Random Thoughts on Facebook Post-IPO - Too Easy to Call?

Over the last few weeks there has been enough debate over the issues surrounding the Facebook IPO that it could give the masses a migraine, but for some reason I am compelled to continue posting on comments sections.  Here are my two best posts below; one on WSJ via commentary on Mark Cuban's blog and the other through SeekingAlpha - I hope this is as therapeutic to you in reading this as it is for me to get these thoughts dumped out of my brain!

Basically my summary thoughts on Facebook are thus... :)

1. The IPO dip on open was due to a massive oversupply of shares and the NASDAQ technical glitch only worsened confidence - what was considered oversubscribed turned very quickly to oversupplied
2. Facebook can't monetize mobile... yet
3. Facebook will most likely hit lumpy growth due to reliance on advertising revenues... don't think investors will have patience with this
4. Facebook's P/E (including other recent social IPOs) is WAY to speculative, they held private investors hostage to now face public investors that aren't buying that there are enough bullets in the gun... at this value
5. Facebook WILL NOT BE MYSPACE... it is not going any where, but it will ultimately sit at a comfy $50-100B Mkt Cap over the next 5-20 years (unless there is a massive shift in professional content to Facebook or Facebook somehow makes new software that revolutionizes an existing market and decides to CHARGE for use)
6. Facebook needs to focus on monetizing SERVICES and less on monetizing content through ads

Mobility Issues

http://blogmaverick.com/2012/05/23/facebook-ipo-post-mortem-killer-but-not-for-the-reasons-you-think/

I love that to Cuban $1M in facebook stock is equivalent to a Mickey Mantel card… Regardless – he is right about the video transition to mobile stall. It is drastically slowing compared to the previous growth rate due to data restrictions placed by Service Providers… the real question is whether your ISP is willing to shell out to Cisco the billions of dollars required to build the right infrastructure in a down economy to bolster your Mobile Data Usage (e.g. video usage) and compete to give you less-pricey unlimited data coverage OR that you dip into your own wallet and pay hostage-like unlimited data monthly prices to pay for and make a profit on those upgrades. Either way its a ‘Share of Wallet’ issue more than a ‘desire’ issue to use video and mobile devices. The even bigger issue is the competitive one – Service Providers ARE IN THE TV BUSINESS, so they are asking themselves “why would I give ad revenue to my COMPETITION in mobile and web apps (e.g. YouTube, Netflix, & Facebook) at cheap prices only to disrupt that big steady flow of income, while I pay for all the technology infrastructure” (search the issues between Comcast and Netflix). Also they are fighting to create comparable mobile apps while not losing their partnerships with the major content creators and distributors (e.g. Hulu, Xfinity, Uverse, licensing through Turner Web). Right now the tentacles of the Service Provider is the lynch pin.

Facebook Valuation Snafu and Future
http://seekingalpha.com/article/640801-why-you-should-not-like-facebook

To believe that Zuck, LinkedIn, and Zynga all can live up to their grossly speculative P/E ratios is impossible over the near term.  History 101 - average P/E for top tier technology companies post-2000 and 2005 is 13 at best.  Companies with P/E higher than 13 have drastically under-performed the market because the companies struggle to meet growth expectations over the long term as their products, operations, competition, and customers mature.  Case in point, Cisco - was at one point valued at $557B (an obscene number at the time) at a P/E of 120.  Fast forward to today, the street has figured out how to value Cisco and the euphoria has passed - $88.5B Market Cap.  But here is the kicker - 12.2 P/E - Right smack dab in the sweet spot for a large cap tech leader.  Not to mention that Facebook is more NBC than it is Google - Facebook is an entertainment distributor that monetizes through advertising - it doesn't sell software (cause it's free) and it doesn't do a good job of selling services (RIP facebook deals - cruddy places, and other bad apps).  Facebook's only major competitive advantage is Connect - a bet for Facebook is a bet for universal ID - this is the secret sauce, Connect provides a simple and elegant way for mobile and web sites/apps to include a user's social graph.  It is revolutionary because of the 900M user base.  However, IT IS FREE - they can't monetize it.  If Facebook were smart, they would sell Connect as a service for something like $12 /yr, $1 /mth - instant re-occuring revenue at a cheap cheap price and nearly all of it will fall to the bottom line.  Facebook will not beat the Disney's of the world, but they can beat any open ID or Yellowpages - their biggest value going forward is as a connection point, not an ad platform.

Lastly some dramatized fun...

Your Full Attention

The Social Network — MOVIECLIPS.com

Until Next time - K

How Does Facebook = $100B Valuation??? Brand Value and a bit of Greed

I think it's fair to say that despite rational logic, the facebook IPO will be a wild success.  They will get their $100B valuation, and the VCs, PEs, Angels, IBanks, early facebook employees, and a muralist will make a mint.  BUT, this company's stock price given the current application features, will eventually significantly stagnate.  It won't be right now, it won't be 3 years from now, but mark my words this version of facebook will be in the $100B valuation range in 5 years give or take 5%.  There is no bubble, its not a ponzi-scheme either, but what it is is an opportunistic event to get people paid while the "potential" and brand is hot.  This is a classic case of strike while the iron is hot, plain and simple.

So what is the key driver in facebook's valuation?  The valuation is being buoyed by the strength of the brand (probably supported in part by the "finger-in-the-air" guesswork of value-per-user), much more than the strength of the business model (typically supported by some variation of discounted cash flow).  The key players are VCs and IBanks who have invested significant capital to keep facebook cash rich to compete with Google, acquire talent and technology, and market the company globally.  Now they need their return plain and simple, and that return will come purely from brand appreciation, not profits.  This IPO is the equivalent of the tax man, but for only for those 1%ers that want to improve the ROI for their facebook led investment funds or return some capital to limited partners to impress for their next fund raise.   Not to mention creating much needed liquidity for employees.  And why do they need liquidity for employees?  Because facebook continues to have a cash problem despite their healthy piggybank.  That's why they are raising $5B in the IPO.  You can't wage a war on talent, without paying premiums (rumored that recent facebook employees only make $80,000 annual cash compensation on average, but fair employee stock of about 40,000 shares) ... and you can only acquire so many companies with stock before employees start asking for the full benefits of an IPO versus secondary markets.  Also to support a $100B dollar valuation you have to continually defend your market and in turn your brand which can be a very expensive war to wage.  And in this case, brand is the foundation.

But, we all should know that brand is a wicked intangible.  The tech bust of the turn of the millennium was due to inflated valuations...based purely on brand and expected future profits.  The failure was that wall street and every Tom, Dick, and Harry placed bets on whether these internet brands would develop and be adopted leading to massive speculation (stamps.com we are looking at you [1999 vs 2011]).  The valuations saddled the companies with expectations that were impossible to meet over the long term, eventually to firing executive teams, key employees leaving for greener pastures, and brands falling apart all after initially cashing out investors.  Proving that brand is a hard foundation to build a house.  However, there are always big winners when things go right.  Amazon is one of those winners, so was Google.  But neither company was laden with $100B dollar pressure either.

However, facebook is a little different, and that is why this will be a hugely successful IPO.  With facebook you know exactly what you are getting, an established brand with significant value weaving itself into the fabric of all media and commerce.  But, the value today is supported solely by brand, and the future value is supported by hopes and dreams that facebook will eventually become one of the few winners in new media.  This means the need to transfer a significant amount of wealth from traditional media (the Disneys, NBCs, and Activisions of the world) to facebook and its family of competitors because the ad and consumer media pie is only so big.

The fact is that social media is quickly converging all forms of digital interaction; and media is the head pin.  So facebook's immediate future growth will be as a digital media company, not necessarily as a technology company.  facebook monetizes amateur and crowd media better than most competitors and the faster they can help amateur's make better content and applications, the more money facebook will print.

As such, they should be evaluated less with the Microsofts, Googles, and Apples of the world and more associated with the Disneys; especially if you are going to value you them at a largely mature market cap of $100B.  So, if you take Disney's current market cap of $72.7B on Revenue of $40.9B, EBITDA of $9.7B, and OCF of $7B - which results in a forward P/E ratio of 12x, 2x revenue, and about 8x EBITDA.  This is for a massive BRAND, whose media properties touch 120 MILLION PAYING VISITORS a year just on theme parks alone, and penetrates probably way more than the 850MM users facebook claims.  And they generate profits from PAYING CUSTOMERS in multiple businesses beyond just an ad model or facebook credits.  Now you look at facebook, which is at $3.7B in revenues growing at about 70-100% annually (depending on ad growth and acquisitions) with expected OCF of $1.5B with a seemingly correlated CAGR to revenue.  So an established time-honored mega-brand is worth $27B less than facebook who makes 1/10th the revenue and generates 1/7th the operating cash flow.  So unless facebook plans to sell trillions of digital hotdogs or create facebook the amusement park, I just don't see the immediate value today.  Talk about things that make you go hmmm.

In fact, if we assessed facebook from a revenue perspective, it would have to grow at a GIGANTIC 82% CAGR over the next 4 years to even equal the revenues of Disney TODAY... again with Disney valued $27B less... However, operating cash flow would only have to grow at a 63% CAGR over 4 years... but, still a Herculean effort for even the most innovative technology companies.

So what does this all mean in the end.  It means that despite anyone's claims that this IPO and its valuation isn't about the money, it has everything to do with money.  It is a very blatant play to book returns for employees and investors through a significantly forward looking valuation.  It's obvious that facebook at 100x earnings and 25x revenues is a ridiculous bet, but it will be successful.  It will be successful because 1) people LOVE brands and 2) dumb money chases smart.  But never fear, as long as you plan to be in facebook for at least 4-5 years, your $100B investment should stand pat!  And if facebook beats guidance and actually grows at that 82%, 63% or even greater than a 20% clip, the valuation will hold.  But one slip up, and that brand foundation could crumble the entire castle.  And if facebook crumbles, I'd hate to see the fallout for the other technology stocks.  So I say long live facebook...because your investment come IPO will probably have to be just as long as their life.

K

Is Google the Walmart of Tech?

To start, I am not a fanboy of any particular technology over another.  I am a firm believer of no technology religion, using the best product or service that fits the job I want to do for the best price.  With my personal disclaimer out of the way, the question remains... is Google the Walmart of the technology industry?

Recently, the news has blown up with companies becoming increasingly aggressive in protecting their market turf through patent litigation, communitiy messaging, and media coverage.  As one company in technology succeeds with a breakout product, it is reasonably assured that 15 other companies will chase to build nearly identical products to flood the market.  It is a continuous cycle, in which companies such as Microsoft have been supremely successful.  But because the tech industry is a particularly entrepreneurial and idea driven community it raises the well known cry of "COPYCAT!"

So first, the business strategy.  Standard competitive strategy teaches that when new innovations occur (i.e. market transitions, market disruptions, tipping points, etc.), revenues and profits are generated.  If profits are extra-normal, then it is assured that competitors will be attracted to the same market because the market has room to accomodate them.  As such, those competitors strive to furnish products that look, feel, and function as a near match to the initial innovation, i.e. a copycat.  So entrepreneurs and idea people beware... if you have a great idea, nothing is stopping anyone from making a copy.  Now you can protect yourself and errect barriers to entry, such as patents, lobbying, market consolidation or whatever your creative and expensive brain can concoct, however, it isn't a matter of if, but when will a competitor come knocking.

As noted in a previous rant, in many cases the markets can sustain a number of large competitors in oligopoly, while numerous solid lifestyle businesses service the niche related markets and fight for industry scraps.  In most cases, companies find pricing parity and work in unsaid collusion to maintain prices and profitability.  But, where it gets ugly is when companies break from the pack, make bold strategic moves, and price competitors out of the market.  While initially great for consumers because it lowers prices, it can mean slow, painful death for competition.



By the above graphic you may think I hate Walmart... I envy Walmart.  I think Walmart is an amazing company with awesome people.  They solve all my needs in one place and I thank them for it, but this is Walmart's alleged strategy.  To be the Low Price leader Always... no matter what.  They have been notorious for allegedly entering communities and offering whole sale generic products at prices that are impossible to maintain for local businesses.  In turn business is sufficiently wounded for surrounding entrepreneurs that they end up selling their business or going down with the ship.  Once the market has consolidated, Walmart is free to offer whatever "low" prices they desire.

So is Google no different than Walmart?  They have brilliant strategists that have taken competition to a whole different playing field.  Google, like Walmart aims to be the 'Low Price leader Always' in everything but except probably search.  Like Walmart, they know that if they can grab you to use one of their 'free' services like Gmail or Google+, then they can own your data, serve you ads, and drive you to spend more time using their search products.  And when you generate as much cash as Google does from a virtually infinitely profitable business model, you can focus on creating a whole host of context products to pull through more growth and more profitability.  If a competitor has a core product in one of your hot 'target' growth markets, Google gives them the option to sell and assimilate or go down with the ship.  If the target doesn't sell or can't be bought (in terms of larger competitors like MSFT or Apple) it builds and deploys a 'copy' product, smashes the price to nil and burns the market to ashes in perfect competition.  It completely and utterly disrupts the business.  Customer's love it in the short term and it limits the possibility that the competitor ever can really reciprocate.  Brilliant...

We are seeing it again today.  Google+ recently added functionality for social gaming, probably one of the best and most powerful features facebook had to offer to its user community.  facebook makes money hand over fist by charging a generally market standard 30% fee for digital purchases through its platform, basically matching market pricing parity  with Apple for platform marketplaces that have large user bases.  facebook can charge this premium fee because it has relatively the best game in town as far as social platforms, and relies on these type of fees to feed other inventions and innovations within its model.  Games, unlike your recent status post about what food you just ate, provide tangible entertainment value and stickiness to facebook and is most likely considered a core functionality of their business.  Seeing that games and digital purchasing was core to the social platform business... Google+ had to launch games.

Now Google could have played it nice, came in at price parity for the revenue split fee at 30% and stuck to the industry standard, but that isn't the Walm... ahem... Google way.  Instead, Google launched a promotional digital goods fee of only 5% to entice developers to add Google+ to their radar.  This 'beta' digital goods fee may or may not remain 5%, but it is hyper-competitive behavior and a Vegas sized signal to facebook that there is no intention to play nice.  The point is that there is room for both Google+ and facebook in the marketplace, but hubris and ruthless strategy dictate that like the immortal Highlander... there can only be one!

Rightly so, the case for Walmart comparisons can be made for other tech companies as well, but Google has definitely been the most visible and aggresive as of late.  While Google might not particularly like being branded the modern Walmart (or even worse to them, the modern Microsoft), their intentions are clear... burn the villages, storm the castle, and take no prisoners.  Its all fair play, and it is brilliant strategy.  So the next time Google comes calling with a nice little acquisition offer... remember that you have been duly warned.  At the same time, can Google realistically maintain victorious by fighting a digital war on all fronts?  Right now, it seems so.

-K

For those that don't want to link...

Can't tech just get along! MSFT vs FB vs GOOG vs AAPL

VS  

In business there is often the need to analyze and over-analyze competition in the market place.  This need for comparison often creates the need to manufacture strategic battles between titanic foes like Microsoft and Apple or Coke and Pepsi.  Today's new digital age is no different, so the social media, browser, operating system, digital deals wars are now upon us.  A flood of social technologies have dominated market headlines and have become the darlings of both private and public investors.  However, these hyper-growth companies have huge questions to answer as they navigate through the infancy of a new digital media age and take aim at incumbent technology leaders and each other.  Unless you have been in a cave, you probably didn't miss the very public twitter, blog, and media battles between MSFT and Google legal councils over patent bullying.  Or how could you forget facebook's Mean Girls move of trying to sully Google's reputation by using slimy PR tactics.  And now Google fanboys and their constant complaining of Android this and Apple is that... Finally, does facebook really have to act like a crazed Ron Burgundy that is being threatened by the arrival of Veronica Corningstone because Google has finally put together a successful social product they didn't acquire.

Now in the immortal words of Rodney King, "Can't we all just get along!"

But while we all grab a bowl of popcorn and watch as the claws, brass knuckles, machetes, mace, and handguns continue to fly out maybe some common diplomacy should enter the discussions.  Yes, these massive conglomerates are competing for billions if not trillions in future profit, but does the land of software and the internets have to be a battlefield?  Software and purely web based products have a very unique property that no other good or service has in its arsenal.  Software is a good that once produced has the potential for near infinite returns... meaning that it has a nearly infinite thresh hold against diminishing returns otherwise known as "increasing returns to scale."  It is easy to store, has little maintenance cost when compared to physical goods, and allows for faster viral adoption because it is easily shared.  By those means shouldn't there be room for Oligopoly instead of Google having to grab a monocle, top hat, and cane and make like Mr. Monopoly?

The point is that in the brave new digital world new markets and new market opportunities are created almost every second.  Barriers to entry are falling and falling fast.  So Google, Groupon, facebook, Microsoft, Apple, Zynga, etc... don't be surprised when a newbie product comes knocking at your front door threatening to take your market share because maybe, just maybe you are counting your market share the wrong way.  With software, because it has the unique property of being a digital good, I can have 5 web browsers running on my machine or mobile device because it doesn't matter to me anymore.  Why can't I be a lover of Opera, Firefox, Chrome, Safari, and yes, even Internet Explorer?  It costs me nothing to download them, install them,  and managing between browsers has become easier than ever.  The same with social networks.  I have an account on just about everything I get my hands on.  LinkedIn meets my needs in one area, Google+ meets my needs in others, and I still post and check my facebook page.

Just like cable and satellite television, why can't we have thousands of unique options?  And that should be the point.  Companies like facebook and Google should strive to capture share of TIME not user share.  If they stop spending on resources to fight and bicker in court and the press, they would have more time and money to spend on creating useful features to capture my TIME.  That will be the battle of the future, so video game companies, cable providers, retailers, web companies and the like beware.  Share of wallet is what will pay for the web of the future, but share of time is where the real battle will take place.  The companies that ignore the hype and fight battles with innovation rather than lawyers will win the day.  So don't put out the competitive fire, just refocus it on what matters, engaging and powerful user experiences.

-K