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Is Mark Zuckerberg Throwing Away Your Money?

After seeing another week of questionable projects and acquisitions with no apparent ties to profit growth, Facebook seems to have jumped the shark. For those of you who weren't around, Happy Days was one of the most popular TV shows in the 1970's, consistently ranking in the top 30 TV shows by Nielsen

Facebook's  (NASDAQ: FB  ) recently announced acquisitions have as much to do with social advertising as a 1950's greaser does with trick water skiing. On top of that, they don't seem to contribute much to growth, profitability, or strategic positioning. Why is Facebook being so aggressive with new projects now? In six months, will its stock price be worth less than it is today?

On March 27, Zuckerberg disclosed on the Facebook blog that the connectivity lab is trying to build drones, satellites, and lasers to deliver the Internet to everyone. While this is a noble goal, is it personal or professional? Again, the venture has nothing to do with social advertising. As shareholders are investing for retirement, is rational allocation of capital something they should have to worry about?  

Google (NASDAQ: GOOGL  ) has invested significant amounts of capital in seemingly obscure ventures, some of which contributed to the bottom line and some which seemed more focused on doing no evil. Remember the goats? For investors, the saving grace has been Google's core business. The profit from Google's Adwords business is great enough to funds these projects without high expectations for success. If one turns into a jackpot like YouTube, then it's a bonus. The YouTube acquisition resulted in a substantial advertising business, but self-driving cars are still awaiting their day. It's hit or miss, but the strength of the core business allows for flexibility.

If you're going to spend like Google, you'd better earn like Google
If Google's paid search business didn't provide stable excess income, shareholders would have sold the stock violently. However, Google's superior search engine produced better results than its competitors, so consumers stayed with the platform. Does Facebook have a similar competitive advantage, as people use Instagram and Twitter? If Facebook is going to spend like Google, it should be able to earn like Google.

Wild capital allocation raises the stakes
In the last two quarters, the market seems to have determined that Facebook broke the code of profiting from social media and its income stream would be sustainable. Dan Niles, a renowned technology investor, stated on CNBC that Facebook is his "favorite stock, bar none."  Niles has a great track record with Facebook for being negative at the IPO and positive on it early in 2013. His firm, AlphaOne, also has enough resources to have a good feel for the pulse of advertising demand. If Niles is right and demand holds up, pet projects like wiring the world, and acquisitions like Oculus should not hurt the stock.

Google didn't have to buy Bing to maintain market share
The big question as we enter into 2014 is, will Facebook remain a key destination site that attracts an increasing amount of advertising dollars? On the September earnings call, David Ebersman, the company's CFO, admitted that "we did see a decrease in daily users, specifically among younger teens." Decreasing daily teen views may not translate into lower advertising revenue today. Some of these users moved to Instagram, mobile continues to ramp, and advertising dollars flow in from new sources, so the numbers may look OK for many quarters. What does this mean for the bigger picture? Google seems to provide experiences you can't get elsewhere with Adwords and YouTube. Does Facebook?      

Summing it up
If Facebook can maintain its profit stream, investors should give it a pass for spending capital on projects that are unrelated to its core business. However, if profit growth slows, Monday morning quarterbacking over poor capital allocations will be a catalyst for professional investors to sell. This is a risk that individual investors should understand.

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  • Report this Comment On April 01, 2014, at 6:22 PM, secularinvestor wrote:

    Zuckerberg is thinking 10 years ahead, unlike the many who criticise him, who can barely see beyond the end of their noses.

    His acquisitions all show a powerful strategic logic.

    * With Instagram Z countered the critics arguments (long before they even realised the argument) that the young are deserting Facebook. Instagram is a favourite location for the young, but is also attracting many other users - so much so that it is growing much faster than Twitter and has overtaken Twitter for users and engagement in the US. Z is only just beginning to monetise Instragram which will now start adding greatly to rapid top line and bottom line growth

    * WhatsApp is adding over a million new users every day, especially outside the US. Critical mass is the key. The more users WhatsApp has the more attractive it is for non users to join. When I joined I was surprised how many of my contacts had already joined. There are several ways Facebook will be able to monetise WhatsApp - not necessarily with advertising but probably with games and subscriptions etc. However the main objecting for them moment is to build up user numbers to more than a billion i.e. the same strategy as with Instagram.

    * Oculus is another great acquisition which will start to pay handsome dividends in a few years. VR is going to be huge in gaming, but, as Z and others have pointed out, it is likely to lead to several different types of social use - not least that people will be able to make and share their own VR videos and 3D stills. Facebook owns the technology and 100,000s of developers and device manufacturers will climb aboard. Whole new industries will be built around Facebook’s VR

    * Two thirds of the world are still not connected to the internet. Z’s objective is find ways that those 4 billion new users can join the internet via Facebook either for free or very low cost. That is a huge new potential market of Facebook users. To achieve this Z has set up the multi-diciplinary Connectivity Lab and brought together some of the brightest and best minds to explore, develop and implement different technologies to achieve this goal, including solar powered drones that slowly circle for months on end at 20 Kms high along with a network of satellites interconnected with lasers.

    Z has taken over from Steve Jobs as the visionary of the post PC world. Facebook’s future growth is unimaginably huge.

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David Eller

I started contributing to the Motley Fool in 2013. I have held research positions at two investment banks and two hedge funds before trying more entrepreneurial ventures. I'm passionate about helping people find freedom in financial independence. Feel free to add comments and start a discussion. I hope to use these articles as forums to learn from you as well as share my opinion.

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