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.

Genius is Not Educated

The WSJ published an interesting article entitled Educating the Next Steve Jobs:

Though few young people will become brilliant innovators like Steve Jobs, most can be taught the skills needed to become more innovative in whatever they do. A handful of high schools, colleges and graduate schools are teaching young people these skills.

In most high-school and college classes, failure is penalized. But without trial and error, there is no innovation. Amanda Alonzo, a 32-year-old teacher at Lynbrook High School in San Jose, Calif., who has mentored two Intel Science Prize finalists and 10 semifinalists in the last two years—more than any other public school science teacher in the U.S.—told me, “One of the most important things I have to teach my students is that when you fail, you are learning.” Students gain lasting self-confidence not by being protected from failure but by learning that they can survive it.

It’s nice to read about the value of failure, a topic that I have written a few words about.

But really, I don’t think that revolutionary thinking can be educated, and I think it’s foolish (and possibly even counter-productive) to try. School by definition inculcates systematic thinking, methodology and dogma. It inculcates competence. That’s generally a good thing; surgeons, medical researchers, lawyers, engineers, musicians and all manner of professionals need to be competent to function. Innovation is not necessarily inherent in any of those fields. But genius and revolutionary thinking is not really about competence and confidence.

Malcolm Gladwell is famous for formulating the idea that with 10,000 hours of practice, it is possible to master a skill.

The key to success in any field is, to a large extent, a matter of practicing a specific task for a total of around 10,000 hours.

So is 10,000 hours of practice all that stands between incompetence and world-changing greatness?

Gladwell grandly theorises that many famous history-changers (“outliers”) like Bill Gates, Steve Jobs, and the Beatles got to where they did with 10,000 hours of practice. But that ignores a lot of silent evidence; for every Bill Gates programming over a mainframe for 10,000 hours, there is a housewife that we have never heard of who has done 10,000 hours of parenting, and (probably much more than) 10,000 hours of housework. There is a surgeon who has done 40,000 hours of operations. There is a truck driver who has driven for 100,000 hours.

Gladwell is keen to point out, of course, that people’s skills also flourish through the networks they cultivate, and the people they meet, and that (of course) it’s just a little more complicated than 10,000 hours of practice.

My view is that all 10,000 hours of practice (something which of course can be delivered within a traditional educational framework) does is lay down a bedrock of competency.

My theory is that revolutionary thinking is not simply a matter of persistence, but is instead attitudinal, and mostly comes out of people who are forced or who force themselves to take a radically different perspective to the rest of the world. They are — almost by definition — autodidacts, simply because their style of thinking has not yet been pioneered. They have to teach themselves, and iron out the kinks. Being an autodidact of course is not necessarily a matter of choice; very often it is a matter of necessity — people who don’t have access to traditional education, or who are forced to exist outside the system. This can be due to poverty, strong personalities, or a preference for self-teaching (very often expressed as a preference for doing over thinking).

The established system is often very useful for such people, because it gives them a framework from which to hang contrarianism. It gives them something to rebel against and kick out against.

On the other hand there are many examples of professional academics and those within the establishment who pioneer and innovate (although of course it should be noted that the overwhelming majority of academic papers today are masturbatory regurgitation). But such activity forces even the most staid into autodidactic learning; it forces them to make mistakes, and challenge themselves and learn their own lessons.

I suppose it is possible to try to inculcate a love of tinkering, of trial-and-error, and an understanding of the value of failure. It is certainly possible to encourage an interest in self-teaching. But it remains to be seen how many of us will really bite. It strikes me as if most of us do not really want to be innovators; I see far more who want job security, loving families, and plenty of leisure time.

I tend to believe that today’s education system is fit for its own purposes; it churns out competent thinkers, competent doers, people who can analyse to a framework and work to a deadline. True autodidacts and philosophers (in the most literal sense of the word — lovers of thinking, learning and wisdom) will find their own way.

Job Creation 101

How would you spend $50 billion?

Last week I talked about how Warren Buffett got both the American credit rating, and the utility of gold very wrong.

This week, Warren Buffett has made a similarly provocative statement, but one I am more sympathetic to. From the New York Times:

While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks. Some of us are investment managers who earn billions from our daily labors but are allowed to classify our income as “carried interest,” thereby getting a bargain 15 percent tax rate. Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.

These and other blessings are showered upon us by legislators in Washington who feel compelled to protect us, much as if we were spotted owls or some other endangered species. It’s nice to have friends in high places.

Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.

While I agree that this is a fundamentally absurd situation, and that so-called “progressive” American taxation is now regressive, alas, the economics of the situation are nothing like as simple as Buffett makes out. Namely, if the system is rigged to favour the rich, then the system is rigged to favour the rich. Stating that fact doesn’t change the 20% youth unemployment rate, the record numbers of Americans claiming food stamps, and the simple reality that not enough jobs are being created to fill the supply of people graduating from school, college and being laid off. Tax reform will not directly address any of America’s problems with malfunctioning infrastructure, its dependence on Chinese imports, or its citizens’ addiction to debt: raising taxes on the rich might help pay down the deficit, but so too would cutting spending on wars and the military industrial complex. But while tax reform cannot directly solve these problems, Warren Buffett and his “progressive oligarch” friends can. How?

Job creation.  Investment in infrastructure. Investment in young people. Look at the humungous of levels bank reserves. There is cash just sitting idly that could instead be channeled into real investment in jobs and infrastructure — the kind that Paul Krugman calls for, just without the government involvement (or the Alien invasion). No doubt government has its own role to play. But why run sheepishly into the arms of government when the private sector has the means and resources to solve many of the humanity’s challenges — and at a profit? So without further ado, here’s where I would invest my money ($50 billion), if I were Warren Buffet:

  1. Carbon-Scrubbing Trees:
    While we don’t know exactly what effects climate change will have on Earth, we do know that keeping Earth’s carbon dioxide level as close to the pre-industrial baseline as possible is undoubtedly a good insurance policy. And doing so could undoubtedly create a lot of jobs. Carbon scrubbing trees allow us to do that by removing carbon dioxide from the air and releasing oxygen using a carbon dioxide removal process called “humidity swing.”
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