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The 'Facebook Bubble' Bubble

January 09, 2014 | About:

A tug of war is taking place between Facebook (FB) bulls and bears. It is playing out in the blogosphere and financial news outlets. Facebook has passionate longs and shorts as can be expected with a stock that has increased to the degree it has over the past year. Those who are short Facebook are clinging to two particular themes that warrant contemplation since the hopes and livelihood of short-sellers are resting heavily upon them:

1. "Facebook is in a bubble." Those who try to convince us that Facebook is a bubble offer specious comparisons to the Internet bubble of the 1990s. There's a problem with this simplistic analysis. The comparison is deceptive because the bubble stocks of the 1990s were trading at over $200 billion market caps before they had legitimate business plans and ever even turned a profit.

Just because a stock's price rapidly increases does not make it a bubble. In fact, based upon the amount of unusual bubble rhetoric, the term "bubble" itself as applied to Facebook may prove to be in a bubble. Here's why:

Recent performance suggests that Facebook's IPO price might have actually been fair. Just because Facebook under a cloud of uncertainty, and skepticism fell below $20 last year, doesn't mean that the low level ever reflected intrinsic value. It is easy to contend it has "run too far to fast" if one bases the stock price increase from the all-time low of $17.55 — instead of the IPO price. However, if the IPO price was right after all of the dumping on Zuckerberg, the increase from the IPO puts it at a reasonable price appreciation of approximately 31% in over a one-year period.

What is happening to Facebook's stock price may be more comparable to what happened with Google (GOOG) which came public (a few years after the Internet bubble). Like Google, Facebook is experiencing rapid growth in revenue commensurate with the rapid growth of share price. Investors used many of the same platitudes about Google being in a bubble, especially since over 96% of their revenue came from advertising and a substantial portion to this day still does (91% but shrinking).

The advertising market is quickly transforming due to growing mobile usage as the statistics below suggest.

  • 91% of all people on earth have a mobile phone.
  • 56% of people own a smart phone.
  • 50% of mobile phone users, use mobile as their primary Internet source.
  • 80% of time on mobile is spent inside apps.
  • 72% of tablet owners purchase online from their tablets each week.

Analysts soon expect Facebook to announce growth in mobile ad revenue of 40% over last year. When you have 1.2 billion users, you can offer companies a compelling opportunity to get in front of more people who watch the Super Bowl — on a daily basis, wherever they are. Mobile Internet usage is fast becoming the primary means of Internet access, and approximately 80% of mobile usage is conducted through the use of apps. One can find Facebook at No. 8 in the top 10 most downloaded apps of 2013, which isn't too shabby, but the statistic that is most important is Facebook's No. 2 spot on the Top 10 Most Frequently USED Applications of 2013:
(See Chart PCTechMag.com)

Facebook could afford not to be the "most frequently downloaded app" because once you download it, all you need are updates from time to time. However, Facebook's app came in second only to Google Maps with 44% of global smartphone users having used the app in the past month. That is as good as being No, 1 in ways because I know as a Google Maps user, when I use Google maps, I am not looking at anything except for directions, and I am impervious to ads if there are any around the map. It is the quality of the usage that sets Facebook apart.

Facebook is in a commanding position in mobile and the stock price may warrant the growth of the past year. I have no problem with Google trading at a valuation of approximately $373 billion despite still deriving over 90% of revenue from ads. By the same token, I believe Facebook is special, unprecedented and will for reasons outlined here be in the same category as Google over the next couple of years as they monetize.

At this point for investors, subscriber growth would be good to see, but they have already achieved dominance. The growth story now and for the future is the growth in the number of different ways that Facebook can monetize its extraordinary user base. Google's search has strengths that Facebook doesn't have and Facebook has strengths that Google doesn't have, primarily with the ever-growing mobile usage. Google has more to lose and recent quarterly reports demonstrate that Facebook's ad revenue is growing at Google's expense since Facebook is more competitive in mobile thus far. As I pointed out in a column in quarter two, Facebook and Yelp (YELP), two companies very strong in mobile, have seen growth that was almost identical to the number by which Google's ad revenue shrunk during that same quarter.

Theme #2. "Facebook will go the way of MySpace if teens continue to migrate." As ubiquitous as that statement is (126 million returns on Google) — it is deeply flawed. It seems those short the shares cling to that hope. MySpace was more of a teen fad but unlike Facebook, most adults didn't embrace it. From what I observed as an adult in my 30s during the peak of MySpace was that many adults I knew were using Classmates.com far more than MySpace, which Facebook later rendered obsolete.

Adults did not follow teens into MySpace, but they did later migrate to Facebook. That is because contrary to the popular delusions, teenagers are not the oracles of civilization to which we all look for guidance. Teens are generally impetuous and temporary in nature as well as biology. They exist as teens for a mere seven years and by age 20 they have entirely new friends and colleagues. Their impulses will prove to have a diminutive impact on Facebook long term (if any at all).

The teen narrative as it pertains specifically to Facebook is silly to me because of the degree to which the media have latched on to it and the false correlation they draw between teenagers' and adults' decisions on social media preferences!

The best way to marginalize this teen narrative is to contemplate the reality of the social life-cycle for most humans. Teens for at least the past century tend to move on with their lives after high school, resulting in a substantial turnover of friends, whether they go on to college or go straight into the workforce.

According to Freakonomics.com: "Seven years from now, a new study reports, your friend group will probably look entirely different, even though it'll still be the same size. Utrecht University sociologist Gerald Mollenhorst surveyed 604 people about their friends and again seven years later, and found that only 48 percent of people's original friends were still part of their network after that time period."

That study will come as no surprise to adults reading this, and that is only a seven-year study. After college, no longer teens, these young adults move on to the professional world, often resulting in another major turnover of friendships. By this time they notice, their lives seem to be accelerating at a rapid pace and their 20s are gone before they can blink.

Here's THE KEY:

Parents often go through a period where they seemingly "lose" their children. They suddenly want to be dropped off a few blocks from school so as not to been seen with mom and dad. So maybe Facebook "loses them" for a brief time as well. That generally passes. The bottom line is, teens are generally impressionable and unpredictable.

Teens are also generally without disposable income. With a growing number of adults taking fast-food jobs in this "recovery, teen unemployment is still at record highs, over 30% this past Summer. Facebook isn't running a dollar store or a body piercing shop. Facebook can make a few bucks running ads toward teens but most their money is not dependent upon this very temporal demographic. The teens go wayward like prodigal children but they will be back in a several years when they are most relevant to advertisers.

They may slow down their Facebook usage but that doesn't mean they forever "check out."

The longer these people who were once "teens" live and the more they mature, the more prone they are to desire reunions and re-connections with the vast number of friends they accumulated through life. Where will they go to do that? Do they suddenly look up the phone numbers for people with whom they have lost touch, haven't spoken a word for 10 to 20 years and then dial them up out of the blue? No, they go to the place that has long established critical mass. They go to the place where over half of the U.S. population and 30% of earth's population can be contacted in a subtle manner within a couple of minutes.

Those falling for the wishful notions of short-sellers have not learned from the past and greatly underestimate the strength that critical mass delivers. Facebook is not just a web application; it has become a way of life. Some users, myself included, do not use it as much as when they first began with the service. However, the habit has been greater solidified nevertheless. Years after the novelty aspect wears off, the user has a better grasp on where Facebook fits into their life. To many it becomes an extension of their lives.

The platitude about Facebook "going MySpace" on us requires mass-quitting. Quitting usage is not simple. Extricating Facebook would be like throwing one's diary, journal and family albums away. Because they achieved dominance so early, a billion plus people have years of memories, photographs stored there in sequence and they are intertwined with those of their families and friends.

Millions of people, myself included, have had family and/or loved ones in their network of "friends" list who have passed away in recent years, with their accounts memorialized and woven together with their friends and family like a virtual tapestry. How difficult would it be to walk away from that? You may stop using it for a while but how many are going to close and delete those years of communication and sharing with family and friends?

As Facebook has matured and the "thrill" of something new has gone, it has transitioned into a regular routine like waking up and reading the morning paper. It is for many the preferred means of communication, replacing the telephone or at least greatly minimizing the amount of time spent on the phone.

Facebook reported extraordinary results in the third quarter. The bears succeeded temporarily in quelling the celebration by isolating a casual remark from CEO Mark Zuckerberg regarding teen usage slipping. What was rarely emphasized by the media and bloggers is the fact that the property to which the capricious teens had migrated, instagram, is also owned by Facebook. The shares were eventually rewarded by reaching new all-time highs weeks later but if there's one lesson from this it might be that Zuckerberg (who was never thrilled about going public) could try to be a bit more circumspect and put such statements into proper context during conference calls. He probably didn't anticipate the degree to which the media and short-seller would dramatize the remark. Although, a part of me respects him for not being prone to pandering.

Nevertheless, amassing wealth takes courage and those who sold in a panic will regret doing so. Those who are shorting with little more than platitudes in their arsenal are going to end up in a great deal of pain.

About the author:

Scott Ryan Anderson
Scott Ryan Anderson is a former Financial Advisor and host of multiple radio talk shows in South Florida including WSBR AM740AM in Boca Raton, Florida (Moneytalk Radio Network affiliate) and 1340AM WPBR in West Palm Beach, Florida. Scott also holds a B.A. in Broadcast Communications from Geneva College.

With a passion for writing as well as broadcasting, has spent several years building a track record of prescient stock selection. As strong proponent of value investing, he looks for value as a bull and a bear, long and short. He believes that in raging bull markets, the best value can sometimes be found on the short side of the market and does not hesitate to take advantage of companies with securities trading far above what he believes to be there “intrinsic value” by taking a short position.

Scott Currently publishes financial and political columns through his websites.

Visit Scott Ryan Anderson's Website


Rating: 2.3/5 (10 votes)

Comments

kfh227
Kfh227 premium member - 7 months ago

The problem with Facebook is that people overtime are getting sick of being super connected. Most of the people I know (litterally over 50%) either do not use Facebook anymore or have outright deletetd tehir account.

If that seems anecdotal, keep in mind that most social media web sites (and apps I guess these days) have a life of two years before people move to soemthing else.

batbeer2
Batbeer2 premium member - 7 months ago

In my book, there's a bubble when two conditions are met:

1) People borrow money at an interest of X% to buy an asset yielding Y%.

and

2) X is much greater than Y

Example: If you could rent a house for $500 and people are paying $1000 in mortgage interest to own that same house, then the price they pay to own the house is dislocated from its current economic value; the buyer buys because he/she expects future prices to be much higher..

Example 2: FB is yielding some 2% on earnings (p/e of 50). If investors are using leverage to buy Facebook and are paying more than 5% effective interest on the money they borrowed to buy that stock, then FB meets the criteria of a bubble.

 

Of course, earnings could grow but it is also possible that they don't. If that happens, people scramble to find the money to repay the interest on a loan they took to buy a non-performing asset. That last bit is why a bubble is called a bubble. It pops without warning and the proces is very fast.

Scott Ryan Anderson
Scott Ryan Anderson - 7 months ago

Makes a great deal of sense to apply that to buying a house. There are not too many ways to monetize a house and many ostensibly do it to live in, not to earn a living with it. Houses do not make new products and services.

To say "of course, earnings could grow but..." is a pretty casual, throw-away manner of the most significant statement that one casn make about WHY we are all here investing in stocks in the first place. If one minimizes that concept, they should be forever in short-term, investment grade bonds.

batbeer2
Batbeer2 premium member - 7 months ago

>> is a pretty casual, throw-away manner of the most significant statement that one casn make about WHY we are all here investing in stocks in the first place.

I can see why you would think that it's a casual statement. It sounds casual because I think it's not hugely important in the context of a discussion about bubbles. You see, I don't believe "we are all here investing in stocks" because we think earnings will grow.

What!?

Yes.

I don't believe we are all here investing in stocks because we think earnings will grow.

People didn't buy expensive houses because they needed them. If they did, there wouldn't have been a bubble. They were buying them out of envy. That was the root cause of the housing bubble. If you like, you can blame the bankers, but then I'd be back to explain how they too were acting mostly out of envy.

In my view, most investors buy Facebook (or for that matter any other rising stock) out of envy.

Lots of investors (especially on a value investing forum) are going to deny this. Then again, I haven't met many people who are willing to admit that they bought an expensive house out of envy. Still, envy is precisely what caused the housing bubble so there must have been lots of people that did.

In short, most investors buy (at least some) stocks out of envy and not because of some conviction that earnings will grow. They will say it's the latter and they may even believe it themselves but I'm not convinced.

AlbertaSunwapta
AlbertaSunwapta - 7 months ago

^ excellent commentary. The leverage insight is bang on though I'd guess is incomplete when it comes to bubbles, but sure explains the deleveraging, disintermediation process when it comes to "crashes".  As such, I think some bubbles, as in extreme irrational valuations, can also slowly deflate with less severe consequences to the few but still relatively dramatic losses to the many.

On top of this is the casino, lottery ticket, card game mentality where most players simply 'enjoy the game' and they aren't there to win. They only hope they are going to win.  That said, many investors need to ask themselves: Am I here to win or just play the game?  Where things go wrong I suspect is where the proverbial 5% play money route proves so successful in the short term that it turns into 25, 30, 40% allocations.  

Moreover, people do what has proven to be successful, and even when the tide has changed the try to reproduce their past successes by throwing good money after now, only slightly obviously, bad money.

It's a failure to recognize and differentiate good luck, good fortune, herd following and correlation from skill.

 

Scott Ryan Anderson
Scott Ryan Anderson - 7 months ago

"Moreover, people do what has proven to be successful, and even when the tide has changed the try to reproduce their past successes by throwing good money after now, only slightly obviously, bad money.

It's a failure to recognize and differentiate good luck, good fortune, herd following and correlation from skill." - AlbertaSunwapta

I have encountered a few people who have accused me of being involved in a bubble. I recognize bubbles. I wrote and broadcasted warnings about bubbles in the late 90s and I PROFITED immensely from the YHOO, AOL & INTC bubbles, more than the 300% I'm up on FB. I have challenged many of the new bubble experts to show me time-stamped, 3rd party verifiable evidence of their prospering during the most notorious bubble of our age. I have yet to find one accept this "duel" so to speak.

As I addressed the issue in this column, short-sellers are making ignorant and specious comparisons between the Internet/Tech bubble & FB. It's not fundamental analysis but closer to psychological word association games and cunning rhetoric to scare.

As a professional, when my expertise is called into question, I must defend it by giving the background from which the writer, myself comes.

DATE: 12/7/2000 TITLE: “The AOL Fantasy Land will soon meet reality”
http://boards.fool.com/Message.asp?mid=13855131

"AOL investors have been seduced by the internet glamour. AOL is a $27 stock to be. I have persistently maintained that AOL should be treated more like a digital magazine. They are not the next Microsoft. Microsoft could defend its Patents through litigation keeping competition out. AOL is leading mostly because of STYLE and being one of the pioneers. This doesn't translate to the type of profits that justify its valuation. (AOL at this time was trading in the hundreds of billions of dollars at this time and surpassed AT&T as the most widely held stock in America..."

Intel Valuation: 1/28/2002 (INTC was then trading at a market cap of $240 BILLION Dollars)
"Intel will continue to be a great company. The question is how do you justify a multiple of almost 200 times EPS when your profits are going backwards by double digits while your cycle is supposedly turning favorable?..."
http://boards.fool.com/price-war-16567786.aspx
http://boards.fool.com/intel-valuation-16766125.aspx

DATE: 1/16/2002 TITLE: “To the Pollyanalysts”
http://boards.fool.com/Message.asp?mid=16476018

"Letter to the Analysts:

It's a tragedy that people still listen to you charlatans. Do earnings mean anything to you?
Does market cap mean anything to you?

When a company like Intel has its earnings drop 80% and it is still priced not for perfection as some like to say, but rather for stupidity, what do you do? You stick to your guns in order to save face and declare it a strong buy! It is typical of human nature to mitigate as you do in order to save face; however, it is disgraceful when your saving face is at the expense of millions of people. With INTC currently near its 52 week high and a market cap of about $240 BILLION DOLLARS, Intel will need to reach a market cap of about $1 trillion dollars in order to live up to the premium by which it now trades.

If Intel's near term future was so rosy, they would b..."

DATE: 12/5/2000 TITLE: “TWX Execs should be fired on spot” http://boards.fool.com/Message.asp?mid=13840483 "This deal was a bamboozlement of TWX shareholders from the beginning. It is the equiv. of agreeing to sell the company for Russian Rubles. These execs must be insane. On one hand, you have..."

OK, so there's a sample of where this author is coming from, warning the "herd" at a time before the word "bubble" was even a concept understood by the generations investing in those shares. Have I changed my beliefs or forgotten what I know since then? NO.

Amateur short sellers have this dead wrong, mainly because they are using unimaginative, cookie cutter thinking and plug-in formulas in their analysis. One can follow their publications and see that they use very similar rhetoric and level often unfounded charges against every stock they short. The problem with canned analysis is that it works on some stocks in the way throwing darts might work. They succeed in spite of themselves. It's bound to happen occasionally. It is dangerous to make blanket statements about companies and casuistry to compare standard price multiples between companies that are in quite different businesses one from another.

When Yahoo, AOL and Intel were trading at those large multiples to revenues, those companies had market caps in the hundreds of billions of dollars. Yahoo had barely ever turned a profit at that point!

When you are trading at near a quarter trillion market cap a couple years out of the gate, it is pretty hard to pull off an encore unless you do what Google has done and what Facebook is in the process of doing (with an evaluation nowhere near bubble territory relative to its legitimate prospects).

batbeer2
Batbeer2 premium member - 7 months ago

>> As a professional, when my expertise is called into question, I must defend it by giving the background from which the writer, myself comes.

 

I for one am not questioning your professional expertise. In fact, I found your article worth reading and I agree with many points you raise. Like you, I feel the word bubble has been used lightly in recent months. (There's been some inflation of the word bubble :o)

In short, as an amateur, I'm just sharing some thoughts.

Scott Ryan Anderson
Scott Ryan Anderson - 7 months ago

Why thank you Batbeer2. It's all business. I do not take disagreements personally. I know that despite having sometimes heated disputes with investors who have opposite positions, if we met under other circumstances , opponents on the grid iron of financial markets might have much in common in other areas of life. Nothing ignites passions like investment theses.

Cheers.

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