The Future of Facebook - I

From Theoretical Speculation to Better Understanding Based on Simple Mathematical Laws

Karma?

Status: Married Priscilla Chan

http://blogs.wsj.com/deals/2012/05/18/facebook-not-busy-enough-buys-company-today-too/ http://www.washingtonpost.com/blogs/reliable-source/post/mark-zuckerberg-and-priscilla-chan-howthey-pulled-off-their-surprise-wedding/2012/05/20/gIQAQVK1dU_blog.html Page 1 of 28

Table of Contents
Topic No. 1 2 3 4 5 6 7 8 9 10 11 12 Topic Summary Hi Mark Annual Revenues-Profits data Calculus: Significance of Rate of Change Importance of Graphical Representation of Financial Data: The Marginal Rate of increase of Profits (MRP) Non-linearity in Profits-Revenues data Closing Remarks Appendix 1: Predicting Revenues Appendix 2: Earning per share Appendix 3: Mathematical Laws, linear and non-linear Data Sources Strange but true Cheers! Om Shanti !!! Page No. 3 4 5 6 8 10 13 16 20 23 26 28

Max Planck to Einstein: I hereby award you the Planck Medal because you expanded my desperate idea of a quantum of energy to the even more desperate idea of a quantum of light. http://www.newworldencyclopedia.org/e ntry/Albert_Einstein
Max Planck presents Einstein with the inaugural Max Planck medal, Berlin June 28, 1929

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Summary
I have reconsidered here the significance of the consolidated financial data, filed with the United States SEC by Facebook, Inc. on February 1, 2012, and reanalyzed it using well established methods commonly used in the physical and engineering sciences. Firstly, I have emphasized the significance of the rate of change, as we understand from our study of calculus. Only a proper understanding of the rate of change can yield meaningful predictions about the future course of a company like Facebook. Secondly, the use of x-y scatter graphs to unravel the underlying x-y relationships is emphasized, as opposed to tabulation of huge volumes of financial data and the widely prevalent ratio analysis (two examples being the familiar profit margin and the earnings per share). The use of such business ratios should be frowned upon, are downright unscientific, and should be abandoned forthright and, indeed, also declared ILLEGAL since it can destroy companies, it can destroy lives, and can destroy nations. It already has and the destruction continues! After all the turmoils that the economy has endured, since the financial collapse of 2008, it is time to demand a more scientific understanding of the financial and the business world. The finance, business, economics, and management sciences now seem to be operating more like astronomy and physics, before Galileo, Kepler, and Newton. It is to be hoped that the 21st century will yield a newer understanding of the financial, business, and the economic world, just as the 19 th and 20th centuries revolutionized our understanding of the physical world around us. From E = mc2, a consequence of his famous theory of relativity, Einstein arrived at the simple linear law, K = E W = hf W, to explain the photoelectric effect (which also fetched him the Nobel Prize). Such a simple linear law and also, perhaps, other non-linear laws, describe the financial and business world. It appears that the methods of quantum physics can easily be extended to economics.

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Mark Zuckerberg

Founder and CEO at Facebook Studied Computer Science at Harvard University Lives in Palo Alto, California From Dobbs Ferry, New York

Do you know Mark? Subscribe to Mark to get his public posts in your news feed.

Hi Mark: We have never met or been friends, until now that is. First of all, congratulations on your wedding. Enjoy the honeymoon. Second, enjoy the IPO. Third, I hope you like this - what I did about Facebook. Cheers! http://www.scribd.com/doc/94325593/The-Future-ofFacebook-I

Sent 22MAY12

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Dear All: As we all know, speculation is the bane of the human mind. We can literally speculate ourselves to destruction. Perhaps, that is what happened in the fall of 2008 and we have not yet fully recovered from the mess that was left. But, speculations can also be used to raise ourselves to lofty heights and to higher levels of understanding. And so, speculate we will now about the future of Facebook, Inc., as it enters its first full week following its historic IPO on Friday May 18, 2012. The darling of millions of users worldwide did not do very well with the Wall Street speculators. Why?

Table 1: Annual Revenues-Profits Data From Financial Statements filed with SEC for the IPO
Qtr/Year 2007 2008 2009 2010 2011 1Q2012 Future ?? Revenue, x $, millions 153 272 777 1974 3711 1060 4800 Profits, y $, millions -138 -56 229 606 1000 205 Best-fit line Prediction -60.89 -23.46 135.42 512.00 1058.47 224.45 1401.08

The reason is very simple. Nobody seems to be sure how Facebook will increase its revenues in the future. Can we learn something using the laws of mathematics and our belief in the rules of calculus to arrive at some new predictions or, shall we say, speculations? This is actually a follow up on some of the earlier discussion, see http://www.scribd.com/doc/94103265/The-FaceBook-Future , about using more accurate mathematical models to study financial data, such as the data we see above in Table 1.
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The true measure of the rate of change as opposed to ratios

First, what is calculus and why is it important? Wasnt this something we all dreaded back in high school and left it for the nerds? Actually, it is not all that complicated. Calculus was invented by Newton and Liebnitz (ah, that is a topic of some furious debate!) and deals with what is known as the rate of change. Newton invented calculus for a very specific purpose. He wanted to study motions carefully, using mathematics. (Liebnitz had his own reasons, not entirely related to the study of motions. He just happened to be a contemporary of Newton.) If we see a car moving, right now, on a highway, at 60 mph, we can say, with a great deal of confidence, that it will be exactly one mile away after 1 minute and 30 miles away in 30 minutes and also most likely 60 miles away from its current location in an hour. Of course, there are still many unknowns. What if the car breaks down? Ok, forget that. What if there is a big traffic jam? Or, the driver decides to take a long break. Or a sudden foggy condition or other weather related delays. Baring such unknowns, we can confidently predict where the car will be in a minute, in 30 minutes, or even in an hour. Why? We can do this because we know the speed v of the car. The symbol v is used here since in physics we use the term velocity, not speed. Velocity is speed in a given direction. Thus, speed v = s/t = s/t where s is the space covered (or distance traveled) and t is the time taken to travel the distance. Now, we must make a distinction here between s and s, the overall distance s traveled by the car since it began its journey (at time t = 0) and the additional distance that it will travel, which is denoted by s, in the additional time t of interest to us. This is all we are interested in when we make our predictions about where the car will be in 1 minute, or 30 minutes, or even in 1 hour. It does not matter how long the car has been on the road (total time t), and the distance it has traveled (total distance s). We know that s = vt where t is the small time interval of 1 minute, or 30 minutes, or 1 hour. We know v = 60 mph and we can confidently make predictions about s, the distance that will be traveled by the car, in the small amount of time of interest to us. The ratio s/t is meaningless for our
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purpose. Only the ratio v = s/t is meaningful if we wish to make predictions about the future position of the car. Or, consider the familiar problem of determining the fuel economy of a car. What do we do if we wish to determine the fuel economy? We fill up the gas tank. We jot down the miles traveled, or better yet, reset the trip meter to zero. Then we drive the car until the fuel tank is (almost! ) empty. The fuel economy = miles driven/gallons consumed. If we added 12 gallons to the fuel tank and traveled a distance of 420 miles, the fuel economy is 420/12 = 35 miles per gallon. We do not (or have to) pay attention to the total miles on the car (the odometer reading) or the total gallons of fuel consumed by the car since the day it came out of the assembly line and was first put on the road. The fuel economy, mpg = y/x where y = additional miles driven and x = additional gallons of fuel consumed. And, whether we know it or not, this is also the principle on which modern fuel level indicators work. It is the rate of consumption of fuel, or y/x, that will determine the miles that a car can still be driven before one faces the unpleasant situation of running totally out of gas and getting stranded on the road. This is what we learn from calculus. It is really quite simple and not just the domain of nerds. The same rules now apply when we consider revenues x and profits y for Facebook, or any other company. The ratio y/x is as meaningless a quantity as is the ratio s/t for a moving car. Just as the speed of the car, the ratio v = s/t is meaningful to make future predictions, we must consider the rate of change of profits as revenues increase. In other words, we must work with the ratio h = y/x not the ratio y/x. The descriptive term marginal rate of increase of profits (MRP) was suggested in the first article on Facebook (see http://www.scribd.com/doc/94103265/TheFaceBook-Future ) to distinguish it from the familiar profit margin, y/x. Please allow me to repeat. The profit margin y/x is like the ratio s/t for a moving car. Now, you can decide if you want to continue using y/x instead of getting serious about understanding why y/x is important. If you still want to use y/x to make future predictions, about the course of a company, do so at your own peril!

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It is the MRP, not the profit margin PM that is more meaningful to study financial data and make predictions, such as the future of Facebook, Inc. With this brief detour into calculus, and why it is important even for the cool Wall Streeter honchos, take a look again at the profits and revenues data summarized in Table 1. This was obtained from page 40 of the Registration Statement filed by Facebook Inc. with the United States Securities and Exchange Commission on February 1, 2012. The data for first quarter of 2012, $1060 million in revenues and $205 million in profits, was obtained from public news reports following the IPO.

Profits (Net Income), y, $ millions

1600 1400 1200 1000 800 600 400 200 0 -200 -400 0 1000 2000 3000 4000 5000

y = 0.315x - 109.03

Annual Revenues, x, $ millions

Figure 1: Graphical representation of the annual revenues and profits data for Facebook Inc. starting with 2007, the first year for which data is available. The data plotted here was again obtained from the SEC filing on February 1, 2012. The simple linear relation between revenues and profits, revealed by the quarterly data, is again confirmed here. The slope h of the best-fit line is also very close to the value obtained from the quarterly data analysis.
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Graphical Representation of Data as opposed to Tables

The financial data summarized in Table 1 can be visualized using a x-y scatter graph, see Figure 1. This reveals a remarkably simple and linear upward trend in the profits as revenues increase. The slope h and the intercept c for the best-fit line through the data points, y = hx +c, can be deduced using classical linear regression analysis. The slope h = 0.319 and the intercept c = -109.03. Hence, it follows that there is a cut-off or breakeven revenue below which the company will not report any profits. This cut-off revenue x = x0 = - c/h = 109.03/0.319 = 346.5 or about $350 million. The theoretical deduction made here using linear regression analysis appears to be consistent with the data summarized in Table 1. However, a careful examination of the data also reveals some underlying issues that need more careful investigation. Consider, for example, the data for 1Q2012. Advertising revenues have strong seasonal effects and are typically higher in the last quarter compared to earlier quarters. Hence, the averaging of the data on annual basis is to be preferred. Nonetheless, we see that with quarterly revenues of $1060 million, which was higher than the annual revenue of $777 million for all of 2009, Facebook reported profits of only $205 million, which is lower than the profits of $229 million for all of 2009. This suggests a non-linear relationship between profits and revenues which may be worth investigating more carefully. The non-linearity is readily visualized if we consider the changing slope of the line segments joining the individual (annual) data points, see Figure 2. The simplest mathematical law which describes this non-linearity is the power-law y = mxn + c. For n = 1, this reduces to the linear law y = mx + c. The constants m and n in the non-linear law can be deduced by preparing a plot of ln (y c) versus ln x. Taking natural logarithms, it follows that ln (y c) = n ln x + ln m (1)

The slope of the graph yields the power-law index n and the intercept yields the value of ln m from which we can deduce the value of the constant m. The values of m = 5.2 n = 0.67 and c = 233, in Figure 3, were deduced by pure curve-fitting
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and have no other theoretical or statistical basis. Notice that n = 0.67 2/3 and we can think of this as the two-thirds power law. Values of n 2/3 are often observed in other physical processes that the present author has studied (going way back to his doctoral thesis, see V. Laxmanan and M. C. Flemings, Metallurgical and Materials Transactions A Volume 11, Number 12 (1980), 1927-1937, DOI: 10.1007/ BF02655112 http://www.springerlink.com/content/45uj4gh37051172r/ ; the value of n reported in this work has since been confirmed by many other experimental investigations over the last 30+ years, by several authors, in many types of experiments, over stress and strain rates far exceeding those studied by Prof. Flemings and the present author.)

Profits (Net Income), y, $ millions

1200
1000 800 600 400 200 0 -200 0 500 1000 1500 2000 2500 3000 3500 4000

Annual Revenues, x, $ millions

Figure 2: The annual revenues and profits data for Facebook Inc. is replotted here to emphasize the non-linear relation between revenues and profits (which was approximated earlier in Figure 2 by the linear law). The slope of the individual line segments is equal to the values of h given in Table 2.
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Table 2: A More Detailed Analysis of Annual Profits-Revenues data Year Revenue, Profit, y x 153 272 777 1974 3711 -138 -56 229 606 1000 Profit Margin, y/x -0.902 -0.206 0.295 0.307 0.269 119 505 1197 1737 82 285 377 394 0.689 0.564 0.315 0.227 Delta x Delta y x or dx y or dy MRP h = dy/dx

2007 2008 2009 2010 2011 08-07 09-08 10-09 11-10

The choice of n thus helps fix the value of m. The value of c can be fixed by simply translating the graph upwards or downwards using different values until a good-fit is obtained. This is now readily accomplished, in a matter of seconds, using modern computational tools such as Mircosoft Excel. The choice of the constants here provided an excellent fit for the actual data points as we see here. It follows that if revenues are almost doubled, to say $8000 million ($ 8 billion) in the coming years, Facebook Inc. can be expected to report a profit of about $1.9 billion. This is based on the assumption that Facebook will continue to operate diligently to increase its revenues and profits, as it has so far, and does not encounter unforeseen circumstances much like the car that is being driven on the highway at 60 mph. There are always unknowns. Yes, one can make educated predictions, rather than engage in the familiar corporate disclaimers, The results of historical periods are not necessarily indicative of the results for any future period, found on page 55 of the SEC filings by Facebook, Inc. on February 1, 2012. http://www.sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954 ds1.htm Notice that a doubling of revenues does not double the profits. This is exactly what is implied when we choose to use simple ratios, y/x, such as the profit
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margin, or the earnings per share, to assess the financial performance of a company. A doubling of revenues will NOT yield a doubling of profits due to at least two very fundamental and scientific reasons: The fixed costs of the operation, or nonzero intercept c, even if h = constant. The non-linear nature of the profits-revenue relationship, or y = mxn + c. With a nonzero intercept c, the doubling of revenues will NOT yield a doubling of profits, even with the linear law y = hx + c. This is the most important reason why the use of the ratio y/x, i.e., the familiar profit margin, can be quite misleading and must be abolished forthright as being UNSCIENTIFIC and made ILLEGAL. The use of this misguided ratio, along with the ubiquitous earnings per share (EPS), in the business world has been destroying companies. It will be a tragedy to allow it to destroy Facebook, or other emerging companies of the 21 st century.

Profits (Net Income), y, $ millions

2,500

2,000

1,500

1,000

y = 5.2 x0.67 - 233

500

-500 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000

Annual Revenues, x, $ millions

Figure 3: The simplest non-linear model, the power-law, for revenues-profits data for Facebook Inc. The law can be written as y = mxn + c. For n = 1 this reduces to
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the linear law. For n < 1, profits continue to increase with increasing revenues but there is a deceleration in the rate at which profits increase with increasing revenues. The rate of increase of profits with increasing revenues (the marginal rate of profit, or MRP) is given by the derivative dy/dx of the function y = f(x) used to describe the mathematical relationship between x and y. For the power-law dy/dx = n(y c)/x. Thus, the exact value of n affects the rate which is more readily understood if we consider the case of c = 0, for which dy/dx = n(y/x).

Closing Remarks
Using simple ratios and percentages, such as the profit margin, without a proper understanding of the underlying x-y relation has been one of the biggest (and yet, surprisingly, least understood) problems with business, finance, and economic forecasting and, yes, speculations. Indeed, many public companies, the domain into which Facebook is now venturing, have been destroyed by unreasonable forecasts and expectations fueled by the rampant use of simple ratios in financial analyses. One can only hope for more scientific studies that help us gain deeper insights into the fundamental workings of a company, all the companies within a given sector, and indeed the economy as a whole. As noted, briefly, in the first such analysis on Facebook financials, business, finance, economics, and management sciences now seem to be operating much like astronomy and phyiscs before the advent of Galileo, Kepler and Newton. A young Galileo, then a medical student following his fathers wishes, discovered the law of falling bodies by appealing to experiments. He showed convincingly that the age-old Aristotlean wisdom that heavier bodies fall faster than lighter bodies was downright erroneous. It all started one day at church, when he decided to time (using his pulse, the medical students instinct) the rhythmic swinging of a chandelier hanging from the ceiling. Perhaps distracted by what was going on at church, or by the swinging chandelier, Galileo noticed something interesting and instinctively started timing the swings. There seemed to be a law governing the motion. Thus was discovered the law of the pendulum which then led to the law of falling bodies.

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Galileo was also a good mathematician and showed that the acceleration of all bodies that fall near the vicinity of the earth is a constant. Today, we have a number that we can attach to this acceleration, g = 32.2 feet per second squared or g = 9.81 meters per second squared. Indeed, it was Galileo who first articulated the notion of acceleration that we all now take for granted. The acceleration a = dv/dt and the velocity v = ds/st and so acceleration a = d2s/dt2, the second derivative of distance with respect to time; hence the seconds squared. We all have an instinctive understanding of speed and acceleration. That is how one wins a race one must be able to accelerate if one wishes to break out of the pack. But, it was Galileo who gave a concrete mathematical expression to these ideas. And, it all started with the timing of that swinging chandelier! Likewise, a young Tycho Brahe was intrigued by the failure of the astronomical tables to predict accurately the conjunction of the planets Jupiter and Saturn. This conjunction could be observed easily, with the naked eye, without any special astronomical instruments. The date of the conjunction had been predicted by the tables. But, it did not occur on the date predicted. Brahe was convinced that the astronomical tables were in error and that improved measurements are needed. Keplers subsequent mathematical analysis of Brahes improved observations (of all the heavenly positions of the planets over more than 20 years), then led to the three laws of planetary motions. These laws were deduced without appealing to any type of theory. Galileos and Keplers laws only relied on good observations coupled with mathematical analysis, as opposed to brute force statistical analysis. This is, unfortunately, the trend nowadays, or computer modeling which involves nothing more than an attempt to solve, without proper understanding, a huge array of equations (simple linear equations, differential equations, or partial differential equations) using essentially brute force methods. Illiteracy and bankruptcy of thinking is essentially being masked by modern computing power and fancy graphics! We cannot expect the computer to tell us what is going on when dealing with complex problems. But, we surely do!

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The large volumes of financial data now being compiled on a quarterly and annual basis, for companies operating in different sectors, all over the world, seem to this author at least, like the old astronomical tables (which only led to misleading predictions that Brahe was bold enough to question) before Kepler reduced them to three simple mathematical laws. Perhaps, young companies like Facebook Inc., and entrepreneurs of the 21st century, will pay heed and look for laws that lie beneath the large masses of financial data now being accumulated and reported and, yes, also being widely speculated upon. It is not all Wall Street greed. There is also a lot of Wall Street stupidity here. This can destroy companies. More importantly, it can destroy lives. It can destroy nations. It already has. We are witnessing it. It is time to wake up. Finally, please accept my sincere apologies if any remarks here appear to be a bit overboard. There are at least three places where I have made some strong statements. Do overlook them. My purpose is certainly not to offend anyone but simply to call for action and a serious discussion/implementation of these new ideas. There is far too much at stake.

Very sincerely V. Laxmanan May 21, 2012

P. S. I have so far resisted participating in all social media/networking. I did set up a Facebook account a very long time ago, mainly to accommodate friend requests but the account is essentially inactive and has been for several years now. I did send a Hi Mark note through FB message to Mr. Zuckerberg AFTER this was uploaded. Also, please note that I have no financial interest in FB at this time. This is being pursued purely as a research topic.

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Appendix 1 The Motion of Facebook in Revenues Space Revenues versus time (number of quarters) for Facebook
A brief discussion of the future revenue estimates for Facebook is provided here based on the earlier discussion of the future position of a car moving on a highway. Predicting future revenues (position of Facebook in the revenues space) is very similar to predicting the future position of a car. The lessons learned from calculus are readily transferred to this problem of revenues estimation.
1000
900

Revenues, x [$, millions]

800
700

600
500

400
300 200 100 0 0 1 2 3 4 5 6 7 8 9 10

Time, t [No. of Quarters]

Figure 4: Graphical representation of the Revenues growth data in Table 1. Time t is measured in number of quarters with the first quarter being taken as Q12010. Applying the analogy of the car moving in a highway at a known speed v, it is possible to predict the revenues for Q12012 based on this data and indeed also
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project to Q2 2012 or Q4 2012. While there are many unknown circumstances, as with a car moving on the highway, which will affect the future position of the car, one can make reasonable assumptions regarding the rate at which revenues are growing for Facebook. The problem is similar to estimating the average speed of a car based on several observations over a period of time. The following estimates can therefore be made for Q1 2012. The average rate based on quarter number 1 and quarter 8 is (943 340)/(8 1) = 86.14 per quarter. This yields an estimate of 943 + 86.14 = 1029.14 for Q1 2012 compared to the actual reported value of 1060 for Q1 2012. Alternatively, one can consider the rate of growth between just the last two quarters. This is a bit unreasonable, considering seasonal nature of the advertising revenues but provides an upper limit. The rate is (943 798) = 145 per quarter which yields a projected value of 1088 for Q1 2012, compared to the reported value of 1060. The following additional estimates for the rate of growth of revenues are possible by considering other pairs of x and t values. Quarters 1 and 2: (424 340) = 84 million per quarter. Quarters 1 and 6: (776 340)/(6 1) = 87.2 million per quarter. Quarters 6 and 8: (943 776)/(8 6) = 83.5 million per quarter. The average of these three rates is $84.9 million per quarter. The earlier overall estimate, between quarters 1 and 8 was $86.14 million per quarter. The reported first quarter 2012 revenues of $1060 million can therefore be taken to be consistent with these estimates of the future position of Facebook in its revenue space. If revenues increase, profits will automatically increase as indicated by the linear law relating profits and revenues. Finally, consider now the three rates depicted in Figure 5 which brackets all of the quarterly data and thus provide an upper, lower, and middle range for the predictions of revenues. The equations for three straight lines can be shown to be Q4 and Q1 : Upper limit estimate: x = 105t + 235 Blue line Q7 and Q9: Lower limit estimate: x = 131t 119 Dashed blue line Q8: Middle estimate x = 117.875t (the last quarter of 2011) Red line
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1600

Revenues, x [$, millions]

1400 1200 1000 800 600 400 200

0
-200 0 1 2 3 4 5 6 7 8 9 10 11 12 13

Time, t [No. of Quarters]

Figure 5: Projections for all four quarters of 2012 can made using this graphical representation which brackets all of the available data for the nine quarters. The annual estimates for 2012 are 5350, 5026 and 4950.75. Hence, the estimated revenue is about $5000 million ($5 billion) for 2012. Above estimates will no doubt be affected by any negative perceptions due to the poor performance of the FB stock on Nasdaq after trading began. FB has a lot of work to do to overcome these negatives. P. S. Facebook had another disappointing day on Wall Street with the stock closing at $ 34.03 on Nasdaq, on Monday May 21, 2012 well below the offering price of $38 per share and the intraday high of $45 on Friday May 18, 2012, the first day of trading, see http://finance.yahoo.com/news/facebook-shares-sink-11percent-053349488.html?l=1 It had dropped to $31.00 on Tuesday May 22, 2012 around the closing time. http://investing.money.msn.com/investments/stockprice?symbol=FB&ocid=qbeb

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1400

x = 87.57 t + 238.06 Revenues, x [$, millions]

1200

1000

800

600

400

200

0 0 1 2 3 4 5 6 7 8 9 10 11 12 13

Time, t [No. of Quarters]

Figure 6: Projections for all four quarters of 2012 can made using this graphical representation and the best-fit line through all of the available data for the nine quarters. The equation of the best-fit line is x = 87.57t +238.06 where t is the quarter number starting with first quarter of 2010. The estimates for quarters 9 to 12 are: $1026.2, $1113.7, $1201.3, and $1288.9 giving the annual estimate of $4630 million for all of 2012. Using the best-fit line (linear regression analysis) is usually the least controversial and often yields a conservative estimate as we see here: $4630 million versus nearly $5000 million obtained earlier (Figure 5).

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Earnings Per Share (EPS) for Facebook Based Registration Statement filed May 9, 2012
http://investor.fb.com/secfiling.cfm?filingID=1193125-12-222368&CIK=1326801

THE OFFERING
Class A common stock offered By us By selling stockholders Total Class A common stock to be outstanding after our initial public offering Class B common stock to be outstanding after our initial public offering Total Class A and Class B common stock to be outstanding after our initial public offering 180,000,000 shares 157,415,352 shares 337,415,352 shares 598,396,119 shares 1,539,688,918 shares 2,138,085,037 shares

Over-allotment option of Class A common stock offered By us 6,029,988 shares By selling stockholders 44,582,314 shares Total 50,612,302 shares Above is extracted from page 7 of the Registration Statement cited here.

Year/Quarter

Earnings (E) Net Income $, millions

$229 $606 $1,000 $153 $137

Earnings per share (EPS), $

$0.12 $0.28 $0.46 $0.12 $0.10

Outstanding Shares (S) Millions

1908.333 2164.286 2173.913 1275.000 1370.000

2009 2010 2011 Q12011 Q12012

The earnings (E), or Net Income in $, millions and the EPS values are obtained from the SEC filing. The outstanding shares given in the last column was calculated: Shares = Earnings/EPS.
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Since the number of outstanding shares (for any company) does not change significantly from one quarter to the next, or even from one year to the next (unless there are significant events) the denominator in the EPS - an increase in EPS is only possible if the numerator increases from one quarter to the next. In other words, one is really looking for an absolute growth in the profits, net income, or earnings of a company. The familiar profit margin (PM), as already discussed, is NOT a good measure to predict the future profits of a company because of the non-zero intercept in the linear law y = hx + c. Consider now the following cases. Recall that the profit margin PM = y/x = h + (c/x). Impact of a Positive intercept c: This is due to reasons discussed already, such as a company operating far away from the breakeven revenues, see http://www.scribd.com/doc/94103265/The-FaceBook-Future The profit margin y/x is keep on decreasing even as revenues x increase. The rate of growth of profits with increasing revenues, as measured by the constant h (the MRP) is, however, constant. The company is being unfairly punished in the market place because of the misleading use the ratio y/x. Impact of a Negative intercept c: This is usually the case when a company operating very close to its breakeven revenues. The profit margin y/x is keep on increasing even as revenues x increase. The rate of growth of profits with increasing revenues, as measured by the constant h (the MRP) is, however, constant. The company is now being (unfairly??) rewarded in the market place, in the short term, with rosy projections, again because of the misleading use the ratio y/x. This, however, leads to false expectations and eventually drives the company out of business. Companies such as Microsoft, Cisco have both gained (and then also lost) due to the false expectations from the misleading use of the profit margin, or y/x ratio.

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In summary, some basic theoretical issues with the two widely used metrics, the profit margin (PM) and the EPS, have been revealed by the analysis presented here.

The EPS essentially relies on the absolute growth of profits for a company to thrive in the market place, since the outstanding shares does not change significantly in the short term (quarter-to-quarter or even year-to-year). The profit margin (PM), on the other hand, ignores the implications of the fixed cost and leads to false expectations, both adverse and favorable, in the short term, but with disastrous long term consequences.

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Appendix 3
From the Linear Law to Power law to the Power-Exponential Laws The following is taken from the earlier write up on Facebook. (http://www.scribd.com/doc/94103265/The-FaceBook-Future ) If careful experimental observations suggest a deviation from the power law, one can use the power-exponential law to modify the power-law. A good example is the performance data (speed versus time, or the acceleration data) for a modern automobile. Carefully controlled acceleration tests indicate (we will NOT discuss this here; this will be presented separately) that the acceleration is not a constant. The behavior similar to that we see in Figure 3 here is usually observed with the speed versus time data. The power-law is a more satisfactory description for the performance data for most cars. However, when we consider high performance vehicles (Corvette, BMW, Lamborghini, Ferrari, etc.) which are tested to speeds in excess of 100 mph, we see deviations from the power law. The power-exponential law now becomes the more appropriate model to describe vehicle performance. This law may be written as: y = mxne-ax (C5)

Here we assume, for convenience that when x = 0, y = 0, i.e., the graph passes through the origin (0, 0) with no intercept on the y-axis. This law was also being used to describe the experimental data on blackbody radiation, towards the end of the 20th century, before Planck developed quantum physics by essentially modifying this law slightly. Plancks mathematical law can be written as: y = mxn [e-ax /(1 + be-ax) ] + c .(C6)

Equation C6 is actually a generalization of Plancks blackbody radiation equation. In Plancks law b = - 1 and c = 0. It can be shown that the graphs of both equations C5 and C6 will reveal a maximum point. The position of the maximum point can be readily calculated using rules of calculus. The graphs will deviate for large x. In blackbody radiation theory, the Rayleigh-Jeans law, which was deduced theoretically using pre-quantum physics ideas, is a power-law (equation C2). This description of radiation lead to serious fundamental problems (it was called the
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ultraviolet catastrophe) indicating a lack of theoretical understanding about the nature of blackbody radiation. Wien deduced the power-exponential law (equation C5) from his experimental studies but was not able to offer any theoretical explanation to justify the introduction of the exponential term. It was essentially what we would call a curve-fitting procedure. (Wien received the Nobel Prize in 1911 for his discoveries regarding the laws governing the radiation of heat, see http://www.nobelprize.org/nobel_prizes/physics/laureates/1911/ ) Planck modified Wiens law to equation C6 (with b = - 1 and c = 0) and introduced what is now called the quantization hypothesis there is an indivisible unit of energy called the energy quantum. Planck was then able to derive equation C6 using statistical arguments (originally due to Boltzmann) that he had despised all his life. The term within the square brackets in equation C6, [e-ax /(1 + be-ax) ], is the correction factor needed to fix the theoretical problems with the Rayleigh-Jeans law which is a pure power law (equation C3). Planck received the Nobel Prize in 1918. Years later, Planck would call this (the introduction of statistical arguments into the physics of heat radiation) his desperate attempt to explain blackbody radiation, at any cost. It eventually led to the birth of quantum physics in 1900. Now, one can think of money in economics as being similar to energy E in physics. In physics, we also encounter what is known as entropy, which is taken to be the measure of the extent of chaos in a system. The higher the chaos or disorder the higher the entropy S. Energy E and entropy S are related to the temperature T via the first and second laws of thermodynamics, viz. T = dE/dS. This is the definition of temperature used by Planck to derive the radiation law, equation C6. Well, even financial and economic systems (and social and political systems) exhibit this property called chaos. Using these mathematical analogies (and pretending that we understand the meaning of entropy S and temperature T as applied to systems outside physics), one can actually go through the exact arguments that Planck uses in his 1900 paper and rederive a generalized version of Plancks law and apply it study the behavior of financial, economic, and even social and political systems. This will not be pursued here.

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At first, even Planck was not sure about what he had accomplished. In 1900, quantum physics just seemed like a convenient mathematical manipulation to justify Wiens law and the experimental observations. Quantum physics took off only after Einstein applied Plancks idea of an elementary quantum of energy, in 1905, to explain the photoelectric effect. Einstein used the power-exponential law (equation C5) to develop the theory and ultimately proposed the simple linear law y = hx + c with the non-zero intercept c. Einstein called c the work function. When a particle of light, which we now call a photon, impinges on the surface of a metal, electrons are ejected from within the surface. The electrons have a kinetic energy K which is less than the energy E of the incoming photon. The difference is the energy that must be given up in this process. Einstein received the Nobel Prize in 1921, see http://www.nobelprize.org/nobel_prizes/physics/laureates/1921/ for this work, not his theory of relativity. The idea of light being made of discrete particles, with a fixed amount of energy, was a revolutionary one back in 1905. Einsteins law can be written as, K = E W = hf W (C7)

Here E = hf is the elementary quantum of energy conceived by Planck, h is a constant, now called the Planck constant, and f is the frequency of light. (Light has both a particle-like and a wave-like characteristic. The frequency f is due to its wavelike nature. The fixed quantum of energy hf is due to its particle nature.) The work function W, the energy that must be given up, is similar to the fixed costs of operation of a company. We can also think of an elementary quantum of money (the elementary unit of revenue generated). Each fixed elementary unit of revenue (like one advertisement for Facebook) produces a fixed amount of profit. But not all of the revenue will appear as profit. There is a W, as in Einsteins law. Profits = Revenues Costs (C8)

Hence, we cannot compare companies using the ratio profits/revenues. Equations C7 and C8 allow us to make the transition from the physics to economics. Chaos prevails in both these worlds, but one has been understood (to a fair degree) while the other beckons our understanding. 19MAY12
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Source of Facebook Financial data analyzed in this document

http://investor.fb.com/secfiling.cfm?filingID=1193125-12-222368&CIK=1326801 As filed with the Securities and Exchange Commission on May 9, 2012
Table of Contents SELECTED CONSOLIDATED FINANCIAL DATA The consolidated statements of income data for each of the years ended December 31, 2009, 2010, and 2011 and the consolidated balance sheets data as of December 31, 2010 and 2011 are derived from our audited consolidated financial statements that are included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2007 and 2008 and the consolidated balance sheets data as of December 31, 2007, 2008, and 2009 are derived from audited consolidated financial statements that are not included in this prospectus. The consolidated statements of income data for the three months ended March 31, 2011 and 2012, and the consolidated balance sheet data as of March 31, 2012 have been derived from our unaudited consolidated financial statements appearing elsewhere in this prospectus. In our opinion, such financial statements include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of the financial information set forth in those statements. Our historical results are not necessarily indicative of our results in any future period. You should read this information together with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the related notes included elsewhere in this prospectus.
Year Ended December 31, 2007 2008 2009 2010 2011 Three Months Ended March 31, 2011 2012

(in millions, except per share data)

Consolidated Statements of Operations Data: Revenue Costs and expenses (1) : Cost of revenue Marketing and sales Research and development General and administrative 41 32 81 123 124 76 47 80 223 115 87 90 493 184 144 121 860 427 388 280 167 68 57 51 277 159 153 88 $ 153 $ 272 $ 777 $1,974 $3,711 $ 731 $1,058

Total costs and expenses

277

327

515

942

1,955

343

677

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Income (loss) from operations Interest and other income (expense), net

(124) (11)

(55) (1)

262 (8)

1,032 (24)

1,756 (61)

388 10

381 1

Income (loss) before provision for income taxes Provision for income taxes

(135) 3

(56)

254 25

1,008 402

1,695 695

398 165

382 177

Net income (loss)

$ (138) $ (56) $ 229

$ 606

$1,000

$ 233

$ 205

Net income (loss) attributable to Class A and Class B common stockholders Earnings (loss) per share attributable to Class A and Class B common stockholders (2) : Basic

$ (138) $ (56) $ 122

$ 372

$ 668

$ 153

$ 137

$(0.16) $(0.06) $0.12

$ 0.34

$ 0.52

$0.12

$ 0.10

Diluted

$(0.16) $(0.06) $0.10

$ 0.28

$ 0.46

$0.11

$ 0.09

Pro forma earnings per share attributable to Class A and Class B common stockholders (2) : Basic

$ 0.49

$ 0.10

Diluted

$ 0.43

$ 0.09

43

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Strange But True

I may be the 1% taking on the 99% at Wall Street with these crazy ideas about MRP versus PM Never really fancied this! May the 99% take over from here!! CHEERS!!!

Shanti Shanti Shanti !!!!!

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