Facebook & the Bubble Mentality

So Facebook keeps falling, and is now floating around the $27 mark.  We’re a third of the way down to my IPO valuation of FB as worth roughly $2-4 a share (or 5-10 times earnings), although I wouldn’t be surprised for the market to stabilise at a higher price (at least until the next earnings figures come out and reveal — shock horror — that Facebook is terrible at making money).

The really stunning thing is that even after all these falls, FB is still trading at 86 times earnings. What the hell did Morgan Stanley think they were doing valuing an IPO without any viable profit model at over 100 times earnings? The answer is that this was an exit strategy. This IPO was about the people who got in early passing on a stick of dynamite to a greater fool which incidentally is precisely the same bubble mentality business model as bond investors who are currently buying negative-real-yielding treasuries at 1.6% hoping to pass them onto a greater fool at 0.5% (good luck with that).

This was achieved by convincing investors to ignore actual earnings and instead focus on projected future earnings. From Bloomberg:

Facebook, with a market capitalization of $79.1 billion, is trading at 29.5 times the company’s projected 2014 profit of $2.69 billion, data compiled by Bloomberg show.

Or much more simply, counting chickens before they hatch.

There’s an interesting comparison to the development of AAPL. Steve Jobs — who went on to do great things — was never fully in charge of AAPL until much later on. AAPL externally recruited CEOs with business experience, and Jobs was eventually thrust out of the company he founded, to continue his journey on his own. Failure is a really valuable lesson. Jobs was lucky to experience it and learn from it early before he ever got a chance to destroy AAPL.

FB isn’t really a bad business, and prospects would look much rosier if it were priced more realistically. It’s generating a profit — just a much smaller one than suggested by the IPO pricing. And management are being swept along by everyone else’s irrational euphoria. Zuckerberg can freely throw away a whole year’s earnings buying Instagram — an App whose functionality FB actually duplicated in-house almost certainly for a tiny fraction of the cash thrown at Instagram. And Zuckerberg — who controls a majority of the voting rights — isn’t going to get thrust out into the cold by shareholders. He can keep wildly throwing cash around so long as it keeps flowing into FB. The problem is, given the steep price falls, it looks like the river is running dry.

As I wrote before FB started falling:

The big money coming into Facebook just seems to be money from new investors — they raised eighteen times as much in their flotation yesterday as they did in a whole year of advertising revenue. For an established company with such huge market penetration, they’re veering dangerously close to Bernie Madoff’s business model.

That’s life. Bubbles get burst; the Madoff bubble, the securitisation bubble, the NASDAQ bubble, the housing bubble, the Facebook bubble, the treasury bubble. The trick is not getting swept up by the irrational euphoria. Better to miss a blow-out top than to end up holding a stick of dynamite.

17 thoughts on “Facebook & the Bubble Mentality

  1. Pingback: Guest Post: Facebook & the Bubble Mentality » A Taoistmonk's Life

  2. Pingback: Facebook & the Bubble Mentality [Azizonomics] « Mktgeist blog

  3. Pingback: Facebook & the Bubble Mentality [Azizonomics] « Mktgeist blog

  4. Such an obvious hyped up Wall Street pump and dump. Everyone with a half decent understanding of business and economics knew $38 was a joke. But hey folks, aint it nice to be proven right within less than a fortnight?

    You can compare big tech companies to a real small town economy. Google is like the big retail mall in town. You get anything you want there, its really convenient, and people frequently spend money at it. Its a business.
    Linkdin is like a members club. You meet like minded fellow professionals to network, do deals, talk business. That’s worth something.
    Whats Facebook like? It’s a park bench. You stroll over for a chat, meet some friends, watch the world go by. What you DON’T do is spend money. Suckerberg invented the most popular park bench in world history, but park benches cant charge for seating. If he tries, people are just going to find another bench to meet at..

    • Very nice and neat analogy. I’ll extend it: Plenty of Fish is like the shitty disco or pub you go to if you want to catch an STD. Amazon is like Wal Mart. Zero Hedge is like one of those bars you go to meet washed-up college professors, junkie dropout philosophers, and Hells Angels.

      • You gave me an idea. I bar in Vegas called Zerohedge.

        The strippers and prostitutes that go there, after servicing high end clients would give the barflys inside information.

    • My credit card got debited this month for LinkedIn access to various facilities to network. That is real money!

      Go long LinkedIn. As the recession bites, more professionals will pay to network.

  5. Hi John,

    It’s my first post, thought I’d say ‘hi.’ Was introduced to your blog through ZH like I am sure many people are. Appreciate the posts you make – it’s a great contribution in providing ‘real’ news like yourself and a whole bunch of others are doing. I too am 24, have awoken from this slumber we’ve all been put into, I’m mad as hell, and I’m not going to take this anymore! (regarding the global situation, past, present, and future)

    I look forward to contributing towards future discussions. To calling out bullshit and exposing false dichotomies… *cheers*

    On that note, I’d like to counter your stance that facecrook isn’t all that bad of a business.

    It is a horrible business that tramples all over user privacy, inhibits positive social interaction (which only happens online through meaningful discussion channels like forums and blogs this one here, and not to forget the best way… in person), devalues personal information and the voice of an individual (and information as a whole), plans an exit strategy to fuck over investors who invest with traditional ‘blind faith,’ (also whose apparent understanding of economics is nonexistent) etc., all the while maintaining the facade of being a service to mankind.

    • Hi, fair points.

      My analysis of Facebook as “not a bad business” is based on money in minus money out. They are producing profits, small ones. Your criticisms are mostly balanced by people opting out, which more and more of us are. I don’t think that it is a big enough business impediment to destroy them (only losing the zeitgeist will do that) but it’s certainly a good reason to personally avoid them.

  6. “Facebook, with a market capitalization of $79.1 billion, is trading at 29.5 times the company’s projected 2014 profit of $2.69 billion, data compiled by Bloomberg show.”

    That sounds familiar. Australian federal treasurer Wayne Swan has been claiming credit and taking accolades for a forecast surplus. How can you boast about a forecast? Blatant dishonesty, that’s how.

  7. Pingback: Facebook & the Bubble Mentality « Financial Survival Network

  8. Pingback: Facebook & the Bubble Mentality « Silver For The People – The Blog

  9. US markets collapsed overnight . Good morning to all. Like I said. Facebook collapses, Retail freaks, risk off, and now we have Global Depression. Nothing will save the economy unless we get a Third Reich style Keynesian infrastructure spend like no tomorrow. Business will not invest unless Government takes the lead by calling for tenders, or directs them to (Giving them Monopoly status)

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