Is Facebook the Next Rule Breaker?

There are six signs of a Rule Breaker.

With dominant social network Facebook gearing up for its hugely anticipated IPO next month, I think it's about time to consider whether the company can prove itself worthy of a spot on the Rule Breakers recommendation scorecard.

Fellow Fool and official Rule Breakers analyst Tim Beyers looked at Facebook partner in crime Zynga (Nasdaq: ZNGA  ) ahead of its IPO and even considered that it might be worth every penny. Alas, that company proved to be a Faker Breaker in disguise.

Let's see how Facebook looks through the Rule Breaking lens.

1. Top dog and first mover in an important, emerging industry
Facebook needs no introduction as the most popular social network today. While it's unquestionably the top dog in social networking, it technically wasn't the first mover, as Friendster's launch predated Facebook by a couple of years. Friendster launched a decade ago, and MySpace followed suit two years later.

Facebook launched around the same time in 2004 but was initially limited to college students. It wouldn't be until 2006 that Facebook would open its digital doors to the masses. It was among the first movers and is hands down the top dog in the increasingly important realm of social networking.

Check.

2. Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors
MySpace was once largely viewed as Facebook's primary competitor, but it has mostly fallen by the wayside and is now geared toward a niche segment of the market. Just last year, News Corp sold the site to Specific Media, losing more than half a billion dollars in the six-year trade.

Nowadays, Google (Nasdaq: GOOG  ) is Facebook's biggest rival as Facebook encroaches into Big G's advertising market. Google's response is its own Google+ social network, although this has yet to gain meaningful traction and is far short of a Facebook killer.

Personally, I don't currently see Mark Zuckerberg as a visionary leader. I tend to view him as a lucky guy who was in the right place at the right time. Although, in fairness, Microsoft's (Nasdaq: MSFT  ) Bill Gates has said the same thing about himself, but Gates had a clear vision of the PC industry. Over time, Zuckerberg may prove that he has a vision for the open and social Internet, so I'll give him the benefit of the doubt.

Facebook's biggest advantage right now is its network effects, as it now boasts more than 900 million monthly active users, or MAUs -- up from 197 million three years ago. That's 13% of the 7 billion global population and almost half of the 2 billion global Internet users that Facebook estimates (based on IDC figures) as its addressable user opportunity. Facebook definitely has business momentum.

Despite my qualms regarding Zuckerberg, I'm going to give Facebook this one due to its overwhelming momentum and lack of meaningful social networking competition, even from heavyweight Google.

Check.

3. Strong past price appreciation
Facebook's valuation has skyrocketed over the years. Just look at this chart that Fools Dari FitzGerald and Andrew Tonner compiled in February.

That price appreciation looks pretty strong to me.

Check.

4. Good management and smart backing
I've already expressed my feelings on Zuckerberg, but he also has a strong management team and board behind him.

COO Sheryl Sandberg, a Harvard MBA, spent seven years at the U.S. Treasury Department, followed by more than six years as the VP of global online sales and operations at Google. She was named COO in 2008. CFO David Ebersman was CFO at now-private biotech Genentech for 15 years. Don't forget that Netflix's (Nasdaq: NFLX  ) Reed Hastings also sits on Facebook's board. PayPal co-founder Peter Thiel is also a director.

Accel Partners was an early venture capital backer for Facebook as early as 2005 (and still owns more than 201 million class B shares), and it also helped fund successful startups like Dropbox, AdMob, Etsy, and Kayak, among many others.

Check.

5. Strong consumer appeal
This one is easy. Simply put: How many people do you know who aren't on Facebook? The site is the de facto standard for social networking, with 901 million MAUs enjoying a free service to connect with people.

Source: Facebook.com.

Facebook has also made it clear that the service will always be free, so it's nearly impossible for Facebook to lose its consumer appeal. It would have to do something unimaginably egregious to put off enough users to invalidate its strong network effects.

Check.

6. You must find documented proof that it is overvalued according to the financial media
There are plenty of examples of the financial media, including Fool.com, calling Facebook overvalued.

  • "Twitter, Facebook Grossly Overvalued" -- Seeking Alpha, April 8, 2009
  • "The Most Overvalued Company in Tech" -- Fool.com, Dec. 20, 2010
  • "Is Facebook Overvalued?" -- The Week, Dec. 29, 2010
  • "Facebook Overvalued at $50 Billion in Investor Poll" -- Bloomberg, Jan. 28, 2011
  • "Is Facebook Worth $100 Billion?" -- The Wall Street Journal, July 14, 2011
  • "Facebook's IPO Will Be Way Overvalued" -- MarketWatch, Feb. 1, 2012
  • "Facebook IPO: Tech Bubble 2.0?" -- Kapitall (via Fool.com), Feb. 2, 2012

Facebook has reported trailing-12-month revenue of $3.4 billion and net income of $974 million. At the expected $100 billion valuation, we're looking at a price-to-sales ratio of 29.4 and a price-to-earnings ratio of 102.7 -- textbook cases of lofty multiples.

Check.

Final score: six of six
By my count, Facebook shows all six signs of a Rule Breaker. This is but a starting point for the Rule Breakers analyst team (of which I'm not a member), but it seems Facebook might just fit.

Professional social networker LinkedIn (NYSE: LNKD  ) was recently recommended by the service, after all, although that company has a very different monetization model for its users. Besides, LinkedIn's P/E of nearly 900 makes even Facebook look like a value stock in comparison.

Now Facebook just needs to complete its IPO, and the Rule Breakers team will have to decide for itself whether the social kingpin can earn itself a fresh "buy" recommendation for its soon-to-be-public shares.

Until then, there's another company sporting all six signs of a Rule Breaker that's detailed in a special free report. Discover the next Rule-Breaking multibagger, which is a company that's earned three recommendations for premium subscribers. The Motley Fool is now giving this report away for free! Check it out now.

Fool contributor Evan Niu holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Google, LinkedIn, and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft, LinkedIn, Netflix, and Google. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. The Motley Fool has a disclosure policy.
We Fools may not all hold the same opinions, but we all believe that
considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (8) | Recommend This Article (8)

Comments from our Foolish Readers

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 April 25, 2012, at 2:20 PM, CromulentBrad wrote:

    good management? facebook paid one billion dollars for a two-year old photo-sharing company.

    they paid a graffiti artist roughly $500 million to paint a wall.

    to me, this is not the mark of good management, but of clueless management that has no idea how to spend its wealth.

    facebook has not innovated anything. all they've done is come up with different layouts for my home page. this is hardly the stuff of visionary leadership.

  • Report this Comment On April 25, 2012, at 2:48 PM, mikecart1 wrote:

    The only rule Facebook is going to break is theft. It is going to wipe out many people's investments in the long run. No doubt Facebook is going to be a stock to make money on. It will be moving up and down for much of this year. The goal is to be on the right side of the trade. If it tanks, you better be able to see it and short. If it soars to like $200 billion, then you have a great chance of making 100% or more on the investment.

    The chart above is sad though. If Facebook had gone public 5 years ago, then it might be something to really invest long term in. Now it is basically as if Apple just went public after the iPhone 3.

    :D

  • Report this Comment On April 25, 2012, at 3:09 PM, ifni wrote:

    If, as anticipated by many, the Facebook IPO results in a market cap of 50-100b USD, then it will have to achieve a market cap of 100-200b to be a 2-bagger for initial investors. Compare this to the Apple's market cap of 570b (@ 04/25/12) and then consider if Facebook's valuation should (or will) really be the same order of magnitude as Apple?

    I agree with mikeart1, above, that a Facebook IPO 5 years ago would have been a much better opportunity. The facebook IPO will be a large payout for original investors as opposed to a genuine opportunity for new shareholders to bankroll an innovative and interesting new venture.

  • Report this Comment On April 25, 2012, at 6:07 PM, CaptainWidget wrote:

    I hope this is for the sake of argument.

    *a 100 billion dollar company with 1 billion in revenue (and their main source of revenue, advertising, DROPPING)

    *their only way to counter dropping revenues is to increase ads or make ad experiences more intrustive

    *their only asset is their user base, and their only way of monetizing user base (more ads) will drive away their asset

    *their "management team" can be rendered completely moot by Mark Zuckerberg, who retains full control over the board

    When faced with the daunting task of trying to live up to their 100 billion dollar valuation in the open market, they're going to have to make you watch ads. Those ads are going to make people want to go elsewhere. Without those users, they have no company.

    It's not common, but I know plenty of young, hip, trendy people who now think Facebook is passe....that's officially Facebook's death knell.

  • Report this Comment On April 25, 2012, at 8:30 PM, Futuroyolo wrote:

    @jukebox71 "good management? facebook paid one billion dollars for a two-year old photo-sharing company. " I could not agree more. What did they buy? When you take a picture with your phone you can share it directly to facebook they do not need instagram especially for $1billion. Goole,Google+, has everything going for it to take market share from facebook in the future and possibility a Facebook to Myspace type scenario. Facebook is not an attractive investment.

  • Report this Comment On April 25, 2012, at 11:28 PM, zpoet wrote:

    You guys are clueless. Facebook's IPO isn't engineered to last, it's engineered to make original investors, banks who have access to shares in the premarket, and all of the management ridiculous gobs of money. Facebook cannot live up to it's valuation, it's impossible to build revenue that high for such a high market valuation passed 100 billion, not with the business they're in. They'll need to delve into other markets to make money, like Google did.

    If you think this is an investment for the long term you're sadly mistaken. Early birds will reap their rewards and leave the rest of us shaking in the ups and downs of this trade. Good luck.

  • Report this Comment On April 26, 2012, at 10:20 AM, fool3090 wrote:

    Ugh. Before this outfit gets a dime from me, it needs to be a Rule Follower -- as in honest accounting. There's no Like for Facebook from this Fool.

  • Report this Comment On May 02, 2012, at 5:15 PM, linecrosser wrote:

    One thing you all seem to be forgetting about Facebook while you rant about advertising revenue is the value of the data they possess. They know absolutely everything about you... EVERYTHING. They know what you like, what you think about, what you read, where you go on the web and everyone you know. That data is worth an absolute mint. The long game is to become the single sign-on for the internet. No more remembering a bunch of usernames and passwords for all the sites you visit.. just sign on with Facebook and off you go.. And what does this mean? This means they know even more about you than they already do. This means they know what you search for and what you buy, in addition to the already formidable records they already have... records that would make any spy agency jealous. Ultimately Facebook will be able to predict your wants and desires before you even know them... if you can't figure out what this means, don't buy Facebook.. But I certainly will. And I for one welcome our new overlords. :)

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1870691, ~/Articles/ArticleHandler.aspx, 12/18/2014 2:57:34 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement