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Henry W. Schacht
Henry W. Schacht

MySpace - A Cautionary Tale

June 29, 2011 | About:

The date is July 18,2005. And News Corp (NASDAQ:NWS) announces the purchase of Intermix Media, parent company of MySpace.com for $580 million. It is said to be Murdoch's greatest coup. And people wondered why the MySpace people would sell so cheaply. Crazy kids!

After all, according the the press release, MySpace was the "World’s Fastest-Growing Social Networking Portal".

Logical then to conclude that this was a billion-dollar asset, not mere millions. The sellers were stupid. Murdoch smart (again). And anyone who missed out would pay... having missed out on the ground floor entrance to "new" media. No mention of profits. Just that this was growing, new, and cool! Everybody's doin' it!

Others in the media world, most notably Sumner Redstone of Viacom (NASDAQ:VIA), were doing a lot of soul searching. We shoulda, coulda, woulda bought MySpace. We really wanted to buy MySpace. But we were outmaneuvered by that crafty Murdoch. Oh dear, oh my. What shall we do?

In true media company fashion, they reacted (after the fact). Heads would roll. In fact, one of the reasons cited for Viacom's CEO Tom Freston being fired subsequently was the failure to buy MySpace. I particularly like this article from the New York Magazine praising Sumner Redstone for firing Freston. Obviously this guy was a serial bumbler, who doesn't GET it. The title - Bright Summer: Why Ousting Viacom CEO Tom Freston Was a Good Idea. You'll never guess who the author is.

Now fast forward 6 short years.

Until today, I would have been hard-pressed to know if MySpace still exists. Suffice it to say that I never had a MySpace PAGE. My online "presence" has since improved, but that's not saying much. But I digress...

My how times change. Reports are that News Corp is desperate to get MySpace sold by the end of its fiscal year. To that end, the Wall Street Journal is reporting that a deal is done or near done. And the price? Wait for it... wait for it... $30 to $40 million. Yes, I said MILLION. No, need for a "B".

The dirty little secret is that this "fastest growing" whatchamacallit thingy didn't make any money. How many times do we have to learn that Revenue Growth is ethereal. And it certainly does not presuppose profits.

The dirty little not-so secret is that MySpace was never much of a business. Just because lots of people use something online doesn't mean there are profits to be had. Hello, Pandora (P)!

But few things are as powerful as the fear of being left behind. And this includes media executives. I remember those bygone days when you did not exist if you were not ON MySpace. Sound familiar?

Yes, I'm going to mention the F-word... Facebook.

Ironically, while MySpace is in the news as the emperor who wears no clothes, reports of Facebook's "value" are everywhere. Over the last couple of years, the market value of the company has steadily risen. $1 billion, $5 billion, up and up we go. Interestingly, the one thing we "KNOW" about Facebook is that it is becoming more valuable by the day.

Once it was listed on Second Market, the numbers really took off. $50 billion sound reasonable? No, that lasted about a week. $60 billion? Nope, that number came and went. Now Facesbook's market value is supposedly closer to $70 billion (and rising of course). And if media sources are to be believed, an IPO is coming. The financial press has termed it the "HOTTEST IPO EVER" with an anticipated market value of $100 Billion.

Why? For the same reason cited by News Corp in 2005.

According to a WSJ post - What we know about the Facebook IPO:

People close to Facebook believe the company is growing fast enough to justify a valuation of $100 billion or more when the company goes public, our Journal colleagues Geoffrey Fowler and Anupreeta Das reported six weeks ago.

CNBC also reported the $100 billion plus valuation today. Only a couple dozen U.S. companies, including lions of corporate America such as Exxon Mobil, General Electric and J.P. Morgan Chase, have stock-market values above $100 billion.
As for revenue and profits?

Facebook is on track to exceed $2 billion in earnings before interest, taxes, depreciation and amortization for 2011, Fowler and Das reported six weeks ago. That’s even higher than the expected 2011 profit circulated in the early part of the year when Goldman Sachs and Russian investment house Digital Sky Technologies invested in Facebook at a $50 billion valuation. If Facebook ends the year with $2 billion in Ebitda, would IPO investors stomach a 50 times trailing multiple valuation? Seems bubble-like.
No kidding. And notice the "before interest, taxes" etc. This is also earnings before stock options dilution. And then there is that small question of SUSTAINABILITY. Perhaps the MySpace folks should send a memo to the Z-Man.

For those infatuated with Facebook and the possibilities of social media as a business, let me share a recent James Grant quote:

I [have] learned never to stand in line to buy an asset. You always want to go where nobody else is in line.
For the record, he was talking about GOLD, but it could easily be speaking about Facebook and the legion of internet focused firms that have come out of the woodwork of late. LinkedIn (LNKD), anyone? With valuations where they are, how likely is it that anyone will be surprised... to the upside?!?

Facebook is a phenomenon. Even I have a page (although I rarely, if ever, log on). But the "market" has obviously decided that the ever growing number of users will eventually constitute a business. And not just any business, but one that will be worth billions. But not just several billion, but $100 billion or more.

Yes, I remember the eyeball metrics and the click metrics. And the "Little Billy Spends 28 hours a day on that website" valuations too. But that is the kind of thinking that got News Corp to belly up to the bar with MySpace. And that worked out quite well. News Corp had a fun night partying. All his friends were jealous... until they saw him the next morning!

News Corp will recover from the fling with MySpace. MySpace's cost to the company is a rounding error when compared to the size, scope, and value of this media giant. The cash flow out of Fox News alone will probably offset the whole affair in a matter of months. While the percentage loss on this investment is eye-catching, it is not in the grand scheme all that much money. And the damage is contained within News Corp.

Those who ascribe a $100 billion to Facebook may face a far more substantial hit. Perhaps the pain will finally drive home the lessons we should have learned years ago. Either way, it is likely to have a profound effect on the markets. Is another Internet Bubble about to burst?

For all you Facebook fans out there, don't bother with the emails. I know what you're going to say.

Wait, don't tell me.... This time it's different!

Disclosure: No positions.

About the author:

Henry W. Schacht
Henry W. Schacht, CFA is the founder of Schacht Value Investors, an investment management firm serving individuals and institutions. He currently serves as President and Chief Investment Officer. He earned his MBA at the University Of Chicago Graduate School of Business and a BBA in finance from the University of Notre Dame. Mr. Schacht is a member of the Association for Investment Management & Research (AIMR), the Investment Analysts Society of Chicago (IASC), and the National Association of Corporate Directors (NACD).

Rating: 3.9/5 (15 votes)


Superguru - 6 years ago    Report SPAM
Think of MySpace and Facebook as networks like ABC, CBS and NBC with advertising revenues. Difference is that MySpace and Facebook have user generated content.

Myspace failed because of management and lack of leadership. We do not know if good leadership could have made any difference. They did not fail because business was not viable.

Before Google came many search engines had failed.

I am not justifying Facebook valuations. All I am saying is that it is too early to claim that there is no viable business model here.

Hschacht - 6 years ago    Report SPAM
I don't have a problem questioning the viability of the business model... certainly the sustainability. MySpace proved that. Their network was pretty sizable, but it didn't prevent Facebook and it won't prevent the next one. There is no stickiness... and what is the content worth? Am I going to pay to see the rantings of some high school acquaintance?

ABC, NBC, etc are finding the limits of their staying power. The online networks have fewer barriers to entry. Under constant assault.

MySpace had more problems than just leadership. If the model was sound, it wouldn't be on the block for $30 million. It was a phenomenon, not a business. A fad. People took advantage of it until something better came along.

Facebook will likely have a similar fate. As such $100 billion market value is laughable. It isn't a question of making $2 billion (pre tax, pre interest, pre-everything)... it is how long it can make that much money.

Funny I keep thinking about Sun Micro. I remember a year when they made $2 billion and were valued at $100 billion. How did that end again?
Superguru - 6 years ago    Report SPAM
"Am I going to pay to see the rantings of some high school acquaintance?"

These networks will have to be forever free and paid for by advertising. They may charge for some advanced features like linkedin is trying to do.

Google, Yahoo and Facebook - primary revenue is from Advertising and secondary from subscription to premium services.

Will they be able to retain people's interest and have them keep coming back only time will tell.

I agree there is no stickiness to facebook and yahoo. orkut was most popular in India and people switched to Facebook so easily and quickly.
Soaringmu - 6 years ago    Report SPAM
Actually I disagree about the quality of facebook's business. Not only do I think that Facebook has a legitimate business model based on advertising, but I think it has somewhat of a moat from its huge user base. It's a classic network effect: the more user you have, the more the advantage of joining facebook instead of a different network.

Obviously, companies like facebook, linkedin etc. are at a high risk of becoming obsolete and disappear. And at current price levels, I wouldn't touch the stocks in my life.

The Google story is quite instructive in my view: It IPOd at a similar multiple, yet made investors a ton of money. Why? Essentially because it increased its earnings 10-fold from 2004 to 2009, or 60% annually. And this isn't users, clicks, or revenues, its real earnings. I don't know what Facebook will do, but just because it has a high multiple doesn't necessarily mean it's expensive.

It comes down to this: There is no reliable way of valuing it. That plus the hype leads me to avoid the stock. And by the way, a few years ago I would have bet serious money that google wouldn't be around today. I certainly underestimated the company.

Hschacht - 6 years ago    Report SPAM
Comparing all internet IPO's and their subsequent financial results to Google is like comparing all college dropouts to Bill Gates.
Soaringmu - 6 years ago    Report SPAM
Agreed, participating in internet (or other) IPOs is generally a very bad idea. I'm merely saying that some of them are not bad companies - they are only bad investments at the current price. Of course, back then, you couldn't know that Google would be so successful.

Hschacht - 6 years ago    Report SPAM
True. Please excuse my poor attempt at a joke.
Tonyg34 - 6 years ago    Report SPAM
@soaringmu regarding the network effect at FB

I don't care if FB has 600 million users and I can "like" corporate sponsor pages. I use it to stay in touch with friends. If 4sq lets me connect with friends w/out all the ads why stay? At the end of the day you'll be able to integrate your "friend" profiles across multiple providers just like you can IM with an AIM user on goog. FB has about as much of a moat as an email address, which is exactly what their service will transcend to over time. So... when's the last time you logged onto your aol, hotmail, yahoo, classmates.com, friendster, myspace, linkedin, FB, 4sq, gmail account? Did it effect you or your business/personal relationships when you transferred from one provider to the next? Did you get to keep your username and address just like teleco's let you keep your old number if you switch providers? Goog has great search and lets you integrate 3rd party apps into your homepage experience (i use FB via feed on my igoogle page, I used to have NYT feed until they tried to charge me for content... hint, hint).

It may not prove to be durable but the model is called horizontal integration. Goog owns the search slice of the industry so they will give you phones, apps, feeds for free to drive search. And it works. Why? b/c you can commodify handsets, storage, or software as a service but you can't commodify search. Whatever the new toy is (youtube, 4sq) it just becomes a tab on your goog page.

Sorry about my tangent but I was trying to show how goog's economies of scale differ from FB's network effect.

Mr. Lonely Value, think you find me another DPS? kidding, enjoy your blog.
Hschacht - 6 years ago    Report SPAM
Absolutely true... the minute something better comes along, FB's network will evaporate. No stickiness whatsoever... and no real business model.

I'll keep working on the next DPS.

Thanks Tony.
Soaringmu - 6 years ago    Report SPAM
Maybe you're right. In many countries, there were similar sites before FB, most of the disappeared. In Germany, studivz (which ironically is essentially a FB clone) was much more popular, but most people switched to FB. And of course, they will switch again eventually.

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