Investor's Business Daily: Facebook Q2 Message Fails to Fuel Investor Confidence

BY BRIAN DEAGON

With its inaugural quarterly report card, Facebook (FB) turned in a grade of C that investors viewed as a fail.

Yes, it can be rough in the public markets - CEO Mark Zuckerberg had held off on making the move - and these are tough times, but there are reasons Facebook got the F grade.

The social networking site, which now has 955 million subscribers worldwide, met profit views and edged sales expectations. But that's it: It just met profit views and edged on sales.

More Facebook users are accessing the site on smartphones, but it's not clear how Facebook will get them to see or click ads when they do so. AP View Enlarged Image

"That's the cardinal sin of the first reported quarter of a new company," said Martin Pyykkonen, an analyst at Wedge Partners. "It's a simple case of Facebook not beating estimates by a mile."

According to many analysts, observers and investors, an unwritten rule is that the first quarter reporting after an IPO should be a knockout.

Business-focused social network LinkedIn (LNKD) had a passing grade. In its first quarterly report after its May 2011 IPO, LinkedIn reported a 120% jump in year-over-year revenue and a 57% hike in EPS ex items, beating Wall Street expectations. Its stock rose 12% the trading day after its report. Facebook's shares fell 11.7% on Friday, its third-highest volume since its first two days as a public company. And its shares fell 8.5% on Thursday, fueled by a weak Q2 report late Wednesday by Zynga (ZNGA), whose games are among the most popular apps on Facebook.

But Facebook has other challenges. Though revenue rose 32% year-over-year, it marked the sixth straight quarter that sales growth decelerated.

Facebook is trading at an all-time low, closing Friday at 23.71.

And that's still too high, based on the company's current performance, says Trip Chowdhry, an analyst at Global Equities Research.

"Facebook revenue needs to be growing at a rate north of 150%," Chowdhry said. "A growth rate of 32% is terrible."

Moreover, he says Facebook executives haven't clearly outlined plans to boost revenue growth and earnings enough to maintain its current value.

Chowdhry says Zuckerberg and his team failed by pricing initial shares at $38 for the May 18 IPO. That valued the company at about $104 billion. Its market value is now roughly half that.

Execs Overvalued Company

"Facebook management didn't know the correct value of their own company, and now they're breathing their own exhaust," Chowdhry said.

Zuckerberg led Thursday's earnings conference call, speaking rapidly from a prepared text, as is common on earnings calls. He ran through the latest company stats, but then did turn to the area of most interest to analysts: Its efforts to make money from all its users now accessing Facebook via smartphones and other mobile devices.

"We're finding that people are quickly adopting our mobile services," Zuckerberg said.

Facebook said its number of mobile users jumped 67% to 543 million.

That's fast growth, but Facebook didn't anticipate such fast growth in mobile users, analysts say. As a result, Facebook launched its IPO while still in the middle of devising a strategy for mobile ads and other mobile revenue opportunities.

"Facebook's earnings release failed the individual investor by offering no commentary on the important aspects of the company's mobile growth strategy," said Jeff Corbin, CEO of KCSA Strategic Communications, which handles investor relations for corporate clients. "It instead relied on its conference call, which most individual investors either don't know about or don't participate in."

Facebook's press release showing quarterly results was void of visionary commentary typically seen in such statements, Corbin says.

"There should have been more information in that release so investors would have had a better understanding of where this company is going," he said.

Facebook addressed social ad spending in the conference, emphasizing its "sponsored stories" and its "news feed" offerings.

"This is what the company is betting its growth on," Corbin said. "They only have one quarter under their belt. It will take numerous quarters of positive results to justify the high valuation of the IPO."

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