Consensus opinion believes that Facebook (NASDAQ:FB) is poised to become the next Google (NASDAQ:GOOG). If that happens, the Facebook IPO represents one of the best opportunities of the decade considering GOOG ramped from $100 a share to $200 in its first year and then went on to reach $700 a share in its fourth year. As one who believes we are in the midst of a tech revolution, I am naturally optimistic when it comes to most IPO's but this one is different. Facebook has some fatal flaws that make it a much more risky than Google. Consider the following four reasons why Facebook could be a flop:
1. Facebook is more mature than the market wants to believe. Facebook has more than 845 million active users. Of the 845 million, 483 million are categorized by Facebook as daily users. In any given day over half of the community checks in. Active monthly users climbed 39% over the past year. Active daily users increased by 48%. Considering Facebook isn't in China, I wonder if growth extrapolations are appropriate from current levels. Can Facebook increase its rate of growth? I would consider Google to have been much more of an infant at its IPO than Facebook is today. 845 million users is almost triple the number of people who live in the United States. Facebook officially launched its service in 2004 and has been mainstream since 2007. It's already been the focus of a major motion picture, "The Social Network," which debuted back in 2010. How many new users are still out there? Facebook needs to add 1 billion users over the next three years to keep up with current growth.
2. As an Apple (NASDAQ:AAPL) investor, my own experience tells me a lot about what to expect from the company. I loved using a Mac which led me to assume others would as well. I couldn't believe how revolutionary the iPhone was and I assumed the device would take over the mobile phone industry. As a Facebook investor, my own experience would suggest that Facebook usage is more of a novelty than anything else. Consistent use lasts for a brief period of time and then dissipates. The manner of communication on the Facebook platform too closely resembles that of teenage girls leaving notes on one another's lockers. The lack of privacy and the promotion of narcissism are uncomfortable for most. The comparison that Twitter causes you to like people who you don't know and Facebook causes you to hate people you've known your entire life seems to be a by product of the juvenile communication platform. I would estimate that among my community of Facebook friends, usage mirrored Facebook's current statistics that claim 57% are daily users ... two years ago. Since that peak, I have witnessed a dramatic decline in daily use to the point that only 10% could still be classified as regulars. I understand that this is merely my own experience, nevertheless, it is my own experience and it makes sense. Adults get bored with Facebook. Teenagers and young adults use it more as a dating tool than anything else. It seems to me that users have experimented with Facebook as a mainstream social network over the last three years but it has failed to live up to the hype. This company could be in the process of returning to its roots as a way for single people to meet. Facebook was created on a college campus and I think that's where it will end up. This kind of commentary for a high P/E stock is incredibly dangerous.
3. Facebook stock has been trading on non-public markets for too long. The unintended consequences relate to valuation. I think that investors will bid up the stock furiously in the initial honeymoon phase, but once the rise stalls, watch out below. The non-public trading means that this stock is starting from a higher valuation than it should. How long could the honeymoon phase last? It might not last as long as you might think.
4. Facebook advertising is far below the industry standard. Its click through rate is 0.5% compared to the industry average of 0.1%. Why would this be? Perhaps it represents that the real demographic of Facebook users is younger than we are being told. The advertising opportunity to the 13-19 year old market is not as enticing as Facebook would like. Bloomberg is running an article titled, "182,901 Ads, 26 Clicks: My Short Life as a Facebook Advertiser," that further discussed the weakness of Facebook as an advertising platform. Can we really think of Facebook as the next Google?
In conclusion, I do think that the honeymoon phase will be good to Facebook shareholders because of the tremendous amount of positive uncertainty surrounding the future of this company. But I would caution investors as to the staying power of Facebook. We will begin coverage on this stock and will discuss trading strategies in detail at the Apple Investor Summit. As with any other momentum stock, the fundamentals rule the day. If Facebook fundamentals are strong it will enable this stock to bounce after it corrects. If Facebook fundamentals are weak, Facebook will crash from its early valuation levels. There is a minority opinion on Wall Street that because Facebook has $3.9 billion in cash on its balance sheet that the only reason to go public is to enable the founders and employees to cash out. Be careful when comparing Facebook to Google. The staying power of Internet advertising is much different than the staying power of a social network.
Disclosure: I am long AAPL.