Facebook Fallout

 | May 22, 2012 | 12:00 PM EDT  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

FB

,

aol

,

twx

,

goog

,

aapl

This commentary originally appeared at 8:12 a.m. EDT on May 22 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.

Last night on "Fast Money" with Melissa Lee and the gang, we discussed -- what else? -- Facebook (FB).

Let's go straight to the tape.

"This is a historic moment in which new media has truly come of age."

-- Steve Case, January 2000

"The Internet had begun to create unprecedented and instantaneous access to every form of media and to unleash immense possibilities for economic growth, human understanding and creative expression."

-- Gerald Levin, January 2000

I likened the publicity and hype that led up to the Facebook IPO to the hoopla surrounding the merger of AOL (AOL) and Time Warner (TWX) 12 years ago. When that deal was announced, AOL's frothy price made it worth twice as much as Time Warner, even though AOL's cash flow was less than half that of Time Warner.

Back then, similar to now, superlatives had been bandied about, but little substantive analysis was delivered.

Both AOL and Facebook have been characterized as gateways to the Internet. But there were problems with the AOL-Time Warner merger (the largest in history) before the ink dried on the transaction. The same could be true for Facebook's IPO.

Following the merger, AOL's shares commenced a steady, multiyear price decline from the high $70s to nearly $10 a share.

I started the conversation with the notion that I was not surprised by the price break in Facebook's shares -- indeed, it was one of my surprises for 2012 -- and I questioned the analyst interviewed in the prior segment, who thought there was only $1 of risk in Facebook's share price (which is insanity, a mathematical improbability and a perfect example why many investors disregard Wall Street research).

Superlatives, not substance, provided the backdrop of the discussion leading up to the Facebook IPO, as it was with America Online 13 years ago.

A rich valuation, fundamental issues plus a continuing and discouraging Greek situation served to provide a poor backdrop for the Friday morning IPO.

To me, Facebook faces philosophical, business, operational, financial and valuation headwinds.

  • Philosophy: The company is run by a 28-year-old who favors a social mission above profits.
  • Business trends: The rate of revenue growth is decelerating -- the latest quarter experienced 45% growth in sales, down from 55% growth in the prior quarter. Advertising, in particular, is slowing, with a 37% growth rate in the first quarter. Google's (GOOG) display ad business (which competes directly with Facebook) is growing faster than Facebook.
  • Profitability: Facebook's 50%-plus operating margin seems vulnerable. With nearly 1 billion current users, the low-hanging fruit -- and I am being somewhat facetious -- might have already been picked. I suspect the next 1 billion users will be less profitable to Facebook.
  • Financial: Facebook is cash flow negative now as the company spends to grow (on data centers, more employees, etc.).
  • Valuation: Let's suppose Facebook's revenue growth accelerates modestly to 50% and that operating margins are sustainable. In this example, Facebook will achieve almost $5.5 billion in sales in 2012 and $8.25 billion in sales in 2013; EPS will be $0.60 in 2012 and $0.95 in 2013. At the offering price of $38 a share, these are high multiples, both absolutely and relative to other leading tech companies such as Apple (AAPL) and Google (at 10x to 11x).

The Disappointing Facebook IPO's Impact on Retail Investors

Melissa Lee inquired how the IPO will impact retail investors.

Retail fund flows continue to be moving toward the safe haven of bonds and away from stocks. In the latest period ending Wednesday, $10 billion was redeemed from domestic equity funds, and $12 billion flowed into bonds. This continues a steady, multiyear outflow out of stock funds that commenced way back in 2007.

The timing couldn't be worse as it relates to the retail investor.

At best, my expectation that the reallocation rally (selling bonds and buying stocks) will immediately commence in the summer months ahead must be scuttled. At worst, the Facebook IPO (and the recent market swoon) will add more strikes to the hearts of individual investors, keeping them away from stocks over the balance of the year. (Retail investors have already endured two large drawdowns in stocks since 2000, a lost decade of investment performance, a flash crash, stagnating incomes while the necessities of life increase in cost.)

Josh Brown, who deals with scores of individual investors in his capacity as a money manager, underscored my view that the Facebook IPO was another blow to the individual investor community.

Columnist Conversations

The iShares TIPS Bond Fund (TIP) has retraced 38% of its 2013 decline. The technicals indicators are trending ...
A survey by Janney Capital Market of McDonald's (MCD) franchisees indicated positive expectations for same-sto...
In addition to the Oscillator chart shown in my column each day, note how oversold Nasdaq is when we use the 3...
After yesterday's huge reversal, futures are pointing to another higher day in the market. Maybe equities can...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.