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The Next Way Facebook May Upset Wall Street

In the wake of Facebook’s botched initial public offering and subsequent stock decline, pressure is building for CEO Mark Zuckerberg to post solid results when the social giant reports second quarter earnings on Thursday.

Facebook
Brendan Smialowski | AFP | Getty Images
Facebook

With Zynga’s massive second-quarter earning’s miss, investors in Facebook are fretting.

The social gaming company reported a quarterly loss of $22.8 million as gamers spent less time playing Zynga’s household-name offerings like Farmville and Mafia Wars. Worse yet, Zynga lowered its outlook for the rest of the year, citing myriad challenges to growth, including mobile.

Zynga shares are reeling from the negativity, hitting a fresh low Thursday and down some 70 percent since it’s December IPO.

The numbers sent Facebook shares plunging as well, ahead of the social network’s first-ever earnings announcement as a public company. That’s because Zynga is responsible for some 12 percent of Facebook’s annual revenue — a growing percentage that is nearly Facebook’s sole income in its payments platform.

For Mark Zuckerberg, a 29-year old wunderkind who’s had a notoriously ‘disruptive’ relationship with Wall Street, impressing investors after a weak pre-IPO outlook likely won’t be an easy task.

The first potential stumbling block: Accounting.

The company will incur a massive charge as it lifts restrictions on employee stock in conjunction with its second-quarter IPO. The company has warned that those could result in nearly a billion dollars in added expenses — a sum nearly equivalent to the $1.15 billion in revenue the company is expected to report in Q2, according to analysts polled by Thomson Reuters.

That accounting item, known as an “RSU” (restricted stock unit) expense, is a common headache for newly-minted public companies, particularly for technology startups which use stock incentives as a key recruiting and retention tool.

This is yet another area where Zynga hasn’t set a positive precedent. On Valentine’s Day, Zynga rang in its first earnings as a public company with a crushing blow in the form of a $500 million RSU charge — an item which contributed to a net loss of more than $400 million. Though the funds had been earmarked per Zynga’s S-1 filing, investors were caught off-guard by the charge: Shares of the newly public company sank roughly 17 percent following the results.

While an RSU-related charge could severely impact Facebook’s earnings, it’s a one-time item at the bottom of many analysts’ lists of concerns, as larger and longer-term worries linger about the company’s ability to monetize its user base and maintain growth.

Evercore’s Ken Sena has built the RSU charge into some of his models, but says that looking for transparency from management is of much greater importance.

“I think [these earnings are] really a matter of: Was the company being overly conservative when they reportedly brought down their numbers headed into the IPO? And are they giving the visibility to investors with how this business is going to evolve?”

Key to those concerns is Facebook’s ability to monetize its growing mobile user base (the company made an eleventh-hour disclosure in its IPO prospectus that it was facing increasing challenges relating to mobile, which would later set of a firestorm of controversy).

The company has been voraciously growing headcount and research-related expenditures as it attempts to tackle the mobile problem. That’s caused R&D (research and development) expenses to balloon, with costs now representing 15 percent of revenue in Q1 2012 versus only 8 percent the same quarter a year ago. Fielding questions during the investor roadshow, Facebook CFO David Ebersman said that R&D expenses will increase both by dollar and percentage amounts, possibly cutting into the margins in the near-term. Investors and analysts now need signs that a payoff is in sights, particularly with regard to mobile.

Facebook Investors Facing Their Own Fiscal Cliff

Making matters more difficult: Facebook investors are facing their own version of a fiscal-cliff. Billions of shares are set to ‘unlock’ and will be available for sale by insiders and other early investors by year-end, which means the potential for significant downward pressure on shares in the months to come, according to analysts.

Facebook
Juan Mabromata | AFP | Getty Images
Facebook

With those lockups looming and the IPO issues still fresh on many market minds, the stress of a big earnings beat is particularly acute for Zuckerberg & Co.

“While we are not expecting a miss,” Piper Jaffray’s Gene Munster told clients on Tuesday in a research note, “we believe that if Facebook were to miss earnings, the stock would be punished more than a typical earnings miss by a tech company.”

Facebook shares were at $28.60 in early trading on Wednesday, roughly 25 percent below its IPO issue price of $38.

For its part, the company has made important strides since going public in many key areas of business development and in the public eye. It launched an app store in early June, announced a new advertising product called “Ad-Exchange”, quelled critics by appointing its first female director (COO Sheryl Sandberg), and is settled a contentious patent dispute with rival Yahoo!.

As it continues to grow, the opportunities for Facebook to entrench itself as a social leader is not lost on investors — in sum, 31 Wall Street analysts have a median price target on Facebook shares that predict a near 40 percent rally over the next year. That’s if the company can deliver — starting with Thursday’s earnings.

Facebook is due to report second quarter results Thursday after the market close, and will host a conference call with analysts at 5pm ET. It is unclear if CEO Mark Zuckerberg will be on the call.

A Facebook spokesperson declined to comment on the earnings call. Analysts polled by Thomson Reuters are forecasting the company will post a profit of 12 cents per share.

-By CNBC's Jesse Bergman and Kayla Tausche
@JBergmanCNBC & @KaylaTausche

email: tech@cnbc.com

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