The Impact Of Facebook’s Follow-On Stock Offering

Facebook (NASDAQ:FB) is planning a follow-on stock offering of 70 million shares. The company will issue 27 million new shares and another 43 million shares will be sold by certain stock holders including Facebook’s CEO Mark Zuckerberg. ^[1] These shares will be primarily offered to index funds as Facebook’s stock will now be included in S&P 500 index. Here is what you need to know about this offering.

The company isn’t in real need of money. Its business is not capital intensive, and the ad monetization has ramped up significantly with EBITDA margins hovering over 50%. The balance sheet seems strong with a net cash balance of close to $8 billion at the end of Q3 2013. This net cash figure is calculated by deducting debt, capital leases and capitalized operating lease obligations from reported cash, cash equivalents and marketable securities. This suggests that Facebook partially wants to cash in on its strong market valuation, which is at an all time high, and use this additional cash to make potential acquisitions.  It also allows the company to satisfy the transient increase in demand for the stock caused by its inclusion in the index.

What will be the dilutive impact on EPS and stock ownership? The additional 27 million shares will increase the outstanding share count by roughly 1%, and the consequential impact on earnings per share will be minimal. Most of this secondary offering appears to be a way for Mark Zuckerberg to unload his shares at an attractive price. Should this raise a red flag? The answer is no. The primary reason why Zuckerberg is selling a huge block of shares is to meet the tax expenses arising from the exercise of 60 million stock options. We don’t think this move should be taken as an indication of management’s lack of trust in the company’s future. Facebook is doing well in terms of revenue and cash flow growth, maintaining a strong balance sheet and acquiring smaller competitors to maintain its leadership in the social networking space.

Our price estimate for Facebook stands at $38, implying a discount of about 30% to the market price.

See our complete analysis for Facebook

Facebook’s success can be gauged by looking at the trend in average revenue per user. We expect Facebook’s average annual advertising revenue per monthly active user to grow at a compounded annual growth rate of close to 12% over the next six to seven years. Mobile will continue to be the core of Facebook’s advertising strategy going forward. Approximately three-fourth of the company’s overall monthly active users are also accessing the network through their smartphones, and the mobile platform accounted for roughly 49% of its overall ad revenues during Q3 2013. ^[2] Mobile represents roughly 12% of consumer media time, but only 3% of the ad budget is directed to this channel. ^[1] Both these figures will increase substantially in the future, thus allowing Facebook to leverage the trend and improve its ARPU.

Currently 25 million small business have their company pages on Facebook, and only 1 million of them are active advertisers. ^[3] This means that 96% of this potential customer base is untapped. Considering the online advertisement trend, it is inevitable that many of these businesses will start advertising on Facebook in the coming years, which will give a strong boost to its ARPU.

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1. Facebook Announces Proposed Follow-On Offering, Facebook Press Release, Dec 19 2013 [↩] [↩]
2. Facebook’s Q3 2013 EarningsTranscript [↩]
3. Facebook Expands Its Definition Of Small Business Pages, Says It Now Has 25M Of Them, TechCrunch, Nov 18 2013 [↩]