PROGRESS REPORT for INTERNET and SOCIAL MEDIA 2_3_12 FINAL.pdf · Making diffuse information about the Internet and Social Media crystal clear IN THIS ISSUE: Facebook: S-1 Fab Kabam

Making diffuse information about the

Internet and Social Media crystal clear

IN THIS ISSUE:

Facebook: S-1

Fab

Kabam

Guest Post: Social Media in Retail

February 3, 2012

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RULE 501 OF REGULATION D UNDER THE

SECURITIES ACT OF 1933 OR

INSTITUTIONAL INVESTORS.

Wedbush Securities does and seeks to

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affect the objectivity of this report.

Investors should consider this report as

only a single factor in making their

investment decision. Please see page

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certification and important disclosure

information.

1000 Wilshire Blvd, • Los Angeles, CA 90017

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PROGRESS REPORT for INTERNET and SOCIAL MEDIA

PRISM

Michael Pachter

(213) 688-4474

[email protected]

Yoni Yadgaran

(212) 938-9924

[email protected]

mailto:[email protected]

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WEDBUSH | PROGRESS REPORT for INTERNET and SOCIAL MEDIA

About Wedbush Securities Private Shares Group The Private Shares Group of Wedbush Securities is a leader in providing research and trading to the rapidly growing industry of privately traded securities, with an emphasis on companies in the social media space. We assist companies in raising growth capital through traditional private placements and provide liquidity options for existing and former employees through tailored selling programs. We also work with Venture Capital, Private Equity and Hedge Fund investors to help them adjust their holdings in some of the most dynamic companies. We endeavor to understand the underlying industries of the private companies we trade, in order to help our clients make informed decisions about their investments. We provide discreet customized solutions for our institutional and accredited private clients through a team of professionals located in New York, Los Angeles and San Francisco.

About Michael Pachter

Michael Pachter is the Managing Director, Equity Research providing coverage across the Digital Media sector and Head of Research for the Private Shares Group. He has been recognized as StarMine’s “Top Earnings Estimator‖ year after year and ―Best on the Street‖ by the Wall Street Journal. Michael brings over 20 years of experience as a financial professional to the Private Shares Group along with extensive knowledge across the social media sector in both public and private companies.

Mr. Pachter holds an M.B.A. from the Anderson School at the University of California at Los Angeles, a juris doctor from Pepperdine University, an LL.M. in Taxation from the University of Florida, and a bachelor’s in Political Science from California State University, Northridge.

About Yoni Yadgaran

Yoni Yadgaran joined Wedbush over a year ago from Bank of America Merrill Lynch. Originally covering Internet & E-commerce within Equity Research, he later moved on to help pioneer the Private Shares Group’s Research efforts. Yoni is a CFA level 3 candidate and received a B.B.A in Finance from Baruch College. Contact Wedbush Securities Private Shares Group: Michael Pachter Managing Director, Equity Research Head of Research, Private Shares Group (213) 688-4474 | [email protected] Twitter: @michaelpachter Yoni Yadgaran Research Associate, Private Shares Group (212) 938-9924 | [email protected]

About Wedbush Securities

Founded in 1955, Wedbush Securities is a leading investment firm that provides brokerage, clearing, investment banking, equities research, public finance, fixed income sales and trading, and asset management to individual, institutional and issuing clients. Wedbush currently ranks a top liquidity provider for NASDAQ, and was ranked #1 stock picker for 2010 by Barron’s. Headquartered in Los Angeles, with over 100 offices nationwide, Wedbush focuses on relentless service, client financial safety, continuity, and advanced technology. (www.wedbush.com)

Cyrus P. Pirasteh Managing Director Head of Equity Trading, Technologies & Operations (213) 688-6661 | [email protected]

Kevin Cohen Director of Trading, Private Shares Group (213) 688-8089 | [email protected]

mailto:[email protected]

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Facebook S-1 Facebook filed an S-1 Wednesday night, and plans to offer Class A shares under the ticker FB on either the NYSE or NASDAQ. We expect the offering in the back half of Q2, allowing time for the six month lock-up period to expire prior to the expiration of the Bush era tax cuts. Facebook Class B shares have ten times the voting power of Class A shares, giving Mark Zuckerberg complete control of the company. The company has become what many consider to be a platform of its own, with a growing number of developers building socially integrated apps (over 7 million) that have proliferated on both mobile devices and PCs. Facebook reported that interactions with the site continue to grow, with 2.7 billion Likes and Comments on the site daily on average over Q4:11, with an additional 250 million daily uploads, and over 9.7 billion minutes spent daily on the site through desktop computers. In December 2011, 360 million users visited the site six out of every seven days, and there are over 37 million pages on Facebook that have more than ten Likes. The 100 billion user connections on the site have given Facebook a critical mass that will prove incredibly difficult to replicate, giving the company a defensible competitive advantage. Furthermore, Facebook has become one of the few places online where users feel comfortable sharing personal information to multiple individuals under their own identity, a psychological advantage that has utility beyond brand targeting. The company has offices and data centers in 20 countries, giving it a competitive moat that few online companies can replicate. Facebook plans to spend $1.6 – 1.8 billion in Capex in 2012, demonstrating how expensive it is to deliver an instantaneous and seamless user experience.

Usage and Engagement The company disclosed it had reached 845 million Global Monthly Active Users (MAUs) by the end of Q4:11, an increase of 39% from the year before, and in-line with our own expectations. We note that despite the large increase in absolute terms, having added 237 million users in 2011, the rate of growth has declined substantially over the last three years. Over the same period, Daily Active Users (DAUs) grew 48% to 483 million, driven by increased user engagement due to apps, chat and mobile.

Global MAU

1 6 12

360

608

845

145

58

0

100

200

300

400

500

600

700

800

900

2004 2005 2006 2007 2008 2009 2010 2011

0%

100%

200%

300%

400%

500%

600%

Y-o-Y Growth

Source: Wedbush Securities, Company Data

As we have noted in the past, we believe that penetration of online users will limit the company’s growth rate to Internet penetration among offline demographics, which is significantly lower than the 39% growth rate in 2011. The company disclosed penetration rates of over 80% in a few (of what we believe to be many) countries that include Chile, Venezuela, and Turkey. On a quarterly basis, Global MAU growth has slowed to 6% from Q3:11; a quarterly growth rate shared by Facebook’s DAUs over the same period.

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Global MAU

197

242

305

482

550

608

680

739

800845

360

431

0

100

200

300

400

500

600

700

800

900

Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

0%

5%

10%

15%

20%

25%

30%

35%

40%

Q-o-Q Growth

Global DAU

92108

144

257

293

327

372

417

457

483

185

234

0

100

200

300

400

500

600

Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

0%

5%

10%

15%

20%

25%

30%

35%

40%

Q-o-Q Growth


Facebook’s DAU growth has largely been driven by countries outside Europe and North America, led by Asia in 2009 and 2010, and most recently Africa, South America and the Middle East, which Facebook lumps together as ―Other‖. DAUs in Asia increased 64% in 2011, adding 41 million users, and accounting for 26% of global daily user growth. Over the same period, DAUs from ―other‖ geographies grew 88%, adding 51 million users, and accounting for 33% of global growth. Contributing to this are the low penetration rates in India and Brazil (20 – 30%), as well as in countries like Japan and South Korea (less than 15% penetration rate). On a monthly basis, Facebook reported that it grew in Brazil by 268% to 37 million MAUs at the end of 2011, while MAUs in India grew by 132%, to 46 million, over the same period. We believe that growth in India and Brazil, which were previously dominated by Google’s Orkut, likely skews substantially towards mobile users, who are worthless on a per-user basis from an advertiser’s perspective. It is important to point out that the company remains barred from offering its service in China, North Korea, and Iran.

Asia DAU

913

20

45

54

64

72

85

98

39

29

105

0

20

40

60

80

100

120

Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

0%

10%

20%

30%

40%

50%

60%

Q-o-Q Growth

Rest of the World DAU

14 16

22

42

5458

87

100

74

109

29

35

0

20

40

60

80

100

120

Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

0%

5%

10%

15%

20%

25%

30%

35%

40%

Q-o-Q Growth


Facebook notes that penetration of Internet users in the U.S. and UK are around 60%, which is reflected by the slower levels of growth that both Europe and North America have had over the last two years. DAUs in North America increased 27% in 2011, adding 27 million users and accounting for 17% of global daily user growth. Over the same period, DAUs from European geographies grew 34%, adding 36 million users and accounting for 23% of global growth.

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North America DAU

3540

53

85

92

99

117

124

82

64

126

105

0

20

40

60

80

100

120

140

Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

0%

5%

10%

15%

20%

25%

30%

35%

Q-o-Q Growth

Europe DAU

3539

50

85

94

107

127

135

120

143

63

79

0

20

40

60

80

100

120

140

160

Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

0%

5%

10%

15%

20%

25%

30%

Q-o-Q Growth


As of Q4:11, Europe is the largest contributor to global Facebook traffic, accounting for 27% and 30% of MAUs and DAUs respectively. North America is the second largest contributor, with respective MAU and DAU contribution of 21% and 26%. We note that from Q1:09, Facebook’s international traction has brought MAU contribution down from 38% to 26% and 38% to 30% for North America and Europe, respectively.

DAU Geographic Contribution

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

North America Europe Asia Other


We were not surprised by the company’s near-term focus on continuing to increase user engagement. From an economic perspective, the longer users spend on the site, the larger the volume of ad impressions that can be served. The stickier Facebook is as a platform, the larger its moat will grow, allowing the social network to remain the most trafficked site on the Internet. Over the last three years, Facebook has managed to consistently grow DAUs as a percentage of MAUs, growing from 51% to 57% at the end of 2009 and 2011 respectively.

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DAU/MAU By Geography

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

North America Europe Asia Other


Financials Facebook’s 2011 revenues were slightly below what was expected following what traditionally has been a seasonally strong fourth quarter for advertising. Full-year 2011 revenues were $3.71 billion, up 88% from $954 million a year earlier. Advertising was responsible for 85% of revenues, having increased by 69% y-o-y. Facebook notes that it grew ad impression volume by 42% in 2011, while increasing the average price per ad by 18%.

Revenue

$0.4 $9 $48

$777

$3,711

$1,975

$153 $272

$-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011

0%

50%

100%

150%

200%

250%

300%

Y-o-Y Growth

Revenue

$345

$432$467

$895$954

$1,131

$731 $731

$-

$200

$400

$600

$800

$1,000

$1,200

Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

-10%

0%

10%

20%

30%

40%

50%

60%

Q-o-Q Growth

`


Fourth quarter revenues came in at $1.13 billion, up 55% y-o-y, and 19% sequentially. Revenue was driven by $943 million in advertising (83% of total revenue), which increased 44% y-o-y, and $188 million from Payments (17%), which grew 147% over the same period. The company continues to diversify away from advertising as a source of revenue, having only begun monetizing Credits in Q2:10, taking a 30% cut of all in-app revenues. The company notes that social gaming revenues made up the entire non-ad revenue segment, which is something we expect to change as Facebook comes up with a model that can monetize off the success of third-party apps like Spotify, which recently announced three million paying subscribers, in large part due to Facebook.

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Revenue

$-

$200

$400

$600

$800

$1,000

$1,200

Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

75%

80%

85%

90%

95%

100%

Payments & Other

Advertising

Ad Revenue Contribution


Facebook notes that 12% or $445 million of its revenue came from Zynga in 2011, while all customers contributed less than 10% of revenue for the two prior years. We assume that Zynga is responsible for 60 – 70% of the $557 million in Payments revenue that Facebook received in 2011, as a portion of Zynga’s revenue contribution was in the form of advertising on Facebook in order to increase traffic to new games. We believe that Zynga will continue to be Facebook’s primary source of non-ad revenue over the next year, as the social gaming company launches a slew of new games and continues to optimize its virtual goods monetization model. We also note that Zynga’s addendum with Facebook is set to expire in May 2015. Cost of revenue grew 73% for full-year 2011 to $851 million, resulting in a slight improvement in gross margins to 77% from 75% the year before. Over the last three years, gross margins have remained relatively stable in the 71 – 78% range, following a drastic decline in 2008.

Costs (Non-GAAP)

124223

$492

$851

$164

$265

$429

$886

$173

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

FY2007 FY2008 FY2009 FY2010 FY2011

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

Cost of Revenue Operating Costs: Gross Margin


Operating costs over the same period grew 107% over the same period, costing Facebook $886 million in 2011. We note that the contribution to operating costs from Sales and Marketing, R&D, and G&A have remained stable for the last three years at 43%, 31%, and 26%, respectively.

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Operating Costs (Non-GAAP)

$-

$100

$200

$300

$400

$500

$600

$700

$800

$900

$1,000

FY2007 FY2008 FY2009 FY2010 FY2011

-50%

-30%

-10%

10%

30%

50%Sales R&D G&A Operating Margin


Over the last two years operating margins have remained stable as well, as Facebook managed to keep its workforce lean. The company grew headcount to 3,200 at the end of 2011, up from 2,127 and 1,218 at the end of 2010 and 2009, respectively.

Operating Costs (Non-GAAP)

$-

$50

$100

$150

$200

$250

$300

Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

40%

45%

50%

55%

60%

65%

70%

75%

Sales R&D G&A Operating Margin


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Non-GAAP net income grew 94% y-o-y for 2011, growing from $628 million to $1.22 billion. Its Q4:11 earnings came in at $302 million, up 20% y-o-y, and 33% sequentially. Net margin fell from 34% in Q4:10 to 27% in Q4:11.

Net Income (Non-GAAP)

$256

$(26)$(65)

$628

$1,218

$(200)

$-

$200

$400

$600

$800

$1,000

$1,200

$1,400

FY2007 FY2008 FY2009 FY2010 FY2011

Net Income (Non-GAAP)

$302

$131

$233

$251 $240

$227

$95

$129

$-

$50

$100

$150

$200

$250

$300

$350

Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11

20%

25%

30%

35%

40%

45%

50%

Net Margin


Advertisers leverage Facebook to target any one of the 483 million users on Facebook daily. User data that can be used to target a subset of online users include age, gender, Likes, geographic locations and other information shared on Facebook. The company believes that it will continue to compete with both online and offline advertising, including performance-based advertising and mobile. Currently, mobile has been incredibly difficult to monetize for Facebook, with Google controlling mobile search, which has proven far easier to monetize relative to display. Approximately 15% of Facebook revenues now come from Facebook’s Credit payment program, which acts as a tax on monetizing developers on its platform. We believe that Credits are similar to PayPal insofar as they can reduce friction for online commerce, can be leveraged by developers through its API, and are being broadly disseminated by a popular platform. The company plans to extend the reach of credits, which can serve to reduce some of the cyclicality in revenues that are associated with advertising. Upcoming investments will likely be targeted to further reduce payment friction by utilizing Facebook’s mobile presence and existing relationships with 3

rd party developers. Of course, the current 30% ―Facebook tax‖ would

not be viable outside of its own platform, and we believe Facebook would not hesitate to establish a tiered-pricing structure depending on the currencies used and transaction origination. The company has reported working with both mobile hardware manufacturers and software developers to further develop its mobile platform, perhaps ultimately allowing the company to integrate with a user’s emerging digital wallet. Facebook estimates 2010 global ad spend at $588 billion. The company believes that global virtual goods revenues were $2 billion and $7 billion in 2007 and 2010, respectively, and it expects virtual item sales to grow to $15 billion by 2014. Facebook made it clear that it does not need the $5 billion it will raise, and will likely spend the money on additional acquisitions for talent, and tax payments on outstanding restricted stock units (RSUs) which the company will incur for six months after the offering. The company cites risks that include competing products (Google+), government intervention, litigation, alienating users, loss of key personnel, potential cannibalization from socially connected third-party sites, use of Pages as a free alternative to advertising, and the move to mobile. The move to mobile is a risk that particularly interests us. As Facebook expands into less developed countries, an increasing share of adopting users will be accessing the platform by way of a low-end mobile device. In developed countries, the move to mobile has continued to accelerate, driven first by adoption of Internet capable smart phones, and most recently through the proliferation of tablets. As mobile time spent online increases, users will find their usage on desktops and laptops decline. This is an issue because Facebook has yet to materially monetize its mobile users. We believe this issue will be addressed as Facebook innovates, following in the steps of Twitter, which is far less engaging than Facebook. Facebook has already begun offering Sponsored Stories, which display a social ad that features an interaction that a friend in your network has had with an advertiser. For example, a friend who ―Likes‖ a brand’s Page on Facebook may have that same brand amplify and retarget that notification towards the user. This type of advertising is less obtrusive to most users relative to a large display ad, is less likely to be ignored, and is effective for small screens with a limited amount of space.

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Facebook’s platform continues to become dependent on Android and iOS. Facebook’s ability to tax users is not novel; Apple has been doing it with iTunes and its own app store long before the mid-2010 launch of Credits. A levy on social gaming revenue that Facebook collects from Zynga may, in turn, require a revenue split with Google. We believe that ultimately, consumers using Facebook on their phones while shopping are one-step closer to being influenced by their own social connections and their opinions. This is something in which Facebook has significant expertise. Adding a geographic element to brand interaction has monetary potential itself. Companies like Groupon have proven that access to an audience is a key element of success in the digital commerce space. Facebook’s audience access is unparalleled, and its positioning as a neutral ground where consumers and brands come together leaves a significant opportunity in the mobile deals space. Furthermore, it is our belief that Facebook has the ability (and will) to offer an alternative form of search that will allow the site to leverage its data base of connections and personal tendencies to facilitate discovery, for both mobile and PC customers. Facebook is one of the largest employers of ex-Google employees, has an obsession with enhancing user experience, and yet has not yet developed a usable internal search product. This leads us to believe that Facebook is putting significant resources into a more developed product. We acknowledge that Facebook would be hard pressed to develop a search product that would be as sophisticated, as all-encompassing, or as quick as Google, but we think that providing users the ability to search their friends’ feeds since they joined Facebook has limitless possibilities for delivering context relevant ads, and would substantially enhance the user experience. However, this past month’s launch of Google’s Search Plus Your World has demonstrated that social context can be valuable, and we believe that a curated experience is often preferable. Another key issue the company may face is how easy Facebook has made the process of sharing and interacting for brands, risking disintermediation, as Facebook is one of the largest online facilitators of brand awareness through its 28% share of display. There are now over 4 million brand pages on Facebook, which allows a company to market freely to fans after they have given their consent by Liking a brands fan page. This can cause brands to increase usage of the medium, and cut back on traditional advertising.

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Fab Fab is a design-centric flash-sales site, headquartered in New York, which attempts to facilitate daily discovery by offering deals across a broad range of prices and categories. The site differentiates itself from Gilt Groupe by offering low-end products along-side expensive items, in contrast to Gilt’s focus on luxury offerings. Users receive a daily email as well as a weekly preview of upcoming sales. Fab attempts to keep its selection interesting to drive repeat traffic and keep subscribers opening their daily emails. Sales start daily at 11a.m. EST, and typically last 72 hours. Sale items sell quickly, and a 12-minute hold time for items in a user’s shopping cart indicates how robust demand for a sale can be. Fab provides a 14-day return-policy for most items, although Final Sale items are excluded from this.

Source: Company Site

The company received over $51 million in funding as of December 2011, including a personal investment from the company founders. A $1-million early-stage round of funding in July, was followed by an $8-million Series A round a month later. At the time, CEO Jason Goldberg disclosed to Venturebeat that the company had reached 400,000 members and was already profitable. Goldberg also told Venturebeat: ―We don’t have any ambition in the fashion category. That’s more about liquidation; our model is more about opening a new channel for suppliers.‖ Participants in the Series A round included Menlo Ventures, First Round Capital, Baroda Ventures, The Washington Post Company, SoftTech VC, SV Angel, and Ashton Kutcher, and Fab had already reached profitability at the time. In December, Andreessen Horowitz led a $40 million Series B round at a $200-million valuation, with participation from existing investors. Jeff Jordan, a partner at Andreessen Horowitz, former CEO of OpenTable, and former President of PayPal, joined Fab’s board as part of the terms for the firm’s investment. Other members of the board include partners from Baroda Ventures, Mayfield Fund, First Round Capital, and Menlo Ventures.

Series B (December 2011) $40 MillionSeed Round (July 2011) $1 Million

Series A (August 2011) $7.7 Million

Fab: Funding Rounds

Andreessen Horowitz

Menlo Ventures

First Round Capital

Baroda Ventures

SoftTech VC

Ashton Kutcher

Guy Oseary

Zelkova Ventures

Kevin Rose

A-Grade

The Washington Post Company

Jason Goldberg

SoftTech VC

SV Angel

Baroda Ventures

Menlo Ventures

First Round Capital

Baroda Ventures

SoftTech VC

SV Angel

SoftTech VC

First Round Capital

First Round Capital


Baroda Ventures

Zelkova Ventures

Angel Investment (January 2010) $625,000


Allen Morgan

Lars Hinrichs

Don Baer

Seed Round (June 2010) $250,000

Baroda Ventures

Seed Round (December 2010) $1.75 Million

Source: Wedbush Securities, Company Site, CrunchBase

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Prior to starting Fabulis, CEO Jason Goldberg started and then sold Socialmedian (personalized news service) to XING AG, worked for President Clinton, and founded Jobster (recruiting site). The company founders had previously raised $3 million to build a social network for gay men, called Fabulis, in 2010. After spending a year on Fabulis, and having reached over 150,000 members, the founders chose to shut down the site (February 2011). At the time, the founders had more than $1 million in left-over capital from investors, and had gone through multiple business models in an attempt to gain the type of traction that founders sought. Iterations of Fabulis had ranged from a Gay Facebook, to a Gay Yelp, to a Gay Foursquare, to a Gay Groupon. According to the CEO, there were three reasons for a major pivot in March 2011:

Revenue projections ($10 million at most) were not high enough to justify the expectations ($50 – 100 million business) of both investors and employees. The company’s user base surpassed 50,000, 100,000, and 150,000 in months three, eight, and eleven, respectively; but it did not seem to be gaining necessary momentum.

Progress on the gay rights front decreased overall demand for their offerings as users became less inclined to

shift usage from mainstream platforms like Facebook.

The company’s gay-focused daily deals iteration did well, selling more than $40,000 in merchandise in its first 20 days. However, because half the buyers were straight, the founders realized that demand for a design oriented commerce site was substantial enough to merit its own project.

The new Fab launched in June 2011 after three months had been spent building the product, with 165,000 pre-launch subscribers and more than 500,000 invites sent to potential users. Within 12 days the site had generated $616,000 in sales, and had 215,000 subscribers, while remaining cash flow positive. The average order size within the period was $150, and the site was picking up 4,000 new subscribers daily. The new site generated substantial word-of-mouth through social mediums that included Twitter, Facebook, Email invites, Pinterest and Google+. According to the company’s CEO, there is a tweet about Fab every 30 seconds, and more than 50% of members came from social sharing. A month after launching, Fab had generated over $1.3 million in revenue with around 45 employees, 300,000 members, and a purchase rate of about 3.3% among members. Fab rewards users who refer a friend to the service both when their friends join, as well as when they make an initial purchase. If a referred friend purchases $25 worth of merchandise within 30 days of signing up, the referrer receives $25 of credit that can be used within six months. Users also receive $5 worth of site credit for the first upload of a photo of their Fab purchase on the sites Inspiration Wall. There are additional incentives for inviting friends without the need for a referral making a purchase. For example, inviting ten new members will get a user $30 worth of site credit.


A social shopping feature drives traffic to the site by sending notifications to a member’s Facebook Timeline when they make a purchase on Fab. The company incentivizes users to turn on the sharing features by offering $5 in credit for adding purchases to their Timeline, and an additional $5 month for allowing Fab to feature a member in their Live Feed. The offer can only be redeemed if the settings for social sharing are maintained for at least ten days.

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13 | P a g e



Fab only recently began allowing users to register without an invite, and likely passed two million members this week. The company is targeting five million registered members by the end of the year; a number which we believe will easily be attained as the company rolls out its expansion in both Canada (launching within days) and Europe (within weeks). The company reports having added 400,000 members over the past month, and has doubled the number of members since November.

Fab: Members (Millions)

0

1

1

2

2

3

Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12


Fab anticipates reaching $100 million in revenue in the near future, following $20 million in revenue in 2011, and a run rate of $80 million in the beginning of December. As of the beginning of December, members of Fab had purchased over half a million products, 100,000 of which were processed in November alone. Currently Fab launches 3,500 new products daily with plans to scale up to tens of thousands. As of mid-January, Fab had sold 750,000 items. Having launched with 15 employees, the company has scaled rapidly, reaching 85 employees as of the beginning of December, and 140 people presently. We note that the company is looking to hire an additional 15 new employees in the near term, primarily in the Supply Chain and Logistics fields. Users can sort merchandise by category (called Shops), color and price points, in addition to viewing multiple items by a particular designer. The company reports substantial supply from over five thousand designers who are looking to utilize Fab’s rapidly growing user base to distribute their inventory. According to Fab, several merchants have reported that a three-day flash-sale on Fab brings in the equivalent revenues of six months with normal distribution channels. Higher price point items ($500 or more) primarily consist of furniture pieces, with an occasional designer jewelry item mixed in.

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Sales that are longer in length (usually 30 days) are called Pop-Up Shops. Users can sort through items in a shop by pricing, purchase frequency, and popularity.


According to the company, as of mid-January, the Fab mobile app (iPhone, iPad, and Android) had been downloaded over 256,000 times. Considering the company had 1.6 million users at the time, mobile users made up 16% of users, yet accounted for nearly one-third of daily usage. Nearly 246,000, or 96%, of mobile downloads were iOS, and the remaining 4% or 10,000 were Android. Mobile orders and revenue were contributed based on a similar ratio.


Fab announced in the beginning of January, that 30% of site usage is driven by mobile, with monthly visits in December approaching six million. The company anticipates 50% of its traffic will eventually come from mobile. According to CEO

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Jason Goldberg, mobile users are twice as likely to convert to purchase an item relative to a desktop user, and purchase amounts from iPads are ―an order of magnitude higher than on iPhone, Android and the web‖.


The company maintains a guarantee that all products sold on its site are authentic. Ironically, there have been several knock-offs of Fab over the last few months, and the CEO’s personal blog cites having seen seven versions of the site in the last month; three of which blatantly copied ―key elements‖ of the site. The company demonstrated the similarities by comparing screen shots of Bamarang, a knock-off of Fab that was launched by Germany’s Rocket Internet. Fab: Bamarang:


In January, Fab acquired FashionStake, an online market place for independent designers. The acquisition brought together a large number of designers looking to distribute their products, and Fab’s need to maintain a steady supply of designer merchandise that are often atypical and unique, without the markups of more established brands. FashionStake’s founders joined Fab following the acquisition. We also note that Alexis Maybank, a Co-founder of Gilt Groupe, had originally invested in FashionStake.


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Kabam Kabam is a developer of hardcore social games for Google+ and Facebook’s platform. The company attempts to differentiate itself from typical social game developers by offering a less casual game experience; focusing on immersive massively multiplayer online (MMO) strategy games with elements of role playing (RPG). The company focuses on engagement to a larger extent than most developers, catering to hardcore gamers. Rather than socializing outside of game play, as is the norm among social games, Kabam users interact throughout their gaming experience by means of instant chat and real time competitive game play against real users. The company was founded in November 2006, initially under the name Watercooler, with a focus on developing social network applications for different companies. CEO Kevin Chou had been an associate at Canaan Partners, who initially funded the founders with Seed capital, and an additional $4 million less than a year later (September 2007). When the original business model did not pan out, the founders teamed up with their backers to start a community on Facebook that allowed fans of different sports and TV shows to interact in an ad-supported environment. The venture generated significant traffic (tens of millions of users according to the company), but due to the recession at the tail end of 2008, could not generate enough ad revenue (which declined 90% within a quarter). The company eventually shifted focus and began developing games on Facebook, MySpace and Yahoo. In October 2009 the company received an additional $5.5 million raise from Canaan Partners. The company launched its first major hit, Kingdoms of Camelot, in November 2009. The strategy game revolved around constructing kingdoms and forming alliances on Facebook. The company changed its name from Watercooler to Kabam in August 2010, and has grown since then from 25 people in a single office, to 275 employees globally in March, and over 500 employees today. The company continues to grow its headcount rapidly by way of both acquis itions, as well as organic growth (≈ 50 job openings in China and the U.S.). An acquisition in October 2010 of a gaming studio called WonderHill in California, added 25 people to the company’s headcount. The company is headquartered in Redwood City, California, with additional studios in San Francisco, China, and Luxembourg (established June 2011). Kabam employs a decentralized studio model, where each studio (over ten studios in 2010) operates autonomously and is responsible for their own P&L. In January 2011, Canaan Partners, Redpoint Ventures and Intel Capital invested $30 million in a Series C investment in Kabam. In May, Kabam received $85 million at a reported $500 million valuation, bringing total funding to $125 million. The Series D included Google Ventures, SK Telecom Ventures, Performance Equity, and Pinnacle Ventures. Last week Kabam acquired Fearless Studios, which is an independent studio founded two years ago, led by the creator of Star Wars: The Force Unleashed, and a former Director of Engineering at LucasArts. The studio has significant expertise in 3-D game development, in which Kabam has an interest. Kabam has launched seven major games to date, five of which are available on Facebook and Google+.

Facebook Kabam.com Google+ MAU DAU MAU/DAU

Dragons of Atlantis ● ● ● 920,000 250,000 27%

Edgeworld ● ● ● 560,000 110,000 20%

Global Warfare ● ● 130,000 30,000 23%

Glory of Rome ● ● 160,000 30,000 19%

Kingdoms of Camelot ● ● 550,000 190,000 35%

Thirst of Night ●

The Godfather ● ●

Facebook User Metrics

Source: Wedbush Securities, Appdata

In 2010, Kabam was reaching over eleven million active users, and 60 million registered users. The company’s MAUs declined to seven million in 2011. Over the last month on Facebook, Kabam has seen its usage drop substantially, declining by 12% from 2.65 million MAUs to 2.3 million as of this week. DAUs have fallen as well, albeit to a smaller degree, declining by 8%, from 660,000 to 610,000. Kabam’s most popular game, Dragons of Atlantis, has seen Facebook usage decline over the past few months, with MAUs down over 75% from June. Furthermore, DAUs have fallen nearly 20% from the beginning of December when the game had over 300,000 DAUs.

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Dragons of Atlantis: Monthly Active Users

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1,000,000

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Source: Wedbush Securities, Appdata

Dragons of Atlantis: Massively Multiplayer Social Game (MMSG) where players combat and strategize as one of four tribes that a player can choose to join while fighting to control the lost continent of Atlantis. Users develop troops, utilize resources, and harness dragons. Armies of dragons can be raised in order to defend a player’s city from invading competitors. The game has the largest Facebook audience among Kabam’s titles, with 920,000 monthly active users (MAUs), and 250,000 daily active users (DAUs). At 27%, engagement on the site (measured by DAUs divided by MAUs) is above the roughly 22% average across most popular social games.

Source: Appdata, Company Data Kingdoms of Camelot: Strategy game and the first MMSG. Players collaborate with friends to expand their cities into large medieval kingdoms. Alliances and other forms of social engagement are facilitated through real-time chat and game dynamics. Although both Edgeworld and Dragons of Atlantis have higher MAUs, Kingdoms of Camelot has a significantly higher level of engagement (35%) due to its core base of repeat users.

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Source: Appdata, Company Data

Edgeworld: MMSG that takes place on an abandoned alien planet. Players assume the role of a Commander, and must build a base and accumulate resources by directing troops. Constant conflict with other factions and competing Commanders require real-time strategy, while diplomacy is necessary at times when collaboration is needed.

Source: Appdata, Company Data

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The Godfather: Five Families: Revolves around prohibition era New York City, with players building empires as members of the mob. The MMSG was created through a partnership with Paramount, who had created The Godfather

films. Users choose between one of the five crime families when joining, and aim to become a Don of their respective family. Users can collaborate by forming alliances for protection and resource sharing, and are constantly competing with other game users. The game is available on both Google+, as well as on the company’s website.

Source: Company Data

Kabam maintains a strong presence on Google+. There are only 36 games that have been allowed on the platform so far, five of which have been developed by Kabam. Although we have yet to obtain a tool that allows us to gauge traffic on the Google+ gaming platform, we attempt to get a sense of usage by measuring traffic generated by the same titles on Facebook. The Godfather is the only Kabam game on Google+ that has not been released on Facebook,

Game Developer MAU DAU MAU/DAU

Millionaire City Digital Chocolate 2.30 0.38 17%

Zombie Lane Digital Chocolate 1.80 0.34 19%

Dragon Age Legends EA 0.16 0.02 13%

Bejeweled Blitz EA 9.60 3.10 32%Crime City Funzio 1.30 0.16 12%

Resort World Game Insight 0.51 0.06 12%

Collapse! Blast GameHouse 1.40 0.32 23%

Uno Boost GameHouse 0.45 0.05 11%

GT Racing: Motor Academy Gameloft N/A N/A N/A

Bug Village Glu 0.09 0.02 22%

Flood-It! Google N/A N/A N/A

Sudoku Puzzles Google N/A N/A N/A

Happy Kingdom Happy Elements 0.02 0.00 10%

Dragons of Atlantis Kabam 0.92 0.25 27%

Edgeworld Kabam 0.56 0.11 20%

Global Warfare Kabam 0.13 0.03 23%

Glory of Rome Kabam 0.16 0.03 19%

The Godfather: Five Families Kabam N/A N/A N/A

Bubble Witch Saga King 12.50 4.30 34%

Backyard Monsters Kixeye 2.70 0.62 23%

8 Ball Multiplayer Pool Miniclip 0.67 0.14 21%

Shadow Fight Nekki 0.72 0.08 11%

Pirates: Tides of Fortune Plarium N/A N/A N/A

Gardens of Time Playdom 7.30 1.90 26%

Wild Ones Playdom 3.10 0.43 14%

City of Wonder Playdom 0.30 0.03 10%

Slotomania - Slot Machines Playtika 5.80 1.80 31%

Angry Birds Rovio N/A N/A N/A

Triple Town Spry Fox 0.19 0.04 21%

GolMania Vostu 0.59 0.04 7%

Bubble Island Wooga 10.20 2.30 23%

Diamond Dash Wooga 13.80 3.80 28%

Monster World Wooga 7.30 2.10 29%

CityVille Zynga 47.50 8.80 19%

Mafia Wars 2 Zynga 3.10 0.33 11%Zynga Poker Zynga 31.70 6.60 21%

Total 166.87 38.18 23%

On Facebook:

Source:Wedbush Securities, Appdata

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Kabam’s games are free to play, and the company derives revenues by means of virtual goods. The company targets a broad rang of social gamers (18 – 55 years old), which in 2010 were primarily in the U.S. and Western Europe, although we believe Kabam’s core audience has recently begun to include Asia as well. Due to the company’s hardcore and engaged user base, virtual goods monetize at double or even four times the industry average. Kabam released a study in September 2011, after polling over 2,500 respondents in the United States. Only 41% (1,000 respondents) of total respondents were social game players, however 56% (1,400) were deemed qualified participants, based on whether a participant had played a game in the past year outside of the casual or arcade gaming category. Using survey statistics, Kabam estimates there are 98 million social gamers in the United States, 69% of which are core game players. Consoles remain the dominant platform among social core gamers, with 92% using a console in some combination, and 67% using a computer.

Source: Kabam, Information Solutions Group

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Guest Post: Social Media in Retail Trends in Consumer Engagement That Drive Conversion Gabriella Santaniello Analyst, Retail Market Research (213) 688-4557 [email protected]

As the first report in ongoing research on the impact of social media in retail, we begin with our findings from our meetings with social media industry experts. Last week, we hosted a lunch that addressed social media in retail with Michelle Crames, CEO and Founder of SkuLoop, and we also attended the Social Retail Summit in Brooklyn, NY. The following are the key takeaways on the latest trends in social media that we believe will potentially have the greatest impact across multiple retail channels:

The Relevance of Social Media At the outset, we’d like to address what we believe will be critical to both retailers and investors as they begin to better understand and define the use of social media in retail. Most notably is the growing and paramount importance of social media in retail and more specifically to not underestimate the power of social media in brand management. Michelle Crames, CEO and Founder at Skuloop, mentioned a Bain & Company study that said, ―effectively engaged fans of a retailer spend 20-30% more on average‖ than fans who are ―accumulated‖ by companies but not engaged. There is more to social media than simply accumulating fans, it provides a company with the opportunity to manage customer service, brand image and personality in real-time. Many of our contacts within the industry have indicated that companies are hiring entire teams dedicated to managing the brand through various social media sites. We believe this is critical in managing the day— aspects but even more so in crisis management as one wrong move can do irreparable damage. The most notorious example being ―Kenneth Cole’s Twitter #Fail‖ where Kenneth Cole’s tweet about the February 2011 riots in Egypt being related to the launch of his spring line went viral reaching significantly more people than his Twitter following of 10,000 and Facebook fan base of 100,000. It is also important to note that social media is not only relegated to Facebook and Twitter as numerous sites are gaining momentum, such as the online bulletin board Pinterest (www.pinterest.com), and the photo-sharing mobile app, nstagram. Michael Kors (KORS) hired a social media and digital team to manage and help the brand navigate the various sites. This strategy has clearly paid off as the brand surpassed Burberry as the number-one fashion brand on the photo-sharing app, Instagram. Sites and apps mentioned as important in creating a social media ―persona‖ and cultivating a brand lifestyle include, but are not limited to: Twitter for updates, Facebook as a brand forum, Spottify for musical tastes, Stamped (app) for sharing recommendations on cultural events, Pinterest as a visual and inspiration ―pin-board,‖ and Instagram (app) for photo sharing. Clearly, the impact of social media on all aspects of retail is in its infancy. As social media continues to grow as an increasingly important channel, and the tools available to retailers continue to expand allowing them to more creatively use social media, we look for a tremendous impact on how retailers engage with their customers. By engagement, we mean using the tools of social media to manage brand image, conduct customer service, drive traffic both online and in-store and more effectively plan inventories to meet the various conversion strategies, all critical to driving incremental sales. The following are just some of the experiences and key tools being used by bricks-and-mortar and on-line retailers.

The Flash Sale Opportunity The Flash Sale originally began as a way for vendors to sell additional inventory via exclusive membership only websites, such as Gilt Group (www.gilt.com), Rue La La (www.ruelala.com), Amazon’s (AMZN) My Habit (www.myhabit.com) and Nordstrom’s (JWN) Hautelook (www.hautelook.com). The success of these sites is primarily due to the scarcity model and using old retailing tricks in a new way. Over the past three years as vendors have become cautious with inventory management, there is no longer the glut of standard production, on-hand inventory that was integral in fueling the Flash Sale sites in the beginning. Therefore, as Flash Sales via these websites continue to gain in

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popularity for the larger vendors, this distribution channel has evolved into a growing outlet strategy with specially made merchandise specifically designed to promote. As an example, a handbag sold at the typical retail channel may have a suede lining whereas the same handbag sold via a flash sale website may have a fabric lining and other small, unnoticeable changes in the details. While one might argue the decline of the Flash Sale due to the recent news of lay-offs at both Gilt Group and Rue La La, the general consensus among the panelists at the conference is that it is not indicative of the flash model, but a sign that these companies hired too quickly to manage aggressive growth. As an idea of the growth and potential of effectively managed social media via the Flash Sale, Michelle Crames mentioned that it took Amazon (AMZN) five years to reach over $500M revenue, whereas it took Gilt Group only three years by ―effectively using social media‖ to drive conversion. What is missing from this equation and where the opportunity lies in a venue for vertically integrated specialty retailers to sell additional inventory. Currently, the only venue is the retailer stores via markdowns and outlets, so the potential of the Flash Sale to drive revenue is significant. A panelist at the Social Retail Summit, whose company also manages Flash Sales, mentioned a test with a global handbag brand that generated $11M in sales in one day. By ―tying together social, mobile e-mail and retail,‖ the Skuloop model (www.skuloop.com) also offers retailers a platform upon which to ―create and measure their own branded shopping frenzies‖ (Flash Sales). The ability to capitalize on the Flash Sale is allowing retailers to retain control of the brand as well as retain profits from the merchandise.

Social Discovery — Content & Curation Social discovery, the process in which customers close the loop by discovering a ―curated‖ or highly specialized shopping experience via social media websites, was a main discussion at the conference. Shoe Dazzle set the stage and standard in the industry by offering customers a curated monthly shoe subscription, and Beachmint uses the same model adding celebrity partnership, e.g. Shoemint collaboration with Steve Madden (SHOO) and actor Rachel Bilson. Given the success of Shoe Dazzle (www.shoedazzle.com) and the Beachmint sites (www.stylemint.com, www.shoemint.com, www.beautymint.com and www.jewelmint.com), a host of companies appear to be jumping on the bandwagon. This type of shopping experience clearly resonates with consumers; and while we do not discredit the model, the barrier to entry is low and the space is quickly becoming crowded. Therefore, it is important to identify companies that tie in branding or offer exceptional product (content), both coupled with effectively managed social media channels. With the recent rise in popularity of Pinterest, self-curation is becoming the newest trend as users are able to create and design their own pin-board reflective of their own tastes. Of course, the next step in this progression would be how to target the consumer through self-curated pages without the privacy issues that come with it. 95% of Retail Sales Are Still Bricks and Mortar While the concern over bricks and mortar is legitimate as online and social continue to grow, it still comprises 95% off all retail sales. For now, the best solution appears to be using a combination of the two, using one to drive the other and vice versa. At the Skuloop lunch, we learned that shopping events, or Flash Sales, that include a specialized group of customers, have the ability to become ―viral,‖ driving conversion online and in-store. Shopping events geared toward Facebook fans or even more specific customer groups, like teachers or moms, actually drove consumers to the stores, significantly increasing the average unit-per-transaction. Groupon (GRPN) is a perfect example of the consumer driven form of the flash sale where retail companies offer consumer-driven coupons online to drive in-store conversion. Gap (GPS) was the first national retailer to offer a Groupon where customers paid $25 for $50 worth of merchandise and sold 441,000 Groupons resulting in $22M at retail of which 50% will go to Groupon. While Gap (GPS) gained exposure from the event, the company also had to forgo a significant amount of revenue that once again brings us to the potential of the in-house Flash Sale.

Conclusion

In conclusion, we believe social media is on the trajectory to become a huge driver in retail sales if managed effectively. It is important for retailers to use these tools now, specifically because the touch points offered by social media are becoming increasingly important in the evolution of retail.

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Social Media Cartoon of the Week

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Covered Companies Mentioned in this Report (priced intraday February 2, 2011)

COMPANY TICKER RATING PRICE PRICE TARGET

ZYNGA ZNGA OUTPERFORM $12.39 $12.50 GAP GPS NEUTRAL $21.52 $17.00 MICHAEL KORS HOLDING KORS OUTPERFORM $31.67 $36.00

IMPORTANT DISCLOSURES The information contained herein is intended for accredited investors as defined in Rule 501 of Regulation D under the Securities Act of 1933 or institutional investors. WEDBUSH SECURITIES

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I, Michael Pachter, certify that the views expressed in this report accurately reflect my personal opinion and that I have not and will not, directly or indirectly, receive compensation or other payments in connection with my specific recommendations or views contained in this report. Disclosure information regarding historical ratings and price targets is available at http://www.wedbush.com/ResearchDisclosure/DisclosureQ411.pdf INVESTMENT RATING SYSTEM

Outperform: Expect the total return of the stock to outperform relative to the median total return of the analyst’s (or the analyst’s team) coverage universe over the next 6-12 months. Neutral: Expect the total return of the stock to perform in-line with the median total return of the analyst’s (or the analyst’s team) coverage universe over the next 6-12 months. Underperform: Expect the total return of the stock to underperform relative to the median total return of the analyst’s (or the analyst’s team) coverage universe over the next 6-12 months. The Investment Ratings are based on the expected performance of a stock (based on anticipated total return to price target) relative to the other stocks in the analyst’s coverage universe (or the analyst’s team coverage).*

Rating Distribution

(as of December 31, 2011) Investment Banking Relationships (as of December 31, 2011)

Outperform:60% Neutral: 35% Underperform: 5%

Outperform:12% Neutral: 1%

Underperform: 0%

The Distribution of Ratings is required by FINRA rules; however, WS’ stock ratings of Outperform, Neutral, and Underperform most closely conform to Buy, Hold, and Sell, respectively. Please note, however, the definitions are not the same as WS’ stock ratings are on a relative basis. The analysts responsible for preparing research reports do not receive compensation based on specific investment banking activity. The analysts receive compensation that is based upon various factors including WS’ total revenues, a portion of which are generated by WS’ investment banking activities. Capital Markets Disclosures as of February 3, 2012

Company Disclosure

Zynga 1

Yahoo 1

Gap 1

Michael Kors Holding 1

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Research Disclosure Legend

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Documents

PROGRESS REPORT for INTERNET and SOCIAL MEDIA 2_3_12 FINAL.pdf · Making diffuse information about the Internet and Social Media crystal clear IN THIS ISSUE: Facebook: S-1 Fab Kabam