Sunday, June 10, 2012

Facebook: It's Good To Be King

Back in the early 1990's, a friend of mine had a message on his answering machine that went something like this: "This is the Thought Police. We know who you are. We know why you called. But get it off your chest, you'll feel better for it.". Even with the aid of biofeedback monitors, corporations are a long way from telepathy, but with social profiling, media customization is becoming the norm. Data aggregation organizations like Facebook (FB), Apple (AAPL) and Google (GOOG), force feed users tailor-made marketing messages on the digital format of the moment.

The company that has come up short on Wall Street's expectations in regards to advertising revenues is Facebook. This may be reflected in the poor performance their share/price since its IPO, but there are a multitude of reasons why the stock has tanked. I thought they were the odds-on favorite to appreciate in price like previous Internet IPOs such as Yahoo (YHOO) and Google, but that was not the case.

Retail investors made a mad dash to get first crack at Facebook with the kind of fanaticism that is seen in the Apple camp, only to be disappointed by an equity that was clearly overpriced by the underwriters. The only winners in the Facebook IPO were the lawyers and the short sellers. Even high-frequency trading firm Knight Capital (KCG) came hat in hand with a hard luck story that they lost $35 million on Facebook's opening day because of the botched listing.

Facebook founder and CEO Mark Zuckerberg presents a compelling case about The Social Graph, where everybody is connected to some respect, like in six degrees of separation. He may actually be right, but he hasn't monetized his company to its full potential, although he has developed the standard software infrastructure to make this happen. The table stakes are high for him. As a species, we are predisposed to taking risks, and Mr. Zuckerberg, the Pied Piper of peer-to-peer networking, has taken an extremely large and calculated risk by going public.

Zuckerberg has a terrific second in command in Sheryl Sandberg whose track record speaks for itself going back to her days at Google. He also has a board of directors filled with Silicon Valley veterans like Marc Andreessen of Netscape fame, and Reed Hastings of Netflix (NFLX). I don't know who is responsible for the IPO fiasco, but the company is a Zuckerberg production, so most of the blame rests squarely on his shoulders. A pop icon gets his photo op, but it was not a pretty picture.

I believe the network effect works both ways, so it's a pressing concern for CEO Zuckerberg to correct the mobile advertising problem PDQ. In David Kirkpatrick's "The Facebook Effect", Zuckerberg professed that Facebook would become a communications utility. Using media like e-mail would be like sending messages in Morse Code once he saturated the planet. Well, if he's not careful, Facebook may be valued like a utility company and have a single digit P/E Ratio. Look what happened to Yahoo.

During the run up to the IPO, Facebook was dubbed a category killer, and that may be true, so I'm going to give them the benefit of the doubt as a company. I think the higher-ups will right the ship. Facebook controls it's own destiny, and there is a lot at stake both financially and reputation-wise. Facebook didn't invent the immersive entertainment experience, but they've had a big part in spreading the gospel. This collective experience that Zuckerberg took to another level is not going away soon.

As of this writing, Facebook has 900 million registered users. Facebook bears like to point out that some of these users have duplicate accounts, and some are not of the demographic to fully embrace the service. I know I don't use it, but this is not about me. I'm at the tail end of the baby boomers. It's the Gen-X and Millennial demographic that can't seem to communicate with one another unless it's on a data-centric device. This is the coveted demographic that advertisers prefer to target.

Even if Facebook detractors are correct in their assumption that 900 million registered users is an inflated number, let's shave off 300 million just for argument's sake. You'd still get 600 million active and entrenched customers at approximately 13-40 years of age. That's almost double the population of the United States. We're not talking about selling Depends Adult Diapers or Phillips Milk of Magnesia to your average Facebook user, but clothes, cars and electronic gizmos. Somebody is going to effectively figure it out without alienating the end user by the constant bombardment of traditional advertising.

In 1995 Steve Jobs said, "The desktop computer industry is dead.". This may be taken slightly out of context, but you get the drift. The Facebook app is number one on both the iOS and Android operating systems. The perfect antidote to a very poor start as a public company would be for Facebook to utilize this application to its fullest potential. They own the digital landscape and can extract tolls from Madison Avenue. Not being able to monetize this treasure chest of assets is a liability. It would be nice to see a plan come together.

Let's see if you want a piece of the action. According to Yahoo Finance, the valuation looks fairly steep. I realize they have a short trading history as a public company, but Facebook has been bought and sold on the private exchanges for quite some time. Analysts have had an enormous amount of time to crunch the numbers. Out of the eleven analysts that cover the security, the average earnings per share is $.54 for 2012 with the highest estimate being $.76. I'll split the difference and call it $.64 to come up with a current year P/E Ratio of 42. Facebook has a projected 5 year growth rate of 36%, so you get a PEG Ratio of 1.2.

If you examine Facebook contemporaries like Google or Apple, you can get a much better bargain as far as valuations are concerned. Both of these technology heavyweights have P/E Ratios in the teens, with hefty growth rates, too. With Facebook, you're paying for potential, but it's already a large cap stock. Uneasy lies the head that wears a crown.