May 22, 2012
The much hyped and anticipated IPO that placed Facebook’s valuation at a whopping $100 billion has been a huge flop, with the stock down by almost 30 percent from its peak share price of $45.
Compare this with other giant tech IPOs like Netscape and Google. Netscape more than doubled on the first day of its IPO. Google jumped 18 percent on the first day, and after 8 years the stock is 7 times its IPO price of $85.
Will Facebook perform like Google, or more like Zynga, whose stock has lost half its value since its IPO?
Here are the top seven reasons why I have to click on the “dislike” button for valuing Facebook at $100 billion when it made a net income of $1 billion on revenues of $3.7 billion in 2011.
1) Unrealistic P/E: The Price to Earnings ratio is the valuation ratio of a company’s current share price compared to its per-share earnings. The higher the number, the riskier it is for the investor. For comparison, Apple’s P/E ratio is about 13, Google is about 18, and for Facebook it was more than 100 at the IPO, possibly the highest among all the S&P 500 companies! Even after the stock’s fall on Monday and Tuesday, the P/E ratio is about 71. If you price Facebook like Google, the stock price would be around $7.
2) Shaky Growth Strategy: Facebook has maxed out its growth in the U.S. and other English speaking countries. In its IPO documents, Facebook touts fast growth in Asia.
But let’s take a look at some of the countries in Asia.
Facebook is banned in China, a country with 1.3 billion people. Chinese have their Ren-Ren which has the exact look and feel of Facebook. Nobody knows when China will open up and, even if it did, the barrier to switching to a new platform with limited differentiation is high.
India has over a billion people but only 10 percent of the population has access to the internet and less than 2 percent has access to broadband. Same with Indonesia, the fourth most populous nation in the world.
In Africa, a continent with a billion people, the statistics are even more dismal.
Let’s also not forget that we live in a world where half the population (more than 3 billion people) make less than $2.50 a day and the last thing on their mind is a ‘status update.’
Bottom line: Facebook’s growth has already transformed from an exponential curve to an “S” curve, and its growth will flatten out very soon (or may even decrease).
3) Low ARPU: ARPU is Average Revenue Per User (per Year). While Google manages to generate $30 per user, Facebook gets a pitiful $4.34 per user. Breaking it down by region, it’s about $10 for U.S. and Canada, $5 for Europe, and $1.79 for Asia.
The number for Asia is this high because of Japan and South Korea but will go down in the future since most of the new members will be from developing nations with a lot less GDP per capita.
In the first quarter of 2012, Facebook’s net income actually fell by 12% compared to 2011.
So the overall revenue per user will continue to go down unless Facebook comes up with a great new strategy.
4) Huge Dependence on Ad Revenues: Eighty-five percent of Facebook’s revenue in 2011 came from Ads. Facebook is trying to get more out of the virtual currency world but so far it has not been very successful.
So Facebook has tried several tricks like making the fonts smaller and increasing the number of ads per page from 6 to 7 (of course, most people never noticed the increase in the ads because most people never look at the ads to start with).
But there are only so many ads you can squeeze on a page before it becomes irritating and turns people off.
5) Efficiency of Facebook Ads: How many times have you clicked on a Facebook ad? Personally, I think I have clicked maybe 3 ads on Facebook in the last 5 years.
Many advertisers are starting to give up on Facebook. GM cancelled a $10 million Facebook ad campaign just days before the IPO.
According to analyst Carlos Kirjner, “The presumption that Facebook is not an effective medium for autos begs the question, ‘What other large verticals may find it inadequate?’ If it does not work for GM, will it work for P&G, or AT&T, or perhaps the highest profile Facebook customer, American Express?”
6) Growth of Mobile Users: More than half of Facebook logins are from smartphone users. Even in developing nations, the future acquisition will primarily come from smartphone users.
Currently, Facebook has no advertisements on their Facebook App for smartphones. Even without the ads, the mobile app is slow to load the pages. Whether Facebook ads can be integrated with the mobile app without disrupting the user experience is yet to be determined
7) Greed and Slime: The average investor must feel quite burned after the disastrous Facebook IPO. The ridiculous price of the stock had only one purpose—to make the early investors and the investment bankers rich. As Vanguard Founder and CEO John Bugle said on CNBC, ”This is a classic example of institutional greed, underwriter greed, and company greed.”
Early investors like Goldman Sachs added 25 percent more shares to the mix and raised the stock price at the last minute. And then they dumped their shares on the first day knowing very well the stock price was unreasonable and unsustainable.
Morgan Stanley, the lead underwriter, repeatedly stepped in and bought Facebook shares to artificially prop up the price of the stock in the last 3 days, which may be illegal.
Also, on Tuesday, it was revealed that just days before the IPO, Morgan Stanley slashed the revenue estimates for Facebook and warned a few of the big investors but kept it a secret from the public. Regulators are looking into it but it is not going to help the mom and pop investors who have collectively lost tens of billions of dollars in just a couple of days.
So much for believing in the “free market.”
There are lots of other reasons, short and long term, why the stock price may go down further. Facebook and its employees will be selling a lot of shares around November after the initial 6-month waiting period is over. This is expected to put more downward pressure on the stock price.
And looking into the future, who knows what consumers will like or want in 3 or 5 years? Remember MySpace?
When a rag-tag team of 13 employees can start Instagram and become an existential threat to Facebook, it’s time to pause.
Facebook’s stock closed at $31 on Tuesday. In the short term, it maybe a falling knife that nobody wants to catch. My estimate for a fair stock price is around $10.