Zynga Facebook

Facebook Inc (NASDAQ:FB) released its 2012 10-K several days ago. Pivotal Research is out with a new report on Facebook using information from the latest SEC filing. They note that Facebook has been successfully diversifying the company’s base of developers away from Zynga Inc (NASDAQ:ZNGA), improving the value of the Platform to all of its constituents. For example, they estimate that non Zynga Inc (NASDAQ:ZNGA) payments remitted to developers tripled year-over-year in 2012, from around $300mm to $1bn. As well, the number of users who purchased virtual goods nearly doubled year-over-year.

In July of last year, the market reacted very negatively to news that Zynga Inc (NASDAQ:ZNGA)’s revenues from (and thus spending on) Facebook Inc (NASDAQ:FB) was weakening. As the analysts learned in the 10-K, total revenues from Zynga amounted to 7% of Facebook Inc (NASDAQ:FB) revenues for the quarter, or $111mm (down 14% year-overyear vs. 4Q11, but a slight improvement from 3Q12’s -24% decline). At the time that Zynga activity on Facebook began to weaken last year, Pivotal thought it to be favorable overall that Facebook was effectively diversifying its base of Payments revenues, consistent with the company’s expectations.

Diversification Working

In 2011 platform developers received $1.4 billion from transactions enabled by Payments. In 2012 the comparable figure was $1.96 billion. If one assumes that Zynga represented $1.1 billion of this figure in 2011 and $900mm in 2012 (i.e. 93% of Zynga’s 2011 bookings and around 80% of 2012 bookings, on most recent Zynga guidance), this implies that platform developers other than Zynga Inc (NASDAQ:ZNGA) received $1.06 billion in 2012, up from $300mm in 2011. This means that non-Zynga developers tripled the payments they received from Facebook. Perhaps equally important, the 10K states that 27 million of Facebook’s users purchased virtual goods during 2012, vs. 15 million in 2011.

A greater number of users and a wider base of economically sustainable developers is important for Facebook because it means there are more developers placing more resources towards improving the overall consumer experience on the Facebook platform. It also means there are more likely more advertisers in the future, as Facebook advertising will undoubtedly be an effective (or at least a very testable!) way for developers to market their wares.

As management pointed out during the company’s earnings call, essentially all payments revenues are derived by desktop-centric activities presently, and growing mobile use will curtail spending growth on payments in the near-term.

Domestic revenues were higher than expected

Pivotal believes that the appropriate figures to consider when assessing Facebook’s regional growth trends are the US and international revenues as broken out in the company’s 10Qs and 10Ks. These numbers can differ substantially from the geographic breakdowns provided in the company’s earnings presentations and which are more prominently highlighted in securities filings, but which are based upon revenues per user.

The appropriate driver of revenue growth is the geographic origin of the advertising budget and NOT the user of Facebook (who may or may provably affect an advertiser’s business).

Pivotal backed out estimated payments revenues on a US and international basis in their model, and then derive a US ad revenue figure. Once they further back out estimates on domestic revenue for FBX – which likely represents spending from different advertisers or different budgets vs. the rest of Facebook — the analysts can see year over- year budget growth for combined desktop and mobile advertising (most of which Pivotal believes to be interchangeable for the advertisers driving the mobile spending) at Facebook of 27% in the US during 4Q12, an increase from 24% in 3Q12 and 8% in 2Q12.

The company can likely sustain domestic growth rates in the 20+% range for most of next year – before including incremental growth from FBX, which likely adds another ~20% in absolute incremental growth for Facebook’s US ad revenues during 2013.

Taxes remain a source of billions of dollars of value to be realized

Several known issues were quantified in the K that were broadly consistent with what was known. Still, the detail provided allows for more precision to be incorporated. Specifically, the company stated that as of year-end 2012, “U.S. federal and state net operating loss carryforwards were approximately $5.83 billion and $7.62 billion, which will expire in 2027 and 2021, respectively, if not utilized”. These NOLs have arisen from the tax losses that Facebook was allowed to accumulate because of the issuance and exercise of options and RUSs to employees.

As a practical (and model-simplifying) matter, Facebook Inc (NASDAQ:FB) should not be expected to pay significant amounts of tax in the United States for many years to come, despite book tax rates which will continue to appear on the company’s income statements.

A high but declining percentage of Facebook Inc (NASDAQ:FB)’s net income is shielded from tax over the next five years; the company end up with a balance of NOLs at that time which on an after-tax basis may be worth hundreds of millions of dollars by that time, but given the vagaries of tax rules, the further out  investors forecast, conservative investors would presume that tax laws reduce the likelihood of recovering these NOLs.