On July 26, 2012, Facebook (FB) reported its second-quarter results at the closing bell. In its first quarterly report since going public, Facebook posted a loss of $157 million upon revenue of $1.18 billion. Taken further, this $157 million loss breaks down to an 8-cents per share loss. Excluding extraordinary, one-time charges, Facebook turned a profit of $295 million, or 12-cents earnings per share. According to Thomson Reuters, analysts expected earnings of 12 cents per share upon revenue of $1.1 billion.
The ticker tape, however, reads that Facebook Q2 earnings severely disappointed analysts. During the conference call, Facebook shares collapsed to an all-time low at $24, which is a far cry from the $45 high touched amid the May IPO feeding frenzy. On the July 26 session, social media shareholders took a one-two punch, in the form of losing reports out of both Zynga (ZNGA) and Facebook. The two are linked, as the American public often retreats deep into the virtual reality to play Zynga games on Facebook.
For shareholders, the Facebook experience has degenerated into a complete debacle in the aftermath of its initial public offering. The collapse of this Web 2.0 bubble is accelerating as recession looms. It is high time for Facebook investors to stop playing games, sell stock, and get out of Dodge.
Web 2.0 Bubble
The Web 2.0 business model creates online communities for socializing. Distinct communities are available that target music sharing, career networking, dating and relationships, sporting events, and political rants. Webmasters ultimately function as broker-dealers, who either sell product directly, or match third-party advertisers to an online base of registered users. On Wall Street, Web 2.0 bubble stocks are easily identified by their lack of earnings and valuations exceeding 30 times revenue. With interest rates at zero, The Federal Reserve Board is forcing the market's hand into throwing money at risky equities.
In retrospect, the May 18 Facebook IPO proves to be the capstone event for a Web 2.0 complex that includes Pandora (P), Groupon (GRPN), Yelp (YELP), and LinkedIn (LNKD). Web 2.0 stock positions have deteriorated significantly following the Facebook IPO event. On its first day of trading, Facebook shares opened at $38 before gapping up immediately to $45 and dropping back down to $38.23.
In a prior writing, Facebook IPO: Thanks, but No Thanks, I anticipated that Facebook stock was already doomed for wreckage before this train even left the station. At the time, Facebook cheerleaders were calling for a $100 billion valuation. The latest Facebook S-1, however, revealed that this corporation only made $1 billion in profit on $3.7 billion revenue during 2011. Facebook's financials indicated that growth was slowing down, at the very same time that bulls clamored for this investment at 100 times earnings. Today, Facebook trades at $21 per share, and still boasts of $55 billion in market capitalization at 70 times earnings. Facebook remains wildly overvalued, despite the fact that its profitability is on the decline.
Zynga's recent collapse foreshadows that investors who still own Facebook stock are playing to lose.
Zynga and Facebook Waste Time
As the largest developer for Facebook games, social media serves as a conduit for Zynga online gaming. In exchange for increased traffic, Venture Beat reports that Zynga pays 30 percent of its virtual goods game revenue to Facebook. Writer Dean Takahashi describes the Facebook-Zynga partnership as a "marriage."
Notable Zynga games include Café World, FarmVille, YoVille, and Mafia Wars. Despite their popularity, the Motley Fool dismisses Zynga games for their "lack of originality" and inability to be effectively monetized. A small subset of Facebook users is known to log on and waste hours of time playing Zynga games. These people are easily identified by Facebook wall postings detailing gaming power ups and points scored. Over time, a stigma has developed that online gaming is best reserved for children, malcontents, slackers, and the unemployed. Clearly, technology investors are fearful that this negative sentiment will inevitably degrade the Facebook experience. According to New York Times opinion makers, Facebook and the entire social media complex operate largely in jeopardy of being written off as a corny fad.
For second quarter ended June 30, 2012, Zynga and its weak financials justified fears of an imploding Web 2.0 bubble. For Q2 2012, Zynga posted a loss of $22.8 million on $291.5 million in revenue. On a per share basis, this performance breaks down to a 3-cent per share loss. Zynga's financials are especially troubling, considering the fact that this company turned a small profit of $1.4 million in the year-over-year 2011 quarter. Zynga's cash position has deteriorated rapidly to the current $436 million. This company maintained $1.6 billion in cash on the books as late as December 31, 2011.
Smart investors refuse to play Zynga's game and are abandoning ship. Today, Zynga shares go for $2.75 en route towards zero. In early March, Zynga stock peaked at $16.
According to Douglas MacMillan and Bloomberg, Zynga blames Facebook for its disastrous results. Zynga executives claim that changes within Facebook's interface have made it difficult for users to access games, click advertisements, and make virtual purchases. I, however, would argue that playing the blame game is largely symbolic of a business model going bust. Zynga is well on the road to oblivion and its shares are a strong sell.
The Bottom Line
Facebook is getting exposed and the Emperor wears no clothes. The Facebook story calling for the monetization of its extensive user base is under assault. In its latest SEC filing, Facebook revealed shocking estimates that duplicate accounts make up 5 percent of its reported 955 million total user base. Indeed, fake accounts for dogs, homeless people, and celebrity caricatures provide laughing stock for Facebook users. Shareholders, however, would prefer not to giggle and play games with money. As was feared, Mark Zuckerberg, or "Zuck" lords over an empire that is going Animal FarmVille.
Fake and inactive accounts destroy every argument for owning Facebook stock. Obviously, there is little that can be monetized through changes in conventional website and mobile architecture, if fewer and fewer legitimate users are actually logging on to the site. Every passing day, Facebook is taking upon the characteristics of a speculative bubble that turned disastrous for shareholders. Investors, of course, will forgive and forget this social media debacle the day that Twitter goes public.
Until that day comes, it is time to stop playing games, sell off Facebook stock, and never look back.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.