Facebook Is Being Frivolous With Its Money

| About: Facebook (FB)

Summary

Facebook's acquisition strategy seems to be based on luck.

It's not buying companies that complement its main business, but instead companies that might become a hit on their own.

Coupled with the fact that Facebook is not a cheap stock, these acquisitions represent a danger point for long-term investors, if they turn sour.

Let me start off by saying that I have said over and over that buying any of the social media heavyweight stocks will probably not make you money in the long run. And let me be specific about the type of investor I am talking about.

I am talking about the conservative buy and hold investor, who doesn't look at the tape every day and rarely trades. Because for you day and momentum traders out there (as well as the technical folks), you don't need me telling you what to do. I am assuming that you are in and out depending on how the wind blows in the wink of an eye.

Facebook (NASDAQ:FB) recently bought WhatsApp for $19 billion ($12bn in stock and another $3bn in restricted stock), but at the same time forked out $4bn in cash. On the back of that, it also bought Oculus for another $2bn, of which $400ml was a cash layout.

If you add that up, Facebook paid out $4.4bn in cash. According to Facebook's latest filing, it had about $13bn in the bank. So minus the $4.4bn in cash, it will have about $8.6bn left. No, Facebook is not in any danger of running out of cash, but it does have to explain what it intends to do with these acquisitions. Meaning, what the benefit will be.

And the reason it has to explain itself, is because Facebook is not a cheap stock and has a very large market cap to support. In my book, Facebook has not explained what it expects to gain from these acquisitions, given the dilution to shareholders and the cash it paid out.

Because contrary to Google (NASDAQ:GOOG), Facebook is simply buying businesses hoping to hit the jackpot if they become big hits. Google, on the other hand (for the most part), buys businesses that complement its main line of business, which is internet advertising.

For example Google bought YouTube in 2006 as a means to push more advertising banners. It bought DoubleClick because it enhanced its core business, and it bought AdMob as a way to promote ads on mobile devices. Even the Motorola acquisition made sense, due to the popularity of Android.

Amazon (NASDAQ:AMZN) bought Touchco because of its touch screen technology, Quidsi because of its e-commerce possibilities and Kiva Systems for its robotics technology. All these deals blend in with Amazon and complement its business one way or another.

Apple (NASDAQ:AAPL), on the other hand, purchases companies as a way to get hold of a specific technology, that overall is helpful in its business (it is a technology company after all) and because it hates paying royalties. However you don't see Apple going on a buying spree simply because it has money. I mean, is there anyone with more money than Apple out there?

And when buying blind, without knowing what will become of the acquisition you made, you don't fork out billions. For example, when Google bought Android back in 2005, it paid only $50ml for it. Knowing what we know today, Google could have probably paid several billion and still Android could be considered a good investment. However that was not a given at the time. Nor did Google ever imagine how Android would turn out, it just happened.

However Facebook's acquisitions are totally irrelevant to its main line of business. It is buying companies just because it can, and just because its stock is overinflated. I mean it might hit a homerun with the past two deals, but the possibilities as I see them border on the chances of making money on a venture capital deal. And at the end of the day, if these deals don't make money, that will be a big hit to the stock down the road.

But besides being frivolous, another reason why I think investors should be very cautious with Facebook -- and should avoid holding the stock over the long term -- is because this is not a cheap stock by any stretch of the imagination

Currently the P/E is about 100 and the Price/Sales ratio stands at 20 with a P/B ratio to match (almost 20). Granted the company is growing, but please take notice that this market has still not corrected by much for a while now and if it does, chances are that high flying stocks like Facebook will be at the very top of sellers' lists.

The bottom line

Facebook is being a little too frivolous with its money. Granted the last two acquisitions might lead to something big, but there are no guarantees. In addition, it's not like Facebook paid peanuts for these assets, it paid their weight in gold. And because Facebook itself is not a cheap stock, if these acquisitions do not produce much in terms of earnings, that might hurt Facebook's stock in the long run. And I think this is a risk long-term buy and hold investors should avoid.

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.