In Part-1 of this series, I looked at Facebook’s historic IPO and its lacklustre start off the finish line with its closing share price only up 23 cents from its original IPO price. I looked at the risks associated with buying an IPO, especially when you buy a company without a long standing corporate history. I also looked at Facebook’s valuation at $38 per share, which is already being shorted, and showing early signs of being overvalued.
In this post, I continue to look at Facebook’s recent decline off the finish line. I also examine its business model, and revenue model. In Part-3, I examine Facebook’s, accountability as a public corporation, potential privacy and legal issues, as well as the lack of shareholder control. I also look at Groupon’s legal problems and how that may impact Facebook.
Here are the Top 10 Reasons why you shouldn’t even consider buying Facebook, continued:
3. The Stock is already being shorted
Although it’s already after the fact, support for Facebook’s IPO is not looking good. Indeed the $100 billion dollar valuation for the Facebook IPO at $38 per share is looking to be overvalued. Investors dumped and shorted their shares of Facebook (FB) this morning, within the first few minutes of trading. FB shares were down to a low of $33.00 per share within the first 15 minutes of trading, a $5.23 loss or negative -13.6% decline from the Friday closing price. For the first day of trading after the IPO day, Facebook shares closed at $34.03 per share, down $4.20 per share or -10.99%. The decline in share price was largely the result of investors selling their facebook shares, after Friday’s dismal IPO, and widespread shorting of the stock. Moving forward, Facebook shares can be expected to face downward pressure this week, with lower lows, and even lower if the lead underwriter Morgan Stanley stops supporting the stock. When a stock is being shorted, and the lead underwriter may pull its support, it’s not a good sign moving forward.
4. Is the economic moat impenetrable?
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Does Facebook have an economic moat? Is it a business that is safe from its competitors? Does it have an economic competitive advantage? This is the one area where Facebook actually shows some strength, since it has actually been around for over 8 years with a huge subscribership and user base. While Google has tried to encroach on Facebook’s popularity with Google +1 and Twitter has become a leading social media platform, Facebook still remains the dominant social media giant. Right now that dominance looks poised to continue, especially among the teenage generation who have grown up with Facebook, not only on their laptops but on their phones. It is as much a part of their life as waking up to a cup of java is for me.
However, continuing privacy issues, personal data mining for marketing purposes, complex privacy controls, and a constantly changing interface for users, may begin to alienate Facebook’s own users. Many people have already begun deactivating their facebook accounts, yours truly included. A new social media platform, with simple privacy standards and an easy to understand user interface may give Facebook a wakeup call down the road. If you invest in Facebook, then you must believe Facebook is immune from competition and has an economic moat as wide as Google’s. For now, the Facebook moat looks impenetrable, but that is certainly not reason enough to become an investor.
5. What is the business model?
How does Facebook generate its revenue? What is the bottom line for profits? Like most online businesses, Facebook claims to generate most of its revenue from advertising. But Facebook is no AdSense, and advertisers have seen poor results with Facebook ads. The main reason people use Facebook is to share photos and communicate with their friends, hence Facebook ads often go ignored by regular users.
Facebook ads are tied into Bing with Microsoft, and generally have very low click through rates (CTR), compared to Google’s AdSense. There are also the direct Facebook Ads which are sold to business, but again I’ve been told Facebook ads have the lowest click-through rates in the industry. The CTR is critical for advertisers. If Facebook is primarily claiming to make its revenue from online advertising, then investors may become sorely disappointed once the earnings reports for advertising start to roll in for Q1 and Q2.
Most of Facebook’s business practices appear to be more secretive than an open book, and borderline on privacy issues and the use of personal information. It’s very difficult to understand how the Company really generates profits, or what its real business model may be. It is one thing to use Facebook and upload photos of your Saturday barbeque, and chat with your friends. But it’s another matter to invest your hard-earned money into the company. So the real question to ask as an investor is – do you understand the business model?
6. Are the earnings sustainable?
Once a company becomes publically traded, it is accountable to shareholders and the public. One measure of that accountability is bottom line earnings, profit, and revenue. Shareholders like to see increasing quarterly growth and profits. In early 2012, Facebook disclosed that its profits had jumped 65% to $1 billion in the previous year when its revenue, which is mainly from advertising, had jumped almost 90% to $3.71 billion (from Wikipedia). Moving forward Facebook will need to increase revenue and profits on a quarterly basis and report these profits to shareholders. Constant growth in subscribership and advertising revenue is critical for Facebook’s success. Is continuing growth in subscribership and revenue sustainable? Some believe Facebook has already achieved its pinnacle of growth and success, and that there is more potential for decline. Either way, as an investor are you willing to take a risk on future growth and future profitability?
In Part-3 I’ll look at other reasons why you should not rush in to by Facebook, including shareholder control, legal and privacy issues, accountability, and the similarity of Groupon’s problems with potential issues for Facebook. If you missed Part-1, be sure to check it out.
Continue to Part-3.
Readers, what’s your take? Do you think Facebook is a sustainable business model? Do you think moving forward Facebook can continue to increase subscribership and revenue growth?