Welcome to Pivotal Research’s “Madison & Wall”. The title refers to our work which sits at the intersection between the advertising industry and the financial world. We hope you’ll find these brief notes useful for their contrast to the hyperbole that pervades much of the chatter at that location.

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Important Disclosures Are Located In The Appendix
PIVOTAL
Pivotal Research Group
U.S. Equity Research
Internet / Advertising
Madison & Wall
A Recurring Review of Topics Affecting Advertising-Supported Media
April 13, 2012
Welcome to Pivotal Research’s “Madison & Wall”. The title refers to our work which
sits at the intersection between the advertising industry and the financial world. We
hope you’ll find these brief notes useful for their contrast to the hyperbole that
pervades much of the chatter at that location.
BEWARE OF GEEKS BEARING GIFS
Cloud computing paired with social media increasingly empowers small
companies to credibly threaten giants. Expect more early-stage companies to
play to this trend, extracting billions of dollars in the process, and causing
some concern that Facebook’s capital needs may be durably higher than
previously expected.
Brian Wieser, CFA
212-514-4682
brian@pvtl.com

2. - 2 - Brian Wieser 212-514-4682 Pivotal Research Group
BEWARE OF GEEKS BEARING GIFS
Cloud computing paired with social media increasingly empowers small companies to credibly
threaten giants. Expect more early-stage companies to play to this trend, extracting billions of
dollars in the process, and causing some concern that Facebook’s capital needs may be durably
higher than previously expected.
Fear is a powerful motivator. In a world of fickle tastes and conditional loyalties, anyone depending upon
taste and loyalty is correct to be fearful. In this context, it is unremarkable that Facebook announced this
week that it is purchasing Instagram for consideration of approximately $1 billion (the percentage of cash
and stock is as yet unknown).
Instagram is a social photo sharing app for mobile devices. Its business model was oriented towards
generating revenue from advertising and tool licensing. The company is private, having raised $7.5 million
to date – not including a round of funding that closed immediately in advance of the acquisition
announcement – and likely generating de minimus revenue. Founded two years ago, the company
reportedly had one million registered users by December 2010 which grew to approximately 30 million
earlier this year.
We’ve previously highlighted that Facebook and Google are locked in a capital spending arms race, as
each company seeks to offer up services with low latency, high speeds and fat storage. Both companies
are each spending hundreds of millions of dollars new data centers every year. In total, we estimate
Facebook will spend around $2 billion each year on capital expenditures, compared with Google (whose
architecture and business needs are much greater given its heavy reliance on video delivery and
processing of data across the web) at a figure that should approach $6 billion each year by 2017. While
Google has a history of making frequent and sometimes sizeable acquisitions appropriate for its business
mix, Facebook’s history had until now suggested smaller acquisitions were its only area of focus, as the
company tended towards “acqui-hires” (whereby a small company would be bought primarily to bring that
company’s founder into Facebook).
There are many small companies with tens of millions of users, which in turn have only required limited
amounts of capital. Some of these small companies will be able to create the conditions under which
larger potential acquirers will fear the strategic disadvantage they may face if they don’t possess certain
capabilities and their director competitors do. There are many instances of failure in this regard (Bebo
comes to mind) but also some successes (Google’s Doubleclick, no less). This possibility that a
competitor will succeed enough to create a wedge against a competitor, even if remote, is enough of a
rationale to justify spending significantly to secure an asset and keep it out of the competitor’s hands.
We saw this play out across dozens of acquisitions that were made in the middle of the last decade,
primarily with each of Google, Microsoft, AOL and Yahoo as potential buyers. Fear could be used (rightly,
as it turned out) to compel each to spend billions and billions of dollars on early stage companies. It really
only benefitted Google. What’s different now is that the next generation of companies which can drive this
fear are able to do so for significantly less capital than ever before. This means that increasing numbers
of small companies are now able to establish themselves as credible threats to incumbent web-based
companies.
Facebook was right to buy Instagram given the very plausible threat that Facebook would have faced if
Instagram were otherwise bought by Google to drive all of this fast growing traffic to its own social
network, Google+. But how many more Instagrams will there be? An extra billion dollars of acquisitions
every year would equate to a reduction of approximately $10 billion of valuation for the Facebook under
our assumptions. It’s possible that the company will “only” need $1 billion on building out data centers and
like functions every year, and so $1 billion in acquisitions could implicitly be incorporated into our model
already. But it is becoming increasingly clear that fear of loss of dominant market share, the openly
competitive markets on the web, and the trends enabling small companies to succeed will require
incumbents to continue spending real money – usually unprofitably – every year.

3. - 3 - Brian Wieser 212-514-4682 Pivotal Research Group
Appendix: Important Disclosures
Analyst Certification
I, Brian W. Wieser, hereby certify that the views expressed in this research report accurately reflect my
personal views about the subject company and their securities. I further certify that I have not received
and will not receive direct or indirect compensation related to specific recommendations or views
contained in this research report.
Legal Disclaimers
Pivotal Research Group LLC is an independent equity research company and is neither a broker dealer
nor offers investment banking services. Pivotal Research Group LLC is not a market maker for any
securities, does not hold any securities positions, and does not seek compensation for investment
banking services. The analyst preparing this report does not own any securities of the subject company
and does not receive any compensation directly or indirectly from investment banking services.
Stock Ratings
Pivotal Research Group LLC assigns one of three ratings based on an expectation of absolute total return
(price change plus dividends) over a twelve month time frame. The ratings are based on the following
criteria:
BUY: The security is expected to have an absolute return in excess of 15%.
HOLD: The security is expected to have an absolute return of between plus and minus 15%.
SELL: The security is expected to have an absolute return less than minus 15%.
Ratings Distribution
Pivotal Research LLC currently provides research coverage of 16 companies, of which 75% are rated
BUY, 19% are rated HOLD, 0% are rated SELL and 6% are unrated. Our company does not offer
investment banking services. This data is accurate as-of March 29, 2012.
Price Chart and Target Price History
Other Disclaimers
Information contained in this report has been prepared from sources that are believed to be reliable and
accurate but are not guaranteed by us and do not represent a complete summary or statement of all
available data. Additional information is available upon request. Furthermore, information and opinions
expressed are subject to change without notice and we are under no obligation to inform you of such
change.
This report is has been prepared solely for our institutional clients. Ratings and target prices do not take
into account the particular investment objectives, financial and/or tax situation, or needs of individual
investors. Investment decisions should take into account all available information, not just that which is
contained in this report. Furthermore, nothing contained in this report should be considered an offer or
solicitation by Pivotal Research Group LLC to buy or sell any securities or other financial instruments.
Past performance is not indicative of future performance and estimates of future performance contained
in this report are based on assumptions that may not be realized.
Material in this report, except that which is supplied by third parties, is Copyright ©2012, by Pivotal
Research LLC. All rights reserved. No portion may be reproduced, sold, or redistributed in any form
without express written consent of Pivotal Research Group LLC.

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dealers. Please contact Jeff Shelton at 212-514-4681 for further information.
Additional Information Available Upon Request