To FB or Not to FB

It didn't take long for critics to start poking Facebook -- and not in that way.

The social networking website wants to raise how much? Mark Zuckerberg -- that pompous nerd from that David Fincher movie -- wants to own how much of the company? This dot-com bubble will pop how soon after the IPO?

I don't think Facebook is a bargain if it winds up pricing anywhere near the levels that some are speculating. However, I can already see the vast majority of analysts and market watchers betting against the company.

If the masses are predicting Facebook's demise as a public company, history says that the better bet is backing the pompous nerd from that David Fincher movie.

Zuck it
Yesterday's S-1 filing shows a company that is growing quickly, flush with cash, and profitable with insanely ludicrous margins. This isn't a company that has to go public because it needs the money.  

Our own Tom Gardner hit Twitter with this bullish note after the filing:

As a cash-rich private co, #Facebook pursued market share. Now earnings will accelerate. Don't lazily accept jokes about the IPO valuation.

I'm glad I'm not alone, even if Tom and I may be in the minority even among our Motley Fool colleagues.

I was one with the masses before. I was skeptical when Microsoft (Nasdaq: MSFT  ) acquired a small stake in Facebook that valued the company at a then mind-boggling $15 billion. Facebook wasn't really worth that. The software giant was simply paying a valuation premium to lock up advertising rights.

I was wrong. I underestimated that a growing company renders overvaluation arguments moot over time.

Wearing military fatigues
Over the next few days, you're going to hear about something called "Facebook fatigue" as a sign that the site is peaking. Some widely followed blogger or analyst will grow tired of Facebook, delete the account, and assume that everyone's going to be following suit.

Let me tell you all what you need to know about this malady. The term "Facebook fatigue" dates back to 2007, when BusinessWeek tagged it as one of the 10 likely events to happen in 2008. You realize that Facebook had just 60 million users at the time -- just 7% of today's base of 845 million monthly active users.

Obviously Facebook can't have a similar 15-fold pop in users over the next five years. There just aren't that many people on the planet! Registration growth will decelerate. However, there's nothing stopping Facebook from milking more revenue out of the users it already has.

There's advertising, of course, where Facebook's 28% chunk of the display advertising market is nearly three times as large as its nearest peer. Slapping graphical ads on a website hasn't been an ideal dot-com model in the past, but sponsors are gravitating to what it means on Facebook. Advertisers paid 18% more for an ad on Facebook in 2011 than they did in 2010. Google's (Nasdaq: GOOG  ) paid search stronghold is where the serious money is made, but did you catch Big G's most recent report? It stunned investors by reporting that advertisers were paying 8% less for every vetted click.

New revenue stream worth paddling
One of the more surprising nuggets in Facebook's report is that it generates 12% of its revenue from Zynga (Nasdaq: ZNGA  ) . Collecting passive revenue from social gaming companies developing on Facebook's platform will be easy money if Facebook continues to grow in popularity.

If Zynga can become such a major contributor to Facebook's fat margins, what happens when there are more Zyngas? Electronic Arts (Nasdaq: EA  ) has been aggressively ramping up its social gaming initiatives through acquisitions and leaning on its marquee brands to create familiar diversions.

Why stop at gaming? As more developers flock to Facebook's platform, there will be an army of Zyngas contributing to Facebook's bottom line.

The cruel law of gravity
It would be naive -- and stupid, quite frankly -- to argue that Facebook will grow in perpetuity. There will come a point where it does peak. Facebook may test the mettle of its users one time too many. A uniquely superior way to connect to acquaintances may come around, even if it will take ages to replace Facebook's 100 billion (and counting) friend connections.

Facebook is a stock that you don't want to overpay for now -- and you're not going to want to hold it forever. However, can't the same be said about any company? If you're going to live in fear of the peak, you will miss the ride up. All you have to do is pay attention. Respect the peak. Enjoy the ride.

The Motley Fool owns shares of Microsoft and Google. Motley Fool newsletter services have recommended buying shares of Microsoft and Google, as well as creating a bull call spread position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


Read/Post Comments (5) | Recommend This Article (12)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 02, 2012, at 12:24 PM, CarlRLarson wrote:

    $FB is way overhyped. If recent tech IPOs are any indication, and I believe that they are, then here's why FB is worth short selling in its opening chapter:

    http://bit.ly/ysswxX

    Long term, FB is a great company. Short or medium term, anything can happen.

  • Report this Comment On February 02, 2012, at 1:56 PM, starz188 wrote:

    No concern at all, Rick, about the increasing percentage of users who are accessing FB on mobile devices and the longer-term trends there?

    In the S1, FB openly admits that mobile users represent a revenue threat since there is no current advertising on mobile.

    Short-term I think this is a great investment.... but are fewer people going to be using mobile devices to access FB in the future - or more?

  • Report this Comment On February 02, 2012, at 4:59 PM, PaperchaserB wrote:

    This will be a good one to own i think, but for some reason im having lingering doubts....

  • Report this Comment On February 02, 2012, at 5:10 PM, EnigmaDude wrote:

    The "average" investor won't even be able to buy shares (or be able to short shares) of FB initially. But I agree that it is likely to be a good investment for those who can get in on the IPO action.

  • Report this Comment On February 03, 2012, at 3:17 AM, CaptainWidget wrote:

    What's the potential upside on Facebook? They've already got 1/8th of the planet onboard and using their program.

    If their growth strategy is to get more ad revenue per user, people will leave. Plain and simple......people don't go there to look at ads, they go there to have a relatively unencumbered look at what their friends are doing.

    If their growth strategy is to increase users....well.....they've got a short way to go until every human being on the planet is using their service.....even the ones who have no access to internet, earn less than $1 a day, and have no earning power to consume from facebook ads (making them extremely undesirable advertising markets).

    Yes, Facebook is growing fast, and so are their revenues. But the one metric that hasn't changed is their earning per user. They earn less than $1 per year per user. That is a remarkably low number for an advertising company, one necessitated by the non-consumer centric business model Facebook has chosen.

    I think it's pretty obvious that their top line growth is based on user growth...and that ceiling is coming fairly soon. I don't get the optimism. Facebook will continue to grow users and stagnate on earnings per user, then get pressured by the market to increase revenue per user, and chase away their entire user base. It's not as if this is a new story. Myspace, Digg, AOL, ect all added no value to their user base (other than the userbase it's self) and chased them away as they tried to monetize.

    I just don't get the optimism.

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