I thought this was a good time to revisit the future of Facebook, and boys and girls, the Menlo Park social giant is definitely showing signs of peaking in users and ad revenues. I have been predicting this since early last year, and it now appears to be happening, but at a faster pace than I ever imagined.
Although Facebook has experienced phenomenal growth in the number of users since the end of 2010, it's advertising revenues have failed to kept pace since the Q3 2011. Things have gotten so bad, that some of its IPO underwriters revised Facebook's revenue and earnings forecasts for 2012 and 2013.
It appears that Facebook timed its IPO before it began to show chronic signs of peaking in the number of users and ad revenues. The year 2012 will truly become the most challenging time in Facebook's history as a public company.
Facebook's Reaches Critical Inflection Point
In a blog post dated March 20, 2011, I provided quite a body of evidence that social networks, especially Facebook, are competing for a finite number of users and their ad-supported revenue model can no longer create exponential ad revenue growth over the long-term. As a consequence, Facebook has reached a critical inflection point where user penetration ultimately reaches the saturation point and advertising revenues stop growing and eventually peak.
When I first wrote the above blog post, I was working without real data about the actual number of Facebook users and advertising revenues, so I relied on estimates from eMarketer and comScore in developing my Critical Inflection Point Theory of Social Networks (The Theory). Now that we have actual numbers to work with, and understand more about the dynamics of Facebook's business model, I feel that Facebook's user growth and advertising revenues will peak a lot sooner than I originally thought. I have stuck my neck out once again, but here are some reasons for this:
- Growth In Users Unsustainable - Facebook's growth in users began to accelerate much faster than I had estimated when I developed The Theory back in March 2011. Most of that growth has come from Asian countries (excluding China where Facebook is banned), Mexico, Latin and South America. When I developed The Theory, it was estimated that Facebook had 600 million users at the end of 2010 and 800 million at the end of December 31, 2011. As of March 31, 2012, Facebook claimed it had 901 million monthy active users (using its own measurement metrics). Amazingly, Facebook has increased the number of users by 50% since December 31, 2010. In March 2011, I estimated that Facebook would not reach 900 million users until 2014 (see graph below). However, if you factored out Facebook's measurement metric that uses Facebook Likes from other sites, that number is overstated by 5% or about 45 million users (according to some experts), and should be closer to the 847 million I forecasted in 2011 (See Calculation of Facebook's Inflection Point graph below). Having said this, I believe that moving forward Facebook's current growth rate in users is unsustainable. In an effort to gain users, Facebook is considering allowing children under 13 years of age to open accounts. I disagree with this due to privacy and child safety concerns and the potential for bullying and misuse withour proper parental superversion.
- U.S. Growth Peaks - On June 11, 2012, The Wall Street Journal reported that according to comScore the number of Facebook's U.S. unique visitors peaked at about 158 million users at the end of April 2012, up only 5% from a year earlier. Approximately $1.736 billion or 56% of Facebook's 2011 ad revenues of $3.1 billion came from the U.S., according to the company's regulatory filings. Clearly, the U.S. is a dominant source of revenue for Facebook. eMarketer estimates that in 2012 the U.S. will account for approximately $2.5 billion or 51% of Facebook's ad revenue. comScore's numbers illustrate how little room there is left for Facebook to grow in the U.S., which is the most important and lucrative market for the social network's two revenue-paying constituencies: advertisers and developers.
- The Mobile Factor - When I developed The Theory, I failed to take into account the number of Facebook users accessing the site using mobile devices because this information was not available until it filed for its IPO in early 2012. At the end of March 31, 2012, Facebook said that it had 488 million monthly active mobile users. Today, Facebook is scrambling to monetize mobile as quickly as possible. To shoreup its weakness in mobile, in late November 2011, Facebook acquired Gowalla, a location-based social network, just for its talented team of developers. Just before its IPO in May, it annouced the acquisition of Instagram, mobile photo sharing app, for an incredible $1 billion. And, just this month, it added Sponsored Stories to mobile newsfeeds to generate ad revenues. There are also rumors that it is working with Asian mobile handset maker HTC to develop its own smartphone, which could give it some of the advantages that Apple has with the iPhone and Google has with Android-based phones and its recent acquisition of Motorola Mobile. Most mobile experts believe that Facebook's mobile phone will fail miserably because of its late entry and lack of experience with mobile. Facebook also does not appear to have a unified and cohesive marketing plan for mobile. Clearly, mobile will be Facebook's greatest challenge as it finishes up 2012 and into 2013.
- Wall Street Revises Facebook's Revenue Estimates - Just prior to Facebook's historic IPO, four IPO underwriters (see below), under the guidance of a Facebook executive, lowered Facebook's revenue forecast for 2012 and 2013. The revised revenue forecasts were provided on a selective basis to a few preferred investors. This has resulted in an SEC investigation into allegations of SEC regulation violations and created a firestorm of class action lawsuits against Facebook and its underwriters. I generally mistrust Wall Street because they are the punkasses that got us into the longest and deepest recession since the Great Depression and nearly bankrupt the U.S. banking system. This time around I side with Wall Street regarding the revenue forecast revisions because in my opinion this is another symptom that Facebook's ad revenues are rapidly reaching a peak. Main Street investors also believe Facebook's best years are behind it, and have spoken with a unified voice by dumping or avoiding to buy its share, and allowing Facebook's share price to drop well below its $38.00 IPO price. At one point, share prices dropped below 26.00 a share, a drop of over 30% below the IPO opening price.
Facebook Users Growing Worldwide, But U.S. Has Peaked
Facebook now has 901 million users worldwide, and has been growing by double digits, but growth in users have showed definite signs of slowing down dramatically especially in the U.S., its largest advertising market, where users grew by only 5% in a recent count.
But, Facebook Revenues Are Not Keeping Pace
In spite of the impressive growth in the number of active users, Facebook's revenues are not keeping pace. In late April, Facebook posted Q1 2012 revenues of $1.058 billion, up 45% year over year from $731 million. Net income however was down, at $205 million, from $233 million in the year-ago period.
There is no doubt that Facebook is still growing its revenues and profits. However, the company’s growth rate seems to be slowing down quickly.
Most companies would kill for 88% revenue growth and 65% profit growth over the last year. This is nothing to scoff at – Facebook sales numbers have been impressive. But the numbers from 2007 through 2011 paint a picture of slowing growth at Facebook.
An even greater concern is the more recent performance.
- Q1 2012: Year-over-year revenue growth of 44%
- Q1 2012: Sequential revenue declined by 6% (compared with Q4 2011 - $1.125 billion)
- Q1 2012: Sequential profits declined by 32% (compared with Q4 2011)
- Q4 2011: Sequential revenue grew by only 19% (compared with Q3 2011 - $889 million)
Facebook explained the 6% decline in revenues between between Q1 2012 and Q4 2011 as a "seasonal" tweak, and there maybe something to this. Facebook's revenues also declined between Q4 2010 and Q1 2011. However, as you can clearly see from the above, revenue growth is definitely declining at a dramatic pace. How worse can the remainder of 2012 be? Facebook's underwriters think it's going to be pretty bad (see below).
Wall Street's Facebook Horrendous IPO Revenue Revisions
In the convoluted case of the botched Facebook IPO, the story goes that the social network’s underwriters, with guidance from a Facebook executive, reduced their 2012 earnings estimates, shared that material information with a few, preferred investors, and let institutional and retail investors take the hit as Facebook’s stock value tanked. This has resulted in a series of class action lawsuits naming the underwriter's, Facebook and Facebook executives as defendants.
According to the projected numbers of four banks, as shared with Reuters by an anonymous investor, Facebook could report 5.45 to 7.28 percent less revenue in the second quarter of 2012 and 3.61 to 6.13 percent less revenue for the full year than originally anticipated. The underwriters also reportedly reduced Facebook’s 2013 earnings per share estimates by has much as 7.35 percent.
The reduced figures, as shown in the table below, dramatically change the valuation of the company.
Click Image To Enlarge
He said.
“The reduction to Facebook’s forecasts of this magnitude — reducing the revenue growth rate by over 6 percentage points — is so material that it should absolutely have been disclosed in a revised S-1 filing before the IPO pricing. The combined net effect for Facebook in this case of both the reduction in the financials and the valuation multiple would have lowered Facebook’s valuation by at least one third.”
If the underwriter's revised Facebook revenue forecasts are correct, Facebook will not reach $5 billion in revenues as many social media analysts had projected. If you average the four new revenue forecasts, it works out to an average of $4.840 billion.
When I posted The Theory in March 2011, little did I know how quickly Facebook's fortunes would show signs of deteriation when it would peak in both the number of users and ad revenues. I can hardly wait to see Facebook's Q2 2012 earnings call to determine if everything I have told you up to this point, becomes reality, or we will have to wait a bit longer.
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