How Does Pinterest Make Money?

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

In this segment from Industry Focus: Technology, host Dylan Lewis and contributor Brian Feroldi take a closer look at Pinterest's financial statements, discuss its competitive advantages, and talk about the significant market opportunity ahead.

A full transcript follows the video.

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This video was recorded on March 29, 2019.

Dylan Lewis: Listeners, we're going to be talking about Pinterest today, one of many tech companies that are going public in 2019. Kind of an interesting one because this one has been around for quite some time. The business model is a little bit more mature. I think a lot of people are probably pretty familiar with this name.

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

Lewis: For the uninitiated, I think Pinterest could maybe best be described as a combination of a Facebook, Instagram, and Etsy. If you look at the Venn diagram between all those social media platforms, that's kind of where you find Pinterest. It's a lot of makers, DIY-ers, people that are looking for some inspiration through a visual medium.

Feroldi: Yeah. They actually say that they're a visual search engine. People come 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 could spark inspiration. A lot of their pinners go there to generate ideas.

Lewis: A lot of the stuff that you see on this platform is people doing DIY projects, whether it's home decor, possibly wedding planning, maybe planning for some renovations to the house, all that kind of stuff.

Feroldi: Yeah, and this is a huge platform. Pinterest has 250 million active pinners, which is what they call users. To give you some context behind that, about 82 million of those are in the U.S. and about 184 [million] of them are international. So this is actually a far more international company than I assumed from the get-go.

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

Feroldi: Yeah. Which sort of makes sense, because if you're going there for inspiration, perhaps you don't need to go there every day to message friends or keep in contact. I do think that makes some sense. But, it's interesting to note.

Lewis: Some other big metrics, just to give you a sense of how activity looks on this platform, about 2 billion monthly searches on the site. Over 4 billion boards, which is where people aggregate ideas and clips from all these different things that they are seeing on the platform. This is a platform that heavily slants female.

Feroldi: Yes, about two-thirds of users are female. I would have actually assumed it would be even higher slant female. But I did see that the number of males using Pinterest has been growing like crazy over the last couple of years. It's actually their fastest-growing segment. Some more metrics to put around that. About 80% of moms are on Pinterest, and about half of millennials use the site.

Lewis: Those are U.S. metrics, right? Eighty percent of mothers in the United States, 50% of millennials in the United States.

Feroldi: That's correct. One other thing that when I was reading through really jumped out to me is that 91% of Pinterest users say that the site is filled with positivity. When I compare that to, say, Facebook or Twitter or Snapchat, that's something that I think separates this company.

Lewis: It is a little different. [laughs] Yeah, you don't run into quite the same toxic elements that you might find on some other social media platforms when you're on Pinterest.

Feroldi: Yeah, that's definitely something that I think is very powerful about this platform. Another number that also jumped out to me was that 85% of users say that they go to Pinterest to start a new project. That's a huge number of people that go to the site, and then take some sort of action in their life. That could be a very valuable aspect to this platform.

Lewis: Especially because they are looking to monetize via ads. That's where most of their money's coming right now, and that seems to be the path for them long-term. The pitch to advertisers is, "You have people coming onto this platform looking for ideas." Whether it's because they're planning an event, they're looking to do a major overhaul to what their garage looks like, maybe they just want to have a fun project for the weekend; very often, those types of things come with having to buy supplies or having to buy products to fill something out. I think the leap for advertisers isn't a very far one.

Feroldi: Yeah. There's a quote in the S-1 that I think is worth highlighting here. They say, "[T]he majority of Pins saved on our service are from businesses. Ads do not compete with the content Pinners want to see -- they are the native content." That's something that, for me as the investor, makes me really excited. People are going to the site because they want to see ads from businesses!

Lewis: Right now, we're starting to get a sense of what that ad business might look like. I know that they are not super mature in the ad business, but they are certainly further along than some of the other companies that we've seen come public recently -- thinking specifically of Snap there. You go to the most recent quarter and their financials, 60% growth in 2018, hitting $750 million in revenue. Almost all that's coming from the United States. Almost all that is ads.

Feroldi: Yeah, that's their primary method of monetization right now. They are an ad-based platform. Even though their platform does entice many people to take action and buy things, they have chosen thus far to only fund their site with ads. Like you said, $750 million in total revenue, 60% growth last year, those are pretty exciting numbers. Ninety-five percent of that total is coming from the U.S. So, although the majority of users are based outside of the U.S., right now this is a U.S.-centric revenue story.

Lewis: Yeah. That 60% figure is something we've seen going back about six or seven quarters now. It's not like we are seeing a deceleration. We've actually seen them go from anywhere between 57% and 61% over the last six or seven quarters. They've been able to maintain that growth rate pretty steadily as they've started to monetize their users a little bit more.

Something super encouraging for me with this company as a fresh IPO is the fact that they have quite a bit 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: Yeah. As is, they're starting from a pretty strong point. To be expected of a tech IPO, this company is losing money.

Feroldi: They did lose $63 million in 2018. That was down by about half from the year before. The thing that really excited me was, this company was actually profitable in the fourth quarter. Now, it is worth pointing out that this is a seasonal business from a revenue and use perspective, which makes sense. People who are going to be buying stuff from this platform are getting ideas mostly around the holidays, so the fourth quarter is one of their bigger quarters. But still, the fact that they were able to post a profit for the first time, that's got to be encouraging.

Lewis: A big reason for that is the fact that they're enjoying expanding gross margins. You look over the last couple of years, 62% gross margins in 2017, 68% in all of 2018. You go to Q4, where they started to post that profit, 75%. That's super encouraging.

Feroldi: Yeah. Expanding gross margin is something that gets me really excited. When a company is scaling its revenue and you see that its margins are growing at the same time, that can lead to outsized growth on 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: Yeah, definitely. The fact that they have decided to outsource the hosting of their site to, in this case, Amazon Web Services is the company that's powering Pinterest -- that's a decision that they made. Perhaps after they get a big thing of money, they could think about, in the future, going with their own model where they build their own data centers to benefit from that leverage. But you're absolutely right, that's something that's worth pointing out.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Brian Feroldi has no position in any of the stocks mentioned. Dylan Lewis has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends AMZN, ETSY, FB, and TWTR. The Motley Fool has a disclosure policy.