Facebook: Good For Speculation, Not Investment

Dec.20.13 | About: Facebook (FB)

Though in existence since February 2004, Facebook (NASDAQ:FB) is relatively new as a publicly traded corporation. Thus, existing financial statements give little hint of a persistent trend in terms of reliable revenue streams and profit margins. Large-scale brand reputation and long-term user enthusiasm about the site and its features are little more than guesses and estimates.

A clear business foundation and defined core competencies is the bread and butter of a large-cap corporation. Facebook is weak in these respects. In terms of risk and uncertainty, FB stock should be treated as a speculative small-cap security.

Value of a Facebook Fan
Facebook and similar social sites that do not charge members for use are very reliant on advertising revenue. In light of that fact, the revenue and ROI of a "Fan" or "Like" is a very important metric to consider.

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In 2013, the average value of a "like" and "fan" of a brand advertised on Facebook reached $174.74, according to recent research by Syncapse. Some mass-market brands, such as Coca-Cola (NYSE:KO), pull in about $70/fan while more exclusive brands such as BMW(BMW.DE) top $1600/fan. Facebook management has to lean toward appeasing more profitable brands such as BMW without coming off as elitist or snooty in terms of user income. After all, there are relatively few Facebook users capable of buying BMWs as opposed to a Coke.

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Recent Service Developments
In terms of mobile access, the Facebook App turned out to be very successful. Despite the app's success in lifting FB in the past, the mobile market limits visual real estate for ads. This weakness hinders the number and magnitude of advertisers that could otherwise contribute to FB's revenue streams and engage with users.

Lately, Facebook management has decided to test video ads in users' newsfeeds. Though video ads are seen as inevitable for FB and similar social media, for now the emphasis is on testing technical performance as well as user and investor reaction. If successful, video ads on FB may take significant advertising revenues from current ad giants such as television and YouTube.

Financial News
Facebook's CFO sold 9 percent of his FB equity. Though the sale was not associated with bad news about Facebook prospects, other data about Facebook's operations and business challenges hint that the CFO's sell-off could be construed as a slightly bearish indicator.

On the bullish side, Facebook has tremendous potential from monetizing its Instagram acquisition. Also, FB beat Q3 2013 revenue estimates of $1.91B by 5.76 percent. This caused much short-term optimism about the company and its ability to hold on to the increasingly important mobile market. Lastly, Facebook has joined the S&P 500 and S&P 100 indexes, leading to indirect FB stock purchases by many index and mutual fund investors.

Advertisers do not have long-term agreements, making FB dependent on continued popularity with users. Additionally, Facebook has to configure its page layout so as to grant sufficient advertising space and prominence.

Facebook operates in a tough competitive environment. Though there are relatively few social networks with Facebook's prominence, the barrier to entry for starting a social networking site is relatively low. This means that Facebook confronts continued market pressure from new, ambitious competing social networks.

One especially prominent thorn in Facebook's side is SnapChat. SnapChat offers a message auto-delete feature that vastly reduces user apprehension about embarrassing digital records. Facebook recently tried to buy out SnapChat for $3B, but the deal collapsed.

Facebook's initial appeal was that it was only for college students. It was a semi-private and somewhat exclusive corner of the Internet for a group of people - college-age adults - that is not usually high up in terms of status on the world stage. That was the secret spice that catapulted Facebook: snob-appeal to college students. They could clear Facebook's barriers to entry and others couldn't. Think of an invitation-only party. Once Facebook allowed everyone to join, that sense of privacy and "hip exclusivity" was gone because, to put it bluntly, if your boss and parents are on it, it's not cool.

When challenged with the inevitable correction or recession, Facebook's weak fundamentals and flimsy business strategy will turn off investors. FB stock should be bought only for short-term speculation. As a long-term investment, Facebook is a bad idea.

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.