Bulrich

Chapter 4 – Corporate Finance Article “Facebook Profit Drops as Spending Rises on New Features”

Bloomberg.com 2/4/2013

Edited by Brahm Canzer http://www.bloomberg.com/news/2013-01-30/facebook-profit-drops-amid-higher-spending-on-

features-ad-tools.html

Questions for Discussion:  Summarize the financial analysis presented in this report for Facebook.  Explain the reasoning for the increase in expenses and subsequent drop in profitability.  Do you believe the spending will eventually prove to be successful?  Would you be a buyer of the company today?

This article describes negative trends concerning Facebook, its profits and revenues. According

to the article, Facebook’s profits fell 79%, expenses increased by 82%, and revenues increased by 40%. This sparked an 8% decrease in the stock’s trading value as of the article’s writing. This is attributed to higher than expected spending on capital technologies for long-term revenue growth. Facebook, who gains most of their revenue through advertising, is targeting ads for mobile devices. Analysts had predicted lower figures for profit and revenue as well as profit per share. User count did grow, and prior to the article analyst ratings had been increasing since October.

The increase in expenses is due to investment in new technologies, considered capital investment for a software and services firm, and caused a significant drop in profitability. Facebook is searching for new streams of revenue as their users change the way they access Facebook’s services. Users previously had primarily accessed Facebook through computers, now they are migrating to mobile devices. These devices are difficult to universally deliver ad content to, and ads are Facebook primary source of revenue. To address this problem, Facebook is investing heavily in development of new apps for mobile devices that will deliver ads more effectively. Any time a firm in any industry invests this kind of money there will be a significant reduction in profit. The goal is to create strong, long-term growth by incurring reduced or even negative profits in the short term. And, in this case, Facebook certainly saw a very strong downturn in relative profit.

The success of the investments is difficult to predict. I would say that any firm in Facebook’s position would be wise to make the investments which they are making. Facebook needs to constantly adjust its technology to compensate for changes in the greater technology landscape, such as new computing devices or access methods, as well as changes in cultural usage patterns, including expanding to new markets. To that end, investing in mobile device software, which is the fastest growing device market, makes quite a bit of sense. However, it far from guaranteed to work; there is no guarantee that users will not change their usage patterns by the time the new technology is ready, or that there won’t be some other unforeseen change which Facebook cannot adjust quickly enough to. There are so many factors which could cause this investment to be unsuccessful that they could scarcely be listed in a short essay.

I would not currently buy Facebook’s stock. This is only in part due to lack of certainty in the success of their current investment; this is also due to a long history of Facebook being significantly behind the technological curve. They failed to effectively deliver ads for quite some time, they failed to

adequately advise users about their security status, they failed to adequately protect users, and they failed to deliver this most recent technology even though mobile device apps have been growing quickly since 2008. These and many other shortfalls in foresight leave Facebook with a very low estimation in my opinion.