May 292012
 

Facebook Slide ChartWhy are Facebook Shares Tanking?

Firstly let us specify that this is not a share investing website and the opinions expressed here are not a substitute for professional advice. We have to, however, follow up on our initial Facebook post, because it was incredibly popular and, having an interest in the IT Industry in general, the whole Facebook IPO interested us in a ‘from a distance’ sense. This is not an ‘I Told You So’ post, it’s just a follow up on an interesting theme.

One of the search term strings for which our initial post most often popped onto people’s screens, many thousands of them, was ‘Why are Facebook Shares Tanking?’, so that’s the name of our post on the same topic.

In our (admittedly very humble) opinion the reason Facebook hasn’t been performing as well as its investors might have hoped is very simple – greed. Morgan Stanley and the initial Facebook shareholders sucked every last drop of juice out of that stock by launching it right at the top of its target price range, while knowing full well it wasn’t worth it. What that said to us was that they cared very little for anyone investing in the share, instead looking to line the pockets of the owners and early stage investors. I won’t labour the point by listing them all here, as they’ve already been listed elsewhere, but just take it that these, and others, now have investors’ money in their pockets and are very happy about it.  If they were interested in generating long term wealth for initial retail share investors they would have pitched the share much, much lower than US$38. It would have shown faith in a company that could generate its own wealth over a long period of time. But that confidence isn’t there. Those backing the IPO knew full well that they were cashing in on Facebook’s extreme valuation based on the current huge tech bubble that exists – not market fundamentals.

Facebook isn’t worth anything like US$38 a share, in fact it’s not worth anything near the almost US$32 at which it currently resides. That doesn’t mean that it won’t breach the US$42 barrier it initially hit after the shares started trading, it very well may do. It depends on how greedy those left in the market are. There are those expecting the share value to bounce back, which means it very well may do as the initial carpet-baggers have now either fled the scene or are holding tight for that bounce. But even if it does bounce back it will eventually succumb to market pressures. It has to, because there just isn’t that kind of money making potential in Facebook.

Look at it realistically, the headline figures for Facebook are eye-popping, but the underlying economics are stark. It lays claim to around 500 million users, being used by 1 in every 13 people on earth, with over 50% of these logging in every day. It sounds phenomenal, and it is, but figures like this mean nothing to stock market investors. They are interested in just one thing – profit. This is, unfortunately, where Facebook falls flat on its face – it has never managed to turn its phenomenal traffic figures into similar monetary gain. Facebook’s revenue grew 87.9% year-on-year to $3.71 billion in 2011. Again, the figures seem incredible, until you factor in that the initial public offering (IPO) valued Facebook at over US$100 billion. At that valuation Facebook’s revenue (not profit, just turnover) is just 3%. At an estimated profit of US$ 1 billion the actual return is less than a paltry 1%. If a bank offered you that return, and they’re not very generous these days, you’d take your money elsewhere. You should do likewise with Facebook. All the people that were going to make huge profits from Facebook have already done so. This share is just waiting to collapse.

Firstly the tech economy in the US is in one giant bubble, that will eventually collapse, much like it did back in 2000. Secondly, there’s no real way for Facebook to make targeted profits from its platform as it currently stands. With Google you can understand where revenues are derived. People tell Google what they are interested in (by searching for those terms), and Google delivers (somewhat) relevant adverts. This means there is a fairly high chance that someone will click on one of the adverts and make a few cents for Google and its investors. Millions of people doing this every day and you can see the revenue stream.

Facebook, on the other hand, has no way to figure out what its users are interested in apart from asking them tentatively when they set up their page, that’s it. Nobody types into Facebook what they want to see in terms of advertising, meaning it is not at all targeted and people don’t often click. In fact, it’s hard enough to find Facebook adverts and many people haven’t even noticed that they are there. But you can expect this to change radically as the company is obliged to chase the mighty dollar for its investors. It is no longer the dormitory startup that could afford to chug along making passable profits (or even losses, which it has done for most of its life). To improve the bottom line expect to see Facebook throw adverts at you from every direction, just to get you to click on them. They have no other revenue stream at the minute and without it the company will simply collapse.

At the end of the day, people will always have to search the internet, so Google, or some other search engine with better search algorithms, will make profit. Facebook is essentially a forum for gossiping, it could easily go the way of Bebo or MySpace (yeah, remember those and Netscape, Yahoo, AOL, Napster, etc., etc., etc.) The internet is littered with dramatic failures, or companies that just didn’t live up to their initial hype, don’t be surprised if Facebook is, eventually, yet another one.

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