- "A face trapped in a book shall bring the darkness, and all in the valley shall lose sight." Akadamus, 1555
- Y-Combinator Cofounder Warns of 'bad times' ahead in Silicon Valley
Turns out I have an ancient relative who already foresaw the Facebook (FB) IPO leading to limited visibility in Silicon Valley. Now onto the meat....
According to a Reuters article, Egypt has officially banned trading in all foreign securities. Why you might ask? Facebook's IPO. By the way this is not another attempt to make fun of Facebook's IPO debacle, this is actual news.
What's next? Blaming Facebook's IPO for the problems with Spain's banks? Maybe the weak unemployment report in the US can be blamed on Facebook's IPO as employers were too busy looking for an allocation instead of focusing on hiring. This whole Facebook thing is getting just a bit ridiculous, and this is coming from a person who three weeks before the IPO sent out a note that consisted solely of, "What comes after Facebook? Nothing, be prepared to act accordingly."
Yes, the Facebook IPO was a failure in the sense that the underwriters left no room for immediate upside or momentum. There is no doubt about that. But at an opening trade of over a $120 billion valuation Facebook hit my bubble target range of $120-$140 billion instantly. There was nothing left to do but short or sell if you'd been buying at much lower valuations over the last year or two. And with Facebook's failure so came the end of the party, which was something I had been expecting as any IPO that has a standing crowd in Times Square waiting to watch its first trade is hard to miss as a sign of a market top. But at a present enterprise value of $55-$60 billion (depending on your share count) Facebook is now at a roughly 40% discount to that first trade. To someone like me who loves looking for contrarian short selling opportunities, hyped sector bubbles, and broken business models this discount is incredible. If shorting growth were this easy, Angie's List (ANGI) would be a $2 and Amazon (AMZN) at $75 right now. But what about the headline articles about the stock trading down to $9, $15, $20, or even $25; don't they imply significantly more downside?
The short answer is absolutely not. Do some analysis and you will understand where I am coming from. Facebook's 2011 Operating Margin was 48%. Their EBITDA was $2.1 billion. That means this company is trading at a trailing enterprise value to EBITDA multiple of between 26-28x. If you are a deep value guy that multiple is pretty crazy, but if you are a market realist it shouldn't even cause you to blink. Consider some comparable trailing EV/EBITDA multiples of some loved stocks: Lululemon (LULU) 30x, Chipotle Mexican Grill (CMG) 27x, Amazon.com 45x, Salesforce.com (CRM) 70x, Linkedin 100+x (LNKD).
Now, tell me does Facebook look expensive?
I didn't think so. This is the premium Internet brand on the planet after Google (GOOG) (some may argue ahead of Google but I still defer to the king of search), and it is trading at pretty decent discount to plenty of stocks in the online space and 'loved brand' growth story space. This is happening because Facebook's stock is caught in a negative feedback loop the likes of which you rarely see (think BP around the spill for a comparable), and thus suffering from massive reality distortion. Which by the way is fine with me as I was not buying this stock at $45, $35, or even $30. But when I read Henry Blodget arguing the fair value is between $18-$24, and random stories pegging it at $9, and sensationalist articles saying the company won't exist in a couple of years; it is hard for me to not get interested in what is going on. And when Egypt uses Facebook as an excuse to force through regulations that are designed to stem capital flight out of the country under the guise of Facebook's IPO failure; I get super interested.
So, what is the bear thesis on the stock at this point? Simple, it is that Facebook won't grow fast enough. As a short seller, I can tell you that if that is all you have at these multiples get ready for some Facebook pain because that matter won't be resolved anytime soon. Yet, here is the market giving you a rare pricing in of Facebook's growth slowing markedly and permanently, with little to no reason to believe such a drastic slow-down is a foregone conclusion. And by the way, if you think Facebook's growth 'warning' was actually a warning you need a market wake-up call. Facebook did precisely what a smart conservative management team does well, they played the street. If you think this is not a beat raise company setting the bar low 4-5 weeks before their quarter closes you are really underestimating Mark Zuckerburg. See, I know a promoter CEO when I see one, and this is not a promoter CEO. He is focused on the task at hand and is clearly someone who thrives on competition. He is not going to talk up his stock because he knows he doesn't need to. At this point that should give you comfort if you want to take the other side of the sentiment trade. Personally, I'd look at sandwiching the q2 quarter close/ earnings report window in the options market to maximize return as I think the stock really starts to rally.
And what if I am wrong?
The way I see it in over a decade plus of short selling I have learned that growth stories reprice instantaneously on the first real disappointment. Until that day arrives, they will remain frustratingly overpriced no matter how seemingly obvious the inevitable sharp slow-down may seem to you. In Facebook shares, the market has almost flipped this proven well established market rule on its head. The only time this ever happens is when a wave of negative sentiment overwhelms a stock and then through the media successfully morphs into a formidable reality distortion field. When that happens, you can actually make some very good money going long.