By Matt Doiron
Facebook Inc (FB), after a rocky start, has been getting some interest from hedge funds. It was actually one of the ten most popular tech stocks among hedge funds in the third quarter of 2012 (see the full top ten list), with Tiger Cub hedge funds Tiger Global and Viking Global being two of the largest holders of the stock in our database of 13F filings (find more stock picks from Tiger Global and from Viking Global). Since dropping below $20, the stock has rallied and is currently trading around $30 per share.
Facebook launched a new product on January 15th: the "Social Graph" which, at least in its early state, will allow users to find people and things that they might be interested in based on their own social network and those of their friends. The user-focused company never answered how this service will benefit shareholders, but the tech media had a few ideas. Let's address some of the more common suggestions we've heard.
It's a social marketing tool that lets users discover and use the same businesses and products as their friends- like Yelp Inc (YELP) or Angie's List (ANGI), only social! Yelp did not react well to the Facebook announcement, falling 8% on the day. Angie's List was up, but this was due to an upgrade that sent the shares up 4% in morning trading- the stock fell about 2% after Facebook's announcement. Other speculation is that Social Graph would integrate well with Netflix (NFLX). We think that this is generally a good use for Social Graph, but the combined market cap of Angie's List and Yelp is about $2 billion. Neither company is expected to be profitable for 2012, with Yelp being expected to barely break into the black this year with Angie's List's consensus EPS at negative 54 cents per share. If anything, we think that these two companies are overvalued and over 30% of the outstanding shares are held short in each case. As a result it's easy to see Facebook creating value from this use of Social Graph, but difficult to see them creating more than a couple billion dollars in shareholder wealth.
It's a recruiting tool, competitive with Linkedin Corporation (LNKD)! Not so fast: free-to-use, advertising-supported recruiting websites don't look like LinkedIn. They look like Monster Worldwide (MWW), which currently has a market capitalization of $680 million. Of course Facebook would bring a bigger brand and heavier traffic to the space, but we think that the utility of finding prospective employees based on connections with current employees-while it certainly exists- is limited to a relatively small number of cases, particularly in the competitive labor market. And good luck to any HR staff trying to get their company to cover a premium Facebook account if the company does decide to charge for full functionality. In any case, LinkedIn is barely profitable and while revenue growth has been very high we suspect that it might be overvalued as well.
It's a dating site! Well, free-to-use dating sites aren't good business either. Operating income in IAC/InterActiveCorp (IAC)'s Match segment- which owns match.com, chemistry.com, and okcupid.com- was $56 million in the most recent quarter. That makes for a billion-dollar business, but probably not a ten billion-dollar business, and match.com and chemistry.com- the core of IAC's dating vertical- get much of their revenue from subscriptions. With a fraction of a fraction of IAC's $3.8 billion market cap coming from free dating sites, it's extremely difficult to imagine such a business being worth half that figure even under the Facebook banner. And would Facebook users pay to date friends of friends when they could ask their friends to introduce them, for free?
We struggle to see these three uses of Social Graph generating any more than $5 billion in shareholder value in the "free" case, and being a difficult sell to users if Facebook Inc charged for the service- not to mention the uproar that would ensue if Facebook charged for just about anything. We think that Facebook needs substantial expansion opportunities in the next several years, judging by the fact the stock trades at 45 times expected earnings for 2013 (which in turn represents high growth in this year, though the company did take some expenses in 2012 that will likely turn out to be one-time events). The Social Graph- at least until we hear more- seems to be a plan to double down on a pageviews strategy to revenue growth, and we don't think that will be sufficient.