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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.

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Failbook’s Epic Fail: Does Zuckerberg Want Users to Pay?

What is there to say about Facebook?

Why would anyone buy a company’s stock when they have no real profit pedigree? When their advertising profit in 2011 came to just over $1 billion, and their book value is the region of $100 billion, how can that really make any sense other than to the kind of nutcase zombie trader who takes Jim Cramer seriously? The sad truth is that people are just not clicking the ads; Facebook ads receive far fewer clicks than competitors such as Google’s AdSense.

If Facebook was floating with a book value of $5-10 billion (or around $2-4 per share) we would be talking about a serious business proposition, albeit one which is already rather saturated (given that there are 2.3 billion internet users, and Facebook already has its claws into 900 million of them). But at these levels? What are people paying for?

Some say the name recognition and momentum (but that’s just paying for hype) as well as the infrastructure and data that Facebook owns. Certainly five or six years of a big chunk of humanity’s likes and dislikes is a valuable database. But how do they monetise that? Does Zuckerberg have any credible plan?

The most under-reported piece of news of the day is surely that Zuckerberg does seem to have a plan. But it’s not very credible.

From the BBC:

Facebook has started testing a system that lets users pay to highlight or promote posts.

By paying a small fee users can ensure that information they post on the social network is more visible to friends, family and colleagues.

The tests are being carried out among the social network’s users in New Zealand.

Facebook said the goal was to see if users were interested in paying to flag up their information.

That’s their plan? That’s Zuckerberg’s big idea? Get users to pay to post premium content!? Did the well-circulated hoax that Facebook planned to get users to pay for use just turn out to be true? If they proceed with this (unlikely) it seems fairly obvious the world would say goodbye Facebook, hello free alternatives.

The truth is that Facebook is a toy, a dreamworld, a figment of the imagination. Zuckerberg wanted to make the world a more connected place (and build a huge database of personal preferences), and he succeeded thanks to a huge slathering of venture capital. That’s an accomplishment, but it’s not a business. While the angel investors and college-dorm engineers will feel gratified at paper gains, it is becoming hard to ignore that there is no great profit engine under the venture. In fact, 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.

On the other hand, they have plenty of time and money to try out various profit-making schemes. Eventually, they may hit on something big; Apple didn’t start out producing huge cashflow or sales, they got there the hard way. But it all seems like a big gamble on an outfit with big dreams but little moneymaking pedigree. I’d consider buying Facebook at $2-4 a share. But current valuations are a joke — and I don’t think the market is falling for it.

Even the NYT notes:

The company’s bankers had to buy shares to keep the stock from falling below its offering price, raising questions about how the stock will fare next week.