Why You Shouldn’t Buy Facebook: Part-2

Facebook IPOIn 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?

[easyazon-image-link asin="B00835T9D8" alt="Buy This Book Before You Buy Facebook: A PandoDaily Expert Guide To The Internet's Biggest IPO" src="http://ecx.images-amazon.com/images/I/51Q6ilzDMsL._SL500_.jpg" align="right" width="187" height="250"]

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?

16 Responses to “Why You Shouldn’t Buy Facebook: Part-2”

  1. Michel

    May 22. 2012

    No, I do not think Facebook has a real business model, for the long term anyway.
    Already, studies show that mobile users are not contributing to the ad clicking. I want to buy something real, like how about Husky Energy at $22 and 5,2% dividend?

    Reply to this comment
  2. farcodev

    May 22. 2012

    I’m agree w/ Michel, especially now there’s a lot of good opportunities to buy good dividend stocks @ low price than this privacy and business scam represented by FB.
    When the sheeps will leave the boat it will be the end.

    Reply to this comment
  3. Eddie

    May 22. 2012

    Avrom, I’m loving this series.
    I had a good loud laugh this morning when I saw how much FB dropped. I think at one point it was at $32 + change. I personally don’t think FB has a real business model, for the long term anyways, and I think the company was way over valued. Finally, since FB heavily relies on advertising for their income they need to go directly head to head with Google in order to gain more of the Adsense market, because just as you indicated FB’s CTR rates through Bing are very poor.

    Reply to this comment
    • The Dividend Ninja

      May 22. 2012

      Eddie, I’ve also enjoyed writing this series, and Part-3 is pretty cool as well! Much is already after the fact, but its looking like a big FB Flop so far. ;) I do indeed question the business and revenue model.

      Unfortunately I’m not laughing for the retail investor who sold their investments to buy FB shares hoping for a quick buck – many lost money over the last few days. On the other hand it was all hype before it even started. Who knows, maybe the last laugh is on us when FB trades at $200 per share (though I doubt it).

      One thing is certain, IPOs have lost their fizzle thanks to Facebook, maybe investors will be more cautious in the future – lesson learned.

      Cheers, stay tuned for Part-3.

      Reply to this comment
  4. Rob

    May 22. 2012

    Hi Ninja,

    I had a friend drop a few thousand $ on FB shares on Friday, even after I suggested to her that it might not be the best investment idea right now. When “Part 1″ popped into my inbox it confirmed my suspicions. Now on Tuesday there’s yet another drop and more talk of overvaluation.

    Give me Canadian banks and the like any day over the Facebooks of the world. People seem to want them more because of the name and their perceived worth (Oooooh, you own FB shares!!?? That’s awesome!) than because of their business models. Part 5 above is the perfect point, as I read much the same thing about FB and their (lack of) click through rates compaired to other sites.

    Great set of articles. Thanks!

    Reply to this comment
    • The Dividend Ninja

      May 22. 2012

      Rob, thanx for the comment. Unfortunately I think things will get far worse for Facebook over the next while. The real test is going to be when the results for Q1 roll in for Facebook. Who knows what the future will hold for this company… we could be very surprised with great results (or not). At the end of the day its a big gamble.

      Your friend probably looked at Groupon and LinkedIn and saw the potential for a quick buck, and thought it was a sure thing. Who was to know the Facebook IPO was going to be a flop? Your friend is in a real bind now, taking a deep loss, or hanging on and losing more to hope for the best – we simply don’t know the long term potential or lack thereof. The stock could turn around, but I’m very skeptical. It’s hard to take a loss, but often its the right thing to do. It may be prudent to get out before the underwriters pull their support. ;)

      Cheers

      PS Like ur site, will add onto my blogroll…

      Reply to this comment
  5. spbrunner

    May 24. 2012

    Not the sort of stock I like either. I would never invest in it. Great post though.

    Also, an acquaintance of mine wanted to know about ETFs. I referred her to http://www.dividendninja.com/category/etfs. Hope you do not mind.

    Reply to this comment
  6. My Own Advisor

    May 24. 2012

    Great post. I do not see FB thriving long term.

    I agree with you Ninja, I think things will get far worse for FB, especially long-term.

    I could be totally wrong of course but the best thing is, I don’t have to worry about it – I have no money invested :)

    When Ninja writes something, I listen!

    Reply to this comment
  7. Dan Mac

    May 24. 2012

    Being a dividend growth stock investor I don’t get caught up in the hype of IPO’s like Facebook. I thought the valuation was so ridiculous especially considering you have the opportunity to go out and buy a solid company that pays dividend with much better current valuations in my opinion. Even though I’m not going to be a buyer though I have been very interested in watching how the whole IPO played out and what it has done in the market since.

    Reply to this comment
  8. Rob Madrid

    May 25. 2012

    Mike over at Wall street Window puts a fair market of 18 dollars, ouch

    http://wallstreetwindow.com/node/6048

    Reply to this comment

Trackbacks/Pingbacks

  1. Why You Shouldn’t Buy Facebook: Part-1 | The Dividend Ninja - May 21st, 2012

    [...] Part-2 to help understand the question of Facebook’s valuation, I’ll look at some of these metrics in [...]

  2. - My Own Advisor - May 24th, 2012

    [...] Ninja continued his series, why you shouldn’t buy Facebook.  One of my favourite reasons from Ninja, not to buy:  “Does Facebook have an economic moat?  [...]

  3. The Weekly Lineup: Spring Makeover Edition | The Dividend Ninja - May 25th, 2012

    [...] Part-2, I continued to look at Facebook’s recent decline off the finish line. I also examine its [...]

  4. Why You Shouldn’t Buy Facebook: Part-3 | The Dividend Ninja - May 27th, 2012

    [...] is the final post to this series on the Facebook IPO. If you missed the previous post, Part-1 and Part-2, be sure to check them [...]

Leave a Reply

*