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Pinterest is preparing to make its big public debut. Should this business excite investors?

In this segment from industry Focus: Technology hosted by Dylan Lewis and Fool.com contributor Brian Feroldi takes a closer look at Pinterest’s financial statements, discuss its competitive advantages, and talk about significant market opportunities ahead.

The full transcript follows the video.

The video was recorded on March 29, 2019.

Dylan Lewis: Listeners, we’ll be talking about Pinterest today, one of the many tech companies that are going public in 2019. Kind of interesting because it’s been around for quite some time. The business model is a bit more Mature. I think a lot of people are probably very familiar with that name.

Brian Feroldi: This is a company that I personally have been on my radar for a few years because my wife was an avid Pinterest user. I personally used Pinterest to find gift ideas for her. I know there is a lot of power in the engine and I was very interested in digging into the rooms behind this company.

Facebook instagram and Etsy Lewis: for the uninitiated, I think Pinterest can perhaps best be described as a combination of Facebook, Instagram and Etsy. If you look at the Venn chart between all these social media platforms, you’ll find Pinterest. It’s a lot of bodies, DIY-ers, people looking for inspiration through a visual medium.

Feroldi: Yes. They actually say they are a visual search engine. People go there looking for ideas that they can’t necessarily put into words, but they know it when they see it. When you see a picture of something, it can trigger inspiration. Many of their pinners go there to create ideas.

Lewis: a Lot of the things you see on this platform are people doing DIY projects, whether it’s home decor, maybe wedding planning, maybe planning some home renovations, all that sort of stuff.

Feroldi: Yes, and it’s a huge platform. Pinterest has 250 million active pinners, which they call users. To give you some context behind this, about 82 million of them are in the U.S. and about 184 “million of them are international. So it’s actually a lot more of an international company than I anticipated from the get-go.

Lewis: We see a slightly different number with their custom metrics, too. We are very used to being monthly active and daily active when it comes to social media companies. We get a weekly active number from Pinterest.

Feroldi: Yes. Which kind of makes sense, because if you’re going there for inspiration, maybe you don’t need to go there every day to message friends or keep in touch. I think it makes sense. But, it is interesting to note.

Lewis: Some other big metrics, just to give you an idea of what the activity looks like on this platform, are about 2 billion monthly searches on the site. More than 4 billion boards where people combine ideas and clips from all these different things they see on the platform. It’s a platform that tilts a woman hard.

Feroldi: Yes, about two-thirds of users are women. I would actually assume this would be an even more inclined woman. But I’ve seen the number of men using Pinterest grow like crazy over the last few years. This is actually their fastest growing segment. A few more metrics to put around this. About 80% of moms are on Pinterest, and about half of Millennials use the site.

Lewis: these are American metrics, aren’t they? Eighty percent of mothers in the United States, 50% of Millennials in the United States.

Feroldi: that’s right. Another thing that when I read through really popped up on me was that 91% of Pinterest users say the site is filled with positivity. When I compare it to, say, Facebook or Twitter or Snapchat, that’s what I think separates this company.

Lewis: it’s a little different. (laughs) Yes, you won’t come across exactly the same toxic elements you might find on some other social media platforms when you’re on Pinterest.

Feroldi: Yes, it’s definitely something I think is very powerful about this platform. Another number that also popped up on me was that 85% of users say they go to Pinterest to start a new project. This is a huge number of people who go to the site, and then take some action in their lives. This can be a very valuable aspect for this platform.

Lewis: Especially because they are looking to monetize through advertising. That’s where most of their money is going right now, and that seems to be the way for them in the long run. Pitch to advertisers: “you have people coming to this platform looking for ideas.” Whether it’s because they’re planning an event, they want to do an overhaul of what their garage looks like, maybe they just want to have an interesting project for the weekend; very often, these types of things come with having to buy materials or having to buy products to fill something. I think the leap for advertisers is not very far.

Feroldi: Yes. There’s a quote in S-1 that I think is worth emphasizing here. They say, ” Most of the Pins saved on our service are from business. Ads don’t compete with the content Pinners want to see – they’re native content.” This is something that for me, as an investor, makes me very excited. People go to the site because they want to see ads from the business!

Lewis: Right now, we’re starting to get an idea of what this advertising business might look like. I know they’re not super Mature in the advertising business, but they’re certainly further than some of the other companies we’ve seen come public recently-think specifically Snap out there. You go into the last quarter and their financial, 60% growth in 2018, reaching $ 750 million in revenue. Almost everything that comes from the United States. Almost everything is ads.

Feroldi: Yes, that’s their main method of monetization right now. They are an advertising-based platform. Even if their platform does encourage many people to take action and buy things, they have chosen so far only to Fund their site with ads. As you said, $ 750 million in total revenue, 60% growth last year, these are pretty exciting numbers. Ninety-five percent of that total is in the United States. Thus, although the majority of users are based outside of the United States, now it is USA-centric revenue history.

Lewis: Yes. That 60% figure is what we’ve seen going back about six to seven quarters. We don’t see a slowdown. We’ve actually seen them go from somewhere between 57% and 61% over the last six or seven quarters. They have been able to maintain that growth rate quite steadily as they have started to monetize their users a bit more.

Something super encouraging for me with this company as a fresh IPO is the fact that they have quite a lot of cash on hand.

Feroldi: Yeah, this is a company that, before their IPO, before they get this huge bolus of cash, they have $627 million in their bank account as of the end of the year. Compare that to their liabilities, which were just $281 million, and that’s a mix of liabilities. The other thing that I think is worth pointing out here from a balance sheet perspective is, they do have $1.46 billion in redeemable convertible preferred stock. We don’t know what’s going to happen to that after the IPO. It’s very likely that this company is going to raise a couple of billion dollars and their balance sheet could change completely. It wouldn’t surprise me to have them wipe out all of their liabilities and be a cash-rich company. But, those are the numbers as they stand today.

Lewis: Yes. As is, they start from a pretty strong point. As expected, this company is losing money from a technology IPO.

Lewis: the Big reason for this is that they enjoy expanding gross margins. You look over the last couple of years, 62% of gross margins in 2017, 68% for all of 2018. You go to No 4 where they started posting that profit, 75%. It’s super encouraging.

Feroldi: Yes. Gross margin expansion is something that makes me very excited. When a company scales its revenue and you see its margins growing at the same time, that can lead to oversized growth in the bottom line eventually.

Lewis: One thing that I think is worth digging into on the cost side is their cost of revenue. This is essentially the cost associated with delivering the core content on the platform. For a company like this, this is going to be their IT infrastructure. Pinterest takes a pretty similar approach to Snap. They use a third-party cloud provider to handle things for them rather than own and operate all their own IT infrastructure. On this show, we have criticized Snap for doing that because rather than have the fixed cost that leads to leverage, you have a variable cost that moves with usage. I think because Pinterest’s ad business is a little bit more mature than Snap’s was when it went public, it isn’t as much of a problem; but, you’re going to have a variable cost. I think cost of revenue is about 30% of sales. Almost all that is related to hosting costs. So, I think that’s something that investors just need to keep in mind with this company.

Feroldi: Yes, definitely. The fact that they have decided to outsource the hosting of their site, in this case, Amazon Web Services, the company that powers Pinterest is a decision they have made. Perhaps after they get a lot of money, they could think about in the future, going with their own model where they build their own data centers to benefit from this leverage. But you’re absolutely right, it’s something worth pointing out.