Facebook the Next Google? For Zuckerberg, Sure; For Public Shareholder, Less Likely
Your credit card companies have for decades known all about your spending habits – what kind of books you buy on Amazon (AMZN), restaurants you frequent, clothing brands you favor, and even more, well, personal items we won’t go into here. But in all that crap the card issuers have stuffed into your monthly bill, or bothered you with online, have they ever guessed correctly and offered you some unexpected delight?
Not likely, unless you have a Jones for worthless insurance policies. They call it data mining but it’s really another form of telemarketing, an annoying effort to piggyback onto a fabulous service, which is being able to pay for stuff without a pocket full of greenbacks; bothering people with sales come-ons that are almost entirely unwelcome.
And therein lies the problem for our brilliant friends at Facebook (FB). They have created a wonderful service, especially for the TMI crowd, and in doing so Facebook learns a great deal about its users. But matching sellers of goods and services with our postings and our likes will prove harder than one might think. First off, people don’t log into Facebook wondering what advertisement the site is going to ram into the newsfeed or run in the right-hand gutter. Again, Facebook ads are akin to telemarketing, unasked for and likely unwelcome.
By the way, it’s worth noting that at least the credit card companies capture honest information – what you actually spend your money on. One could argue Facebook postings and profiles and Likes are at times less sincere. Your buddy, high as a kite on caffeine and sugar, clicks on the Like button for Red Bull and you’re treated to what Facebook calls a “sponsored story” – seems so much more useful than “paid advertisement” – on your FB page. Ugh.
And that’s where the comparisons to Google (GOOG) become very difficult for Facebook. Google ads are in response to your search – you asked for them. Even if you strongly prefer the search results the algorithm produces, the paid-for listings are at least on topic (and often repeat what the Google brain sent you). Not like telemarketing. The user initiated the process. The information is largely welcome and possibly helpful.
So, if you’re pondering buying Facebook shares after the IPO (we’ll assume you’re not among the favored few who’ll get shares at the actual offering price), ask yourself: with that more difficult business model, will Facebook match Google’s fabulous run since its IPO?
To do so, from the speculated-upon IPO market cap of roughly $100 billion, Facebook would have to become a $500 billion market cap company in less than a decade. Apple’s (AAPL) there. Exxon (XOM) was. Microsoft is up about 30,000% since trading began in its shares in 1986. Apple about 17,000% since that same point, both according to Yahoo (YHOO) Finance.
And certainly, a rising market could help the value of Facebook shares to rise. But it will have to do most of the lifting itself. And the recent financial results, suggest a company struggling against limitations in its business model and pushing hard for revenue gains in ways that forsake net income. Operating leverage – higher revenue producing even higher gains in profits – has yet to become a reliable feature of Facebook’s reported results. In that, Facebook -- such a young company, has more of an excuse rushing to exploit its market position than more mature tech companies – could grow to resemble the popular but overpriced stocks of Amazon and Salesforce.com (CRM). Unleverage:
Sales growth via free shipping (Amazon Prime), also known as price slashing, isn’t so good for the bottom line.
The market hasn’t seemed to mind much, in the cases of Amazon and Salesforce.com, but sooner or later profits do matter.
Google has generally operated at a very high profit margin, tempered by huge investments in efforts to expand beyond search.
In the first quarter, Facebook profits fell about 12% to $205 million, on a 44% rise in revenue. Costs rose quickly during the quarter vs. a year earlier – marketing and sales more than doubled; R&D nearly tripled; the number of employees was up 46%.
Perhaps more worrisome – and this has been widely reported on, for good reason – as people migrate to mobile engagement, Facebook faces an even harder time ramming those ads at users. Facebook only added ads to mobile apps and its mobile website in March. In the very first risk factor in the IPO prospectus, Facebook warns “any number of factors could potentially negatively affect user retention, growth, and engagement, including if:”
And the third “if” listed is this: “We are unable to successfully balance our efforts to provide a compelling user experience with the decisions we make with respect to frequency, prominence, and size of ads and other commercial content that we display.”
In other words, we better not junk up the site too much, but junking up the site is how we make money. In that, Facebook will be competing against other social networking sites, all providing fabulous services but challenged in how to turn loyal users into revenue sources: LinkedIn (LNKD), Twitter and Yelp (YELP).
Facebook shares will very likely benefit from the cool factor – like Apple, Amazon, Netflix and other consumer-oriented tech stocks – buoyed by the popularity of its service offering, and in some investor minds quite apart from its business model or actual results. Chipotle’s (CMG) another in that category (love the 1,000-calorie buritos, so the stock must be great!).
Another reason to be leery of the Facebook IPO is its timing. Mark Zuckerberg, 27 -- and if what we see at the movies is any indication, exquisitely focused on his own wealth and power – waited until his company had an implied market cap of $100 billion to go public. Hell, he’s already halfway up the mountain. And truth is, Facebook, with $8 billion in credit facilities and decent cash flow, doesn’t so much need the IPO proceeds of $6 billion-ish as it does a way for early investors to cash out. Two thirds of he IPO proceeds could be spent on tax obligations triggered by the IPO.
It’s expensive to get rich.
And the lock-up periods for investors not selling in the IPO are short. Early investors in public shares of Facebook could be swamped in a title wave of selling. Less so, of course, if the stock rises smartly.
Filed under: Company Analysis