Web 2.0 internet stocks have not been having a very good time of late. After Facebook's post-IPO stock collapse, some sanity seems to be returning to the investment community and it is now focusing on the valuation part as well, in addition to 'hype'.
I recently scanned some of the Web 2.0 internet companies to find stocks that have reached attractive levels and the ones that are still over priced. Groupon (NASDAQ:GRPN) and Zynga (NASDAQ:ZNGA) stand out as the two stocks that are attractively valued, while Facebook (NASDAQ:FB) and LinkedIn (NYSE:LNKD) are still trading at obscenely high multiples.
Below is a table showing the expected growth rates of the four companies and their forward PE multiples.
Current Year EPS
Next Year EPS
Current Year Topline Growth Rate
Next Year Topline Growth Rate
Note: All numbers are consensus expectations of sell-side analysts and are sourced from Yahoo Finance.
Groupon is the cheapest stock in the above list and my favorite long candidate. The stock has been an easy target for bears since its IPO, and skeptics have even called it a Ponzi scheme. Although, I do agree that Groupon was expensive when it was trading in the high 20s, the stock is now trading below $10 and is way too attractive to ignore.
Further, Groupon's recent results show that it is a 'real' and profitable business. It reported $39.6 million of operating income and $70.6 million of free cash flow last quarter. Its North American business accelerated 33% q/q, despite its lower marketing expenses and its take rate (revenue split with Merchants) remained stable at ~41%. Also, its international margins turned positive for the first time in the last quarter.
I am positive on the local deal opportunity and Groupon's recent results are compelling enough to make it a worthy buy. Groupon has shown 50% plus incremental margins in the last two quarters. It is likely to maintain similar incremental margins run rate going forward and its top-line growth will lead to a disproportionate increase in its EPS.
I believe a lot of investors are still on the sidelines due to the negative press the company has received and its accounting restatements recently. I believe a couple of more quarters with good results will act as a catalyst for the stock. I recommend buying the company as risk-reward profile for the stock appears very attractive. After all, how often do you get a company with revenue growth of 47% (current year estimates) at just 14x forward PE?
Zynga is another company in the above list which I would recommend buying. Zynga reported strong last quarter results with its revenues and margins both above expectations. Most of this upside was because of stronger-than-expected results in mobile - which is still a nascent market. I like Zynga's leadership position in Social gaming with 66 million Daily Active Users (DAU) and 282 million monthly active users (MAU).
I believe the company's deep pipeline of games and new releases in 2H2012 are likely to re-accelerate growth and serve as a catalyst for the stock price. Further, in order to lessen its dependence on Facebook for revenue growth, the company is expanding to mobile platforms such as Apple's (NASDAQ:AAPL) iOS and Google's (NASDAQ:GOOG) Android. The company's daily active users on mobile increased to 21 million in 1Q12 from 12 million in 4Q11. The mobile business will not only improve Zynga's growth going forward, but it will also significantly de-risk the company's business model by reducing its dependence on Facebook.
LinkedIn is the most expensive company in the above list on a P/E basis. Although I find the business fundamentals of the company going in the right direction, its valuations are way too high for me to consider buying the stock. I believe investors are pricing in too many positives into the stock price at the current levels and are likely to be disappointed going forward.
I don't believe that the company's top-line growth can continue at the current run rate for long. Also, monetizing international users wouldn't be as easy and the company is likely to face more competition and require more investments for international growth. Another major short-term negative for the stock is disappointing US job data that can negatively affect the company's growth prospects in the near term.
Facebook is expected to post the slowest EPS growth from the current year to next year in the above list. It is also the one that will be most affected by the secular trend of user shift from PCs to mobiles. Facebook derives most of its revenues from advertisements - which will be adversely affected by increasing mobile usage as the screen sizes of mobiles are smaller.
On the other hand, Groupon, Zynga and LinkedIn derive a relatively small portion of total revenues from advertisements and consumer shift towards mobile will not be a big headwind for these companies. Another issue that concerns me about Facebook is corporate governance. The Facebook IPO was marred with controversies and it was alleged that Facebook selectively disclosed current quarter trends to some favored analysts. I am not sure about the legal aspects, but this is clearly a breach of trust. Another corporate governance issue is the company's founder having the majority of voting rights in the company. This is not very uncommon these days, but after the "selective disclosure" scandal, how can one be sure if he would act in the best interest of ordinary shareholders?
From the relative valuations perspective also, Facebook appears a lot overvalued. Just because a company has a Web2.0 tag doesn't mean that it should get a high PE multiple. There are several other high growth companies that are expected to see better trends than Facebook, but are having significantly lower P/E multiples than Facebook.
For example, consider Baidu (NASDAQ:BIDU): the company's expected topline growth for the current year is 56.80% and for the next year is 41.60%. Its EPS is expected to grow 39.5% from the current year to the next compared to Facebook's expected 20.37% EPS growth. Still, it is trading at a valuation of just 18x forward earnings - which is an over 50% discount to Facebook on a P/E basis. Clearly, even after the post-IPO correction, there is a plenty of downside still left for the Facebook stock and I would recommend avoiding it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.