for some extraordinary items, and rise to more than $1 a share by 2015.
If they’re right, and Facebook’s share price doesn’t move, the P/E will fall to 46 by the end of 2013 and 24 by 2015.
While that might look like a reasonable valuation for an exciting company with big growth ahead, it puts a lot of pressure on Facebook management to get things right – perfectly right.
Judging from the share price performance in the first year, there is not a lot of patience for setbacks. The slightest whiff of Facebook users losing interest in the site – raising privacy concerns or balking at Facebook’s attempts to commercialize something – has often hurt the stock.
Indeed, one of Facebook’s biggest problems is trying to transform the company into a big money-maker without alienating those who use the site or discouraging future users.
For sure, the share price already reflects these issues to some extent. At Friday’s close of $26.25 on Nasdaq, the stock is down 31 per cent from its IPO price a year ago.
Over the next year, Facebook will have to convince investors that this poor debut is unwarranted. Getting everything right – especially earnings growth – will merely prove that the current share price makes sense.
To drive the share price higher, it is going to have to expand the business well beyond a social media site, just as Google moved beyond its start as a search engine.
The company has been making some bold moves. It bought the photo-sharing company Instagram last year and recently introduced new software applications, called Home, to make Facebook easier to access and use on Android smartphones.
But a bet on the stock requires a big leap of faith.