On August 16, Facebook's (FB) lockup period for 271 million shares expired. These shares are now available for trading on the open market, after being distributed to insiders at the initial public offering (IPO). Predictably, these insiders dumped stock at their first opportunity to cash out. On the session, the Facebook Corporation lost more than 6-percent of its value and closed slightly beneath $20 per share. Facebook shares now trade at an all-time low, and this break down in price is especially troubling.
This recent collapse serves as evidence that Facebook insiders have long lost faith in the sustainability of this business. In retrospect, the May 18 Facebook IPO serves as the capstone event for the Web 2.0 movement. The bubble has since burst, as social media stocks collapse towards zero. Unfortunately, the Facebook fad is doomed to emerge as one of the greatest flameouts in business history.
The Facebook IPO
In my prior writing, Facebook IPO: Thanks But, No Thanks, I foreshadowed that this investment would be a proverbial train wreck before the engine even left the station. The buildup towards the Facebook IPO pitted a toxic mix of speculative journalists, novice investors, corporate insiders, and Wall Street bankers against each other. Logically, prospective investors wanted to buy in at a low price for improved probabilities of solid investment returns going forward. Alternatively, Facebook executives targeted higher prices for the offering, in order to raise the most cash possible to finance ongoing operations. Investment banks Goldman Sachs (GS), J.P. Morgan (JPM), and Morgan Stanley (MS) collected fees to serve as traffic cop and allocate shares to investors.
Prior to the event, Facebook cheerleaders called for a $100 billion price tag on this corporation. According to Facebook's last S-1 registration statement, however, the business had only clocked $1 billion in profits on $3.7 billion revenue over the prior year. In fact, Facebook's profit growth was actually slowing down heading into this IPO. Facebook countered its critics with claims that investments into the build out of its sales team alongside fresh applications for mobile would drive future growth. These arguments must have largely sated Wall Street, as evidenced by that fact that Facebook shares peaked at $45 on their first trading session. In the weeks since, many of us have come to realize that the entire Web 2.0 complex is little more than a smoke and mirrors charade.
Social Media is a Fad
The Web 2.0 business model is structured around creating virtual online communities. Once a user base is established, the web-master effectively operates as a broker-dealer between consumers, merchandise, and third-party advertisers. Social media websites have been created to share music, break down sports footage, analyze political rants, organize job leads, and plan dates. Beyond Facebook, prominent Web 2.0 firms include Pandora (P), Zynga (ZNGA), Groupon (GRPN), and Yelp (YELP). All of these corporations debuted for public trading at highs, only to break down completely towards zero over time.
Juxtaposed against the 2000-2002 dot-com bust, this Web 2.0 collapse is similar to comparing the 1906 San Francisco earthquake to the 1989 Loma Prieta earthquake. The dot-com and Web 2.0 sectors have both triggered irreparable damage to investor positions, despite their scale relative to the overall economy. Social media is a fad not only for investors, but also for consumers who increasingly shun wasted time, violated privacy, and a lack of personalized warmth.
The Bottom Line
Facebook and its reported 900 million regular registered users originally fed the Web 2.0 bubble. Investors, of course, bought into the belief that Facebook would easily monetize its online army for cash. On July 26, 2012, Facebook released its first quarterly report since going public. The proper analysis of this report is critical to determine whether Facebook can actually capitalize upon its nominal popularity and turn a profit.
For the second quarter period ended June 30, 2012, however, Facebook presents shocking calculations that roughly 9-percent of its user base is "undesirable." According to The Guardian, 83 million Facebook profiles are fraudulent. A quick scroll through the Facebook website will reveal multiple duplicate accounts alongside web pages for dogs, celebrity caricatures, and homeless people. The prevalence of these fake accounts destroys Facebook's credibility as an ongoing concern. Advertisers will refuse to pour money into a platform that has degenerated into a running joke.
For Q2 2012, Facebook posted a loss of $157 million on $1.2 billion in revenue. Compared to the year-over-year period, expenses for marketing and sales, research and development, and administration ballooned from $278 million to $1.6 billion. Despite the sharp increase in business investment, revenue only increased by 32-percent between Q2 2011 and Q2 2012. Meanwhile, game developer Zynga reported a $23 million loss for the quarter. Although Zynga executives blame changes to Facebook design for the company's weak performance, I would argue that these losses signify declining interest for the entire Web 2.0 complex. Users now choose to either migrate over to Twitter to connect directly with celebrities, or abandoning social media altogether.
At $20 per share, Facebook is still worth $50 billion. This stock trades for 50 times trailing earnings and is still wildly expensive considering the declining underlying financials. To avoid further carnage, it is critical for investors to dismiss Facebook as a fad, sell off shares of 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.