Fade The Crowd: Why Facebook Should Not Be Shorted

| About: Facebook (FB)

Since bottoming around $17.50 in early September, shares of Facebook (NASDAQ:FB) have soared nearly 60% to $28 as of last Friday's close.

As a result of this rapid gain, many investors are likely considering shorting the stock to obtain a seemingly attractive entry point. These investors are potentially considering such a move for a host of misguided reasons:

  1. "Facebook can't monetize meaningfully, especially on mobile platforms, which is where users are increasingly moving to."
  2. "Facebook's valuation is excessive. 145 times trailing earnings is simply unrealistic."
  3. "Facebook's business is easily replicable, and is likely to go the way of MySpace."

The Low-Quality Conversation On Monetization

Nine short months ago, Facebook wasn't even attempting to make money in the mobile space. In Q3, Facebook made about $150 million on mobile ad sales, yet the general consensus seems to be that Facebook simply can't meaningfully monetize on the mobile platform. Facebook's alleged inability to make money in this increasingly mobile environment is arguably the most common thesis for shorting FB.

For those who access the social network on smartphones, you may (or even better, may not have) noticed the new class of ads that Facebook has rolled out over the past few months. As users scroll down the news feed, a brief series of "sponsored" ads are seen. - these ads have superior recall due to their positioning in the center of the feed as opposed to the right hand side of the web page.

Facebook Exchange, still in its infancy, is another fascinating story. The offering allows online retailers to track purchases by members who have viewed their ads, giving them valuable and unique insights into the effectiveness of their advertising campaigns. The program allows advertisers to bid in real-time on ultra-targeted web users, creating a market that allows retailers to pay for what they value the ad opportunity. A measure of return on investment, "cost per lead," is 5.5 to 6.5 times better on FB Exchange than non-targeted advertisements. The cost is 53-85% lower than similar ad platforms.

Perhaps the biggest opportunity lies in CRM and data management services. While companies like Dell and Hewlett Packard have struggled with the transition into the analytics arena, Facebook has a major competitive position given the nature of their user base and the amount of data FB keeps on them. COO Sheryl Sandberg has noted that there is massive potential in the space given the company's "sheer size" (1 billion members and counting) and analytics data.

Shorting Stocks On Valuation: A Loser's Game

This isn't so much Facebook-centric as much as it is an investing principle. Shorting stocks with a thesis heavily reliant on valuation is a sure-fire way to get underwater on your position quickly.

Firstly, never underestimate the potential for a company to grow into its valuation. Facebook, at 143 times trailing earnings, may certainly appear overvalued compared to the broader market, but let's entertain a hypothetical scenario. If Facebook meets analyst estimates for FY13 EPS of $.65, the shares will be trading at about 43 times earnings. Is 43 times earnings excessive? I have no idea, and neither do you. If FB grows EPS at a 20% rate for the next few years (not implausible for a company with >$5 BB in annual revenues and 1 billion users), then today's valuation is certainly reasonable.

Investors absolutely may be willing to wait several years for a company to improve their earnings, while simultaneously bidding up shares. Amazon (NASDAQ:AMZN) has a stunning P/E ratio for years. It's safe to say the shorts have been fried time and time again. The harsh reality is that for as overvalued as a P/E, price to book or discounted cash flow model may make a company look, there is simply no reason to expect a drastic repricing of the shares unless new information is unearthed. Growth stocks follow stories that investors are often very unwilling to let go of.

Facebook's Legitimate Barriers To Entry

It's not so easy to get 1 billion people in the same place, and when you're doing it at no explicit cost to users, they're probably going to stick around. The term power in numbers comes to mind here. There is a massive ecosystem of advertiser-user relationships and analytics, carefully constructed profiles, and exclusivity.

There are major relevant differences when it comes to Facebook and MySpace. The first is that MySpace attempted to monetize far too often and early in the user growth process, resulting in a cluttered, difficult to navigate platform. Furthermore, the concept of an actual, exclusive "network" of people and the news feed was the major draw for FB - on some level, people like seeing what their friends are doing or saying, whether it's mindless or not.

Shorting FB on the rationale that someone else will offer a product that draws enough people away to meaningfully eat into the company's bottom-line requires answering to a burden of proof that I've yet to see sufficiently supported.


In sum, Facebook is clearly making rapid progress in the monetization of the all-important mobile offering, and its FB Exchange program has impressive potential to draw eager advertiser dollars thanks to its real-time bidding abilities and superior ROI.

The valuation is largely irrelevant as far as a thesis for shorting goes. Facebook managed to turn the mobile business into $150 million quarterly in less than a year, simply by making the investment in monetization of the mobile user base. The impossible quantities of user information makes FB an asset that could very well be worth multiples of what it is today, so it all comes down to execution.

Given the developments over the past 9 months, I'm not willing to bet that FB's minds fail, and you shouldn't be either.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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