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.

Doubling Down On Velti

It's sometimes difficult to make sense of irrational behavior, and I'm not referring to the 10% market correction we're experiencing. The market pullback is painful in the short term, but this is healthy for the indexes going forward, especially after a six month run-up. What I'm talking about is the current valuation of multinational mobile marketing operator Velti (VELT). Although the futuristic advertising agency is not slated to become profitable until the second half of the year, they've been hauled over the coals the last few weeks because receivables were deemed light by Wall Street during their last conference call.

When you look at Velti's numbers on Yahoo Finance, I don't think they look that bad. Average analysts' estimates for 2012 is $.73/share, and for 2013 it increases to $1.00/share. Velti lists at $6.75, which gives us P/E Ratios of 9 for this year and 6.75 going forward. This is very inexpensive for a stock that is slated to grow earnings at a 35% pace per year for the next half a decade. I'm not an outlier in my belief that this is an undervalued security. Here are some of the twelve month price targets of the analysts that cover Velti: Canaccord Genuity - $21, RBC Capital Markets - $19, Needham & Company - $20, and Jefferies & Company - $23.

In my last Velti posting, I gave a business description and discussed their brief trading history. The article touched on a lawsuit against Velti by Augme Technologies (AUGT.OB), and I really didn't go into it. This type of litigation is very common with technology companies, however, it has come to my attention that this lawsuit by Augme doesn't just target Velti, but also includes companies with deep pockets like Yahoo (YHOO) and AOL (AOL).

The suit alleges that Velti and other companies infringed on Augme's patents related to distributing targeted advertisements to mobile users on their ultraportable devices. Velti has five patents regarding online advertising, so Velti may counter, but this is just speculation.

I'm not suggesting this is a penny-ante scheme by Augme, but they are a very small player in the nascent viral communications industry where Velti has established a newfound global presence with their recent acquisition of CASEE, the largest mobile ad exchange and mobile ad network in China. Augme does the the majority of their business in the United States. The sun never sets on Velti with their international reach.

I actually think Augme Technologies would be a great acquisition target for Velti. Both companies do the complex backend processing to facilitate ads through the mobile Web, but Velti is a much, much larger company than Augme. Augme has the majority of the market share in the United States, but that's about as far as it goes. Europe, India, Brazil and China belong to Velti, and they are gaining ground in America. The economies of scale are against Augme, and as consolidation narrows down the field, they may get steamrolled by the competition.

One company that could be a suitor for either Augme Technologies or Velti is Facebook (FB). This idea didn't just pop into my head out of thin air, but came to me after reading a guest editorial Forbes piece by Velti's Chief Marketing Officer Krishna Subramanian. The article gives this industry insider's take on what Facebook should do to monetize their dominant mobile presence. Facebook is the most used app across both the Apple (AAPL) iOS and Google (GOOG) Android platforms.

Here's what Mr. Subramanian had to say right before the Facebook IPO: "Facebook knows it needs to succeed in mobile, and it is about to see its war chest swell by billions of dollars. Not much could stop them from simply partnering or buying up a highly successful mobile advertising company or platform to help create monetization success.".

Sounds like a business proposition.

My impression is that Velti would be a great partner with Facebook because they are both international organizations. Facebook is huge in both India and Brazil, and Velti has a presence in both countries. With Augme, Facebook would only be getting domestic exposure. Velti has that covered, too, with offices in San Francisco, New York and Atlanta.

Some companies just don't get this new paradigm shift to mobile and peer-to-peer advertising platforms. Facebook is one of them and they are the undisputed worldwide leader in social media. Go figure. I tip my hat to an organization like Ford (F) that is at the forefront of embracing the benefits of digital marketing. Not only do they effectively utilize Facebook, but they also teamed up with Velti to win the 2012 Mobile Merit Award of Excellence. The award is given to the best brand or agency in mobile marketing.

The advertising landscape is rapidly changing, and although traditional channels like television, radio and print are still an important part of a large-scale corporation's media mix, social and mobile should also be incorporated. An organization like Velti can make that happen.

Velti is not a new company, but it is a new public company, and they're experiencing some growing pains as they make headway mounting an offensive to increase their global footprint. My original stake in Velti was at $12/share, and I recently took another position at $6, making my average cost at approximately $9.50/share. As the gamblers so often say, "the only sure thing is that there is no sure thing", but my view is that with a sizable bet on Velti at $9.50, I'm going to make some money with this security in the next year or two.

The Globalization of Glu Mobile

For the past five months, I've been doing extensive research on the wireless broadband industry by reading books, examining market research and studying earnings call transcripts of pure play companies in the sector. One organization I've uncovered and taken a position in is Glu Mobile (GLUU). Glu Mobile designs and produces gaming apps for feature phones as well as next-generation handsets and tablets. If you require a more detailed business description, my previous article will give you a more robust profile.

Many investors look at the market like a tote board at the race track attempting to make a quick kill, but I'm a bit antiquated and like to think I'm buying a piece of the company. I'm glad I have a stake in this one because my impression is their technological foresight may make them a viable alternative to legacy gaming systems in the next few years. After reading Glu Mobile's latest conference call transcript, my take is that they are a first-rate organization and the top brass has their eyes on the prize.

The first thing that struck me when examining the Q1 2012 transcript is that their global-spanning business plan takes into account regional anomalies when targeting rabid diehard gaming fans. Although the wireless World Wide Web knows no borders, global regions have cultural differences. Just like a McDonald's (MCD) in Beijing has a different menu than a franchise in Manhattan, Glu Mobile can tailor their games towards the indigenous cultures in various locations world-wide.

Glu has design studios in both China and India, putting them in the sweet spot on the demand curve. The two global superpowers have many more mobile users than here in the United States. China has more than one billion mobile subscribers and India isn't far behind with over 900 million. China is now the largest smartphone market in the world with 22%, overtaking the U.S. with 16%. As far as games are concerned, the number of Chinese people who play mobile video games is estimated to hit 215 million in 2012, and is expected to reach 360 million in 2014.

CEO Niccolo de Masi gives an example of the internationalization of Glu Mobile in the conference call: "Small Street was our first title that launched in both English and Chinese. It peaked at number 57 top grossing in iOS and the US app store. However, it reached number one top grossing in China. Going forward, we will be actively pursuing more localization at launch wherever we find compelling returns on both cost and opportunity cost.".

Although the large number of subscribers in China sounds like a bonanza for Glu, Mr. de Masi implies that for them to be successful, they must continue to partner with Apple (AAPL) and Google (GOOG): "In China obviously the user base is starting to grow. Of course we’re going to follow Apple and Google where they ship their store. Remember in China you’ve got the phenomenon of jail broken phones, and there’s a more difficult mechanism for frankly obtaining cash from end consumers.".

Jail braking is what hackers do to get free or expanded services. Google and Apple's deep pockets may stem sales shrinkage from those with unauthorized access to premium data and services, plus guarantee payment. Another benefit from partnering with these two technology giants is more obvious: preferential positioning on their respective app stores. Just like eye-level shelf space in the supermarket is coveted, so is being highlighted on digital real-estate like Apple's App Store on iTunes.

During the last nine quarters, Glu Mobile has had almost 100% of their releases featured by both Apple and Google. Featuring lasts for one or two weeks, so it's important to get the word out quickly to gain gamer's mindshare. With this direct-to-consumer distribution channel, it's essentially self-serve and word of mouth advertising to hard-core enthusiasts. A great brand and street cred is important. This may be obtained by producing a quality product. One step they've taken to solidify quality control is to extend live beta testing prior to worldwide releases. The additional refinement period should lead to larger lifetime revenues of each game.

Glu Mobile has street smarts. They're participating in the powerful distribution mechanism known as the Google and Apple ecosystems which are primarily known for running on smartphones and tablets in the wireless space, but will be coming soon to your living room. When Google and Apple television initiatives come to fruition, Glu will be there as gamers use applications on their HDTVs. I'm not sure how the aspect ratios translate as they migrate from smartphone to tablet to television, but the designers at Glu are taking the necessary steps to make this happen.

I believe Glu Mobile's business associates also feel they are doing an outstanding job in product design which is illustrated by their strong working relationships. Not only were they the launch partner for Google in the new Google Play store, but they also partnered with Amazon (AMZN) when they introduced the Kindle Fire.

As CEO de Masi states: "We’re operationally diversified and we have a very clearly focused strategy which is to be in the content segment of the value chain and to partner closely with Apple, Google, Amazon, Microsoft (MSFT). We’re not trying to compete with Apple, Google, Amazon, Microsoft and their stores. We believe we’ve got a really healthy, viable and rapidly growing business over time by being a pure content player.".

Looking at the numbers, we can see that they are losing money, and won't be operating cash flow positive until Q4 of this year. Next year is a different story. The highest analyst estimate for earnings per share in 2013 is $.27, and the lowest projection is for $.05/share. Although the stock crosses the tape at roughly $4.40, you may believe that you are getting Glu Mobile at a rock-bottom price, but my take is that it may come in a bit. There is a short float of 18% on this stock, its price/sales ratio is 4 and price/book ratio is 6; this is not an inexpensive security. Yesterday one of the traders on CNBC recommended the stock over Zynga (ZNGA), and the stock got goosed 15%, only to crash today.

These small cap stocks trade in a broad range, so buyer beware. That said, I own the stock, and just deal with the wide price swings. My current long-term investing strategy is to buy shares of companies in the wireless broadband sector, and just sit on them until they kick in. Stocks tend to sit, then run. If you read the teachings of value investors like Warren Buffett, Philip Fisher or Peter Lynch, they stress that one of the ingredients in buying a company is solid management. After reading their last three conference call transcripts, I'm impressed and think the executives at Glu have found the recipe for success. I'm all in.