Why Facebook Is A Sucker's Bet

by BILL WADDELL

Valuing Facebook at $100 billion killed the company. While it could have continued to limp along as a privately held company, as a publicly traded company it has nowhere to go but down.  That is a simple application of the Golden Rule ... not the one about doing unto others, but the one that says, 'Whoever has the gold makes the rules'.

The reason people make the mistake of thinking Facebook is a good proposition is confusion over who their customer is.  They think the Facebook user is the customer, and that innovation and improvement will be directed toward increasing Facebook user satisfaction.  That is hardly the case.  The customer in Facebook's business model - and in yours and in any other business - is whoever pays.  In Facebook's case, that is the advertiser.  The Facebook users are not their customers - they are Facebook's product.

The Facebook business model is pretty much the same as television's and the news media.  They offer up something for free to attract a crowd.  They then sell access to the crowd to advertisers.  The bigger the crowd, the more they can sell.  Their measure of quality is not based on the content of the television programming, The accuracy of the news or anything else of value to their viewers or readers.  The measure of quality is the size,demographic and spending power of the crowd they draw, and sell.

If you are a Facebook user, you get access to Facebook content 'for free',and in return Facebook sells access to you through passive advertising, and even more so by selling access to your personal data to advertisers.  That's the deal.  the more of you and your information they sell, the more they make.  You, as a Facebook user, will tolerate being sold and having your time and privacy invaded so long as access to Facebook content is worth it.  When you reach the point that the intrusion on your life from being sold as Facebook's product is no longer worth access to the content (or more likely you find another way to access the same content with less intrusion) you drop out of Facebook and they have fewer products to sell.  It is a pretty straightforward deal, really.

 So what can be expected from a publicly traded Facebook?  Intense quarterly pressure to increase revenue - sell more advertising - grow the top line - with the only way to do that being to sell greater access to you, waste more of your time, intrude on your personal information more.  And at the same time, reduce costs - which means spend less on enhancing the Facebook user experience.  They may do a little or a lot of both and they may do it sooner, or they may do it later.  But make no mistake, they have every pressure to push the scales away from making it a better proposition for the Facebook user, and absolutely no financial pressure to push the scales the other way.  Privately held companies can invest in the product for the benefit of reasonable long term profits - but not publicly traded ones.  So where it will end is very predictable.  And the smart bet is, with a $100 billion book value - 100X earnings - the pressure to tilt the scales hard and fast will be intense.

What makes it even worse for Facebook is that, unlike television or the media, they don't even control the content that draws the users they sell to advertisers.  The users do. So every time a user says the scales have reached his or her personal equilibrium, they not only drop out of the pool of products Facebook has to sell, they take their personal information with them, degrading by a tiny bit the very thing that makes Faceook an OK proposition for users.  Television and the news media can at least assure content that draws a pool of people to sell to advertisers by paying for it.  Facebook can't - hence, they are screwed in the long term.

 I am quite sure the Facebook originators are well aware of this logical conundrum, which is why they chose to cash in quite a few of their chips while the cashing in was good.  If you were one of the unfortunates who fell for the Facebook IPO, my advice is to cash out quick while the Facebook fever is raging.  For the rest of us, sell Facebook short if you can, otherwise just sit back and watch to see who the suckers are holding the Facebook paper when the music stops.

Original: http://idatix.com/manufacturing-leadership/why-facebook-is-a-suckers-bet/

Comments

[Kevin]

Completely agree - and it was interesting watching FB dip back down to even and and then have to be supported at $38 by the underwriters right after it started trading this morning. That weak start then tanked a bunch of other social media and internet stocks.

It's like Instagram - where's the revenue? A decade ago I was talking with an older (and wiser) friend of mine who said the internet stocks of the day still needed to conform to normal business rules - ie revenue and actual profit driving real cash flow. I laughed and said "times and business models had changed." A year later he was laughing, and I had a much smaller portfolio value. History is repeating... at least I learned my lesson. Some apparently haven't.

More to your point, there was a good article in the WSJ this morning on how FB is already testing adding fees for that which had been free - in this case a fee for "priority posting" in New Zealand. Flopped - users didn't see the value. I see that happening again and again. Oh well.

http://online.wsj.com/article/SB10001424052702303879604577408481688851336.html

[John Meyer]

I don't quite follow this. Regardless of what the share price does, FB is sitting on such a mountain of capital it is still up to them to determine their fate -- it would be many years before their board would subject to the type of pressure you describe. Public ownership does not force an organization to preclude all its stakeholders especially if goodwill is intrinsic to the business model. Bezos has proven that public ownership can give more capital and discretion to visionaries -- even in the face of miniscule or negative EPS -- by placing less emphasis on "exit strategy" than in a venture capital phase.

I think rather than saying that company governance becomes necessarily inept due to presence of public investment, you might build a stronger argument around the story of myspace and the fickleness of user behavior in this space. I agree that FB needs a stronger relationship with its users. FB needs to prove they can mitigate that by improving the customer experience and they should hopefully now have the capital and freedom to do that.

[Mark Welch]

I think the new word for this should be "Suckerberged." As in, I got "Suckerberged."

[bignassim]

I think you are missing the point. With that amount of money in the bank, FB could easily start buying up foreclosure real estates and make a huge killing.... My point is.. How they use the money (even to diversify... buy up the competition etc..) will determine the 'new' public FB.

[Bill Waddell]

Somehow I don't think the people who bought Facebook shares did so with the expectation that Zuckerberg was going to invest it in real estate or to become a diversified company. There are a lot of people who know more about real estate and other businesses than Zuckerberg. In fact, he raised the money based on Facebook's prospects for monetizing their current business model. Certainly Facebook will acquire more periferal businesses, but which of those do you think is going to make a difference?

The big problem is that Facebook earned $1 billion last year. With a book value of $100 billion, that is a whopping 1% return. Facebook doesn't just need to grow and expand - it needs a radical plan for at least a 10X increase in profits ASAP just to give the investors a 10% pretax return ... and you know nodody invested in it expecting that little.

[sandy]

JM, you are assuming that they will use the money wisely, and i think instagram shows you that they are clueless how to "use" the money.

[Krzysztof Kajetanowicz]

@bignassim: you don't think FB has $100 bn in the bank, do you? They raised $6.84 billion for the company in the IPO (the rest going to selling shareholders), which brings their cash to around $11 bn. Let's say they invest all of it and make an absolutely staggering 50% a year. That's a 5.15% return for an investor in the $107 bn company. Hardly something that would come close towards justifying a 100x P/E ratio.