May 2019

Pinterest is of Interest

Wall Street is male-dominated; in fact, women only make up 20% of the executive positions in financial services firms. However, out of Pinterest’s 265 million users, nearly 70% are females.

 

According to the company’s prospectus, “this includes eight out of 10 moms, who are often the primary decision-makers when it comes to buying products and services for their household, as well as more than half of all U.S. millennials.”

 

This simple male-female discrepancy is a fertile breeding ground for a mispriced stock.

 

Background

 

If Facebook is a social discovery platform, able to transport your high-school friend group to the digital age, Pinterest is an interest discovery platform.

 

Users, affectionately called Pinners, scroll through a feed tailored to their interests.

                                    

If a user likes to use Pinterest for recipes, more recipes will appear. That’s the magic of the algorithm. Every scroll, every click, every post you look at for more than a second, allows the algorithm to better tailor the feed to your preferences.

 

The company describes itself as, “the productivity tool for planning your dreams.”

 

This is important because it implies intent. When you log onto Facebook, your intent is not necessarily to buy something. But when Pinners open up the Pinterest app, it is more intentional.

 

Yet, look at what Facebook has been able to achieve. In North America, it’s average revenue per user (ARPU) comes in at $35. And worldwide, the same metric is $7.4.

 

Facebook is a helpful comparison for what Pinterest could become so let’s dive a little deeper.

 

Zuckerberg’s creation has 2.3 billion monthly active users (MAUs). Of those, 242 million reside in the US or Canada. But remember, the ARPU for this segment is $35. This translate into $8.5 billion in revenue. The company did nearly $17 billion in 2018 sales.

 

That means half of Facebook’s sales came from just 1/10th the number of users.

 

This dynamic is similar with Pinterest. Check out these charts.

 

 

Pinterest’s MAUs (in millions)

So you can see that Pinterest has 82 million users in the US and 184 million internationally. What’s interesting is that in Q1 of 2016, these two populations started in the same place.

 

In the US, users grew at an annual rate of about 12% whereas internationally, they grew 71% on average.

 

Even still the total number of users is about 11% of Facebook’s user base. However, factoring in the female-heavy bias of Pinterest, the company could reasonably double its MAUs but probably not 10x the number.

 

Moving on…

 

 

Pinterest Revenues (in millions)

Notice anything?

 

Though the US accounts for 31% of the total users it makes 94% of the sales. This is even more dramatic than Facebook’s 10% of users and 50% of sales.

 

Pinterest does not break out, like Facebook does, the different geographies of the international user base. This makes sense though, because Pinterest’s international user base is much more immature at this point.

 

Check it out…

Pinterest ARPU

For each US user, Pinterest can make $3.16 in sales. Yet that number shrinks to 9 cents internationally. Some may see this as a concern, but it actually points to room for expansion.

 

Let’s check in on where Facebook’s ARPU is international.

That’s a lot higher than 9 cents.

 

Plus, Pinterest is an interest discovery platform. Pinners log on with the intention of buying.  Facebook is just social discovery, albeit a very powerful one.

 

Don’t get me wrong. US consumers will almost always spend more than their international counterparts. But let’s do some modeling to see what Pinterest’s potential could be.

 

In 2012, right after Facebook IPO’d, it’s worldwide ARPU (blended between North America and international) was $1.23. It had 955 million MAUs and it was doing about $1.18 billion in revenue/quarter.

 

Now, that number is $7.37, a compounded annual growth rate of 35%. That means Facebook has been able to either raise prices, show more ads or increase engagement by 35% cumulatively each year across the globe (from now on, I’ll just say “raise prices”.)

 

That’s the magic of Facebook’s business model and hopefully Pinterests’ too. The incremental costs of goods sold are basically non-existent so all the additional profit flows to the bottom line.

 

Let’s say that in 5 years, Pinterest can reach 100 million US consumers and 300 million international buyers. This is a fairly conservative estimate for international as it assumes just 10% annual growth whereas users grew 32% last year.

 

That means the US will make up 25% of users just lower than the 30% it currently accounts for. If Pinterest can follow Facebook’s playbook and raise ad prices 35% for the next 5 years, then the ARPU for US consumers will be $14.3, still a far cry from Facebook’s $35.

 

On 100 million consumers, that’s $1.43 billion in sales. 

 

For the international part of the equation, let’s say Pinterest can raise prices at 25% per year. This is not random. Facebook has been able to raise prices internationally by about 27% vs. almost 39% in North America (this is why the blended growth rate is 35% as mentioned earlier). 

 

So, in 5 years, 25% growth would result in international ARPU of just 27 cents. After multiplying by 300 million MAUs, we’re left with $81 million in sales.

 

Together, that makes up $1.51 billion in sales. However, that is based off of Q4 which is the highest grossing period. Looking back, Pinterest typically makes between 36% of total sales on Q4 alone. So if we do the calculations, (100/36)*1.51 then we get 2023 sales of $4.1 billion. That’s a compounded annual growth rate of 40%. Pretty good and certainly possible within the grand scheme of the $800 billion advertising industry.

 

Once again, since Pinners use Pinterest with more intention than Facebook-ers use Facebook, it is possible that the company could raise prices slightly faster than Facebook’s historical trends.

 

Plus, after talking at length, to some avid Pinners they believe Pinterest could place even more ads in the feed. What makes the platform really interesting is that the ads are so native. People click on them not even realizing they are ads. Bottom line: the ads aren’t disruptive.

 

If you’ve ever been on Forbes or most financial news site, the ads are just so in-your-face. It’s not a pleasant user experience because they aren’t native to the experience. When you go to Forbes, you’re not looking to buy something.

 

Pinterest is as if you logged onto a financial newsletter aggregator looking to find the best newsletters on the web. You, at least, have an inkling you want to buy something.

 

And this is playing out in the numbers as well. The last four quarters of revenue growth are as follows:

You can see that the sales growth has stayed around 60%. It even accelerated year-over-year this past quarter, from 50% to 58%.

 

This was because the company raised ad prices faster than it did in 2017.

 

One concerning thing is the company’s margins. Though it is an immature ad platform by scale, operating margins are still negative.

 

But let’s set the scene with more historical context.

 

Pinterest was founded in 2010 and only really started monetizing in 2014. On the other hand, Facebook was started in 2004. In only 5 years, Facebook reached the scale Pinterest is at now, unsurprisingly, 5 years after monetization efforts started. Now I am not saying that Pinterest is on the same level as Facebook. When Facebook was at this scale in terms of MAUs and revenues it was still doubling every year. Unfortunately, Pinterest is not. But still, if Pinterest can perform a fraction as well as Facebook, this will be a good investment.

 

What’s more, even at an immature scale, Facebook was doing 30% operating margins. Pinterest’s are -10%. So no, Pinterest is not Facebook. It just doesn’t have the same reach.

 

However, those operating margins are getting better and better. On the year, margins improved from -29% to -10%, a huge feat. Again, that’s the power of an advertising platform.

 

But the real question remains. Why are the margin profiles so different between Facebook in 2009 and Pinterest today?

 

In fact, around 2009, Facebook had revenue per employee of about $1 million. Pinterest has about 42% of that.

 

So why is this?

 

Well, first of all, as we’ve mentioned Facebook is a social platform, therefore it is accessible to everyone. Pinterest, right now, is more of a niche platform. Remember, 70% of users are female. And we’ve seen MAU growth slow from 36% in 2017 to 23% this year.

 

So the scale will likely never come close to Facebook. But the crux of this investment is that the company can deliver advertisers a high ROI and therefore have the leverage to raise ad prices.

 

I do think the probabilities of this happening are high. Facebook’s platform, though still powerful, is seeing some drop off in millennial usage. Plus, the ARPU is 10x that of Pinterest in North America. There is plenty of room for Pinterest to raise prices.

 

Look further and the Facebook-Pinterest similarities continue. Pinterest’s CEO, Ben Silbermann started the company in his 20’s and is only 36 now, two years older than Zuckerberg. Pinterest also brought on a more experienced female COO, similar to Sheryl Sandberg.

 

As we’ve seen, Facebook has been a helpful comparison so we can wrap our heads around Pinterest. Obviously, the platforms are not the same. Pinterest will likely not operate at the same scale but it makes up for it with the purchase intention of the users.

 

Now, let’s move onto the valuation.

 

In my opinion, it was great that Pinterest and Zoom IPO’d on the same day. Zoom got all the attention while Pinterest had a very respectable pop.

As you can see, Pinterest falls well below the line-of-best-fit. If you’re curious, yes, that dot on the far right is Zoom. While this line is not a perfect representation of reality, as reality contains a lot of nuance, it is helpful.

 

Pinterest seems to be reasonably valued. We already did a bottoms-up valuation so I won’t cover this much more.

 

Risks

 

Pinterest’s sales leverage comes in three main ways.

 

  1. Charge advertisers more.

  2. Shows users more ads.

  3. Get more users.

 

If we see ARPU slowing down, that would be a big red flag. If it does not grow year-over-year by at least 20%, then we’ll need to dig in to re-evaluate. It could be that the company wants to gain advertiser loyalty before cranking up prices but we’ll still keep a close eye on it.

 

It’ll be harder to tell on #2 but we’ll keep doing boots-on-the-ground research.

 

Lastly, we’ll keep an eye on how saturated Pinterest’s target market is becoming.

Conclusion

Pinterest is an underappreciated company. The current perception is that it is a niche offering that can easily be replicated. The data and a lot of people I talked to goes against that consensus. Pinterest has solid engagement and its users have a high intention of purchasing which is an advertisers dream.