Facebook: 'Hotel California' 2012

| About: Facebook (FB)

A lot of noise around Facebook (NASDAQ:FB) has been made this past week. Most of the volume came from founder and CEO Zuckerburg's "fireside chat" at TechCrunch in San Francisco on Tuesday. The perky,upbeat vibe exuded by Zuckerburg resulted in a $3.02 gain for the week ending September 14 for Facebook shares. Apple's (NASDAQ:AAPL) iPhone 5 launch has also added to the buzz around social media companies including FB.

An article in Inquirer Technology seemed to signal that the Facebook team wasn't up to speed with CEO Zuckerburg's claim "We are a mobile company". Facebook director of product management Peter Deng said during a briefing with reporters at the company's campus in Menlo Park, California, "We have really just re-organized the company to build faster on mobile,".

It seems the jury is out as to where Facebook's growth is going to come from. Zuckerburg threw out the "search" possibility at TechCrunch. Well, truth be told search only makes money if you are really adept at advertising integration with search which Google (NASDAQ:GOOG) has mastered and Facebook has just begun to learn. Moreover, search is a capital intensive business to implement as Microsoft (NASDAQ:MSFT) has learned with its Bing service.

The Facebook forte to date has been building a large on-line global community which is free for users and has had its controversial moments regarding user privacy, personal data protection and ownership. The real question with Facebook is user retention. There are many articles of users trying to cancel their account encountering a frustration level. The problem we have experienced with Facebook is after you cancel your account, you still receive notifications from them trying to lure you back. Will Facebook "spam" everyone into leaving because of their quest to satisfy Wall Street? Our recent experience with Facebook reminds us of the great hit song from the Eagles, "Hotel California", where "you can check out anytime you like, but you can never leave". We researched this concept and found that Edgar Whittley from theguardian.co.uk wrote Facebook:the virtual Hotel California highlighting the privacy concerns and difficult disentanglement process from Facebook.

In fact, we think this feeling may apply to current and former employees who are waiting for their options, restricted stock to vest and/or be freed from their lock-ups. Its also may be the case for many financial institutions that participated in the FB IPO, Nasdaq and UBS just to name a couple, who are in a heated fight over large losses incurred in the offering.

Moreover, Facebook has a problem with younger users declining within its user base as reported by Ken Sena at Evercore Partners as Forbes summarized and we quote:

(Ken)"notes that U.S. ComScore data for August shows that time spent on the site was down 12% on a pro forma basis on a year-over-year basis. The biggest drops were in the 12-17 year old group - down 42% - and 18-24 year olds - down 25%."

We have polled our own ad-hoc sample group of youngsters and get the same result that seems to be occurring above. Our group is using Twitter and leaving Facebook for now. Imagine what happens to Facebook if this trend spreads to the other demographic groups inside the Facebook community.

Facebook's fully diluted adjusted market-cap with approximately 2.7 billion shares using the most recent closing price of $22.00 is approximately $59.4 billion.

We have written in the past regarding the current plight of Facebook resembling a "Death Spiral" security where lower prices cause more dilution. Although not exactly the same, we think the situation here could actually be a dicey scenario given the upcoming lock-up expirations in October 2012, November 2012, December 2012 and May 2013.

Possible Scenario 1 : Prospective new investors bid up prices which in turn encourages recently "freed" shareholders to sell now resulting in share prices to go back down and hurting these new investors.(See recent sales by Moskovitz, is he trying to get ahead of the herd?)

Possible Scenario 2 : Stock market optimism lifts "all boats" and Facebook shareholders get a reprieve until the scheduled earnings release on October 23rd, 2012 and the second wave of "Float Bloat" arrives on October 29,th,2012. The combination of these two events is bound to create an interesting scenario for traders in this name. We believe that there will be downside in the share price which could resume at any time given the number of potential real sellers of the stock who have either been freed or about to be freed from their lock-up agreements.

Possible Scenario 3 : Shareholders see the coming increase in float and refrain from purchasing which results in share prices declining from here and further scaring newly "freed" shareholders and option holders into selling at any price to insure some profit from their equity stake.

An important point that we like to make is that Nasdaq reported a drop in the short interest of FB shares by approximately 2.5 million shares as of 8/31/12. The short interest stands at 85,350,481 shares short as of 8/31/12. Therefore the drop in share price in late August came from real sales of shares and not an increase in short-seller positions. Insider selling is always a concern, regardless of the spin the seller puts on his reasons for the sale.

One does not have to go any further than Seeking Alpha to see the wide debate about the prospects for Facebook. The only thing we know for sure: 1.186 billion shares are being released in addition to the Facebook current float of 692 million shares. The 1.186 billion share increase is not including any of the 504 million Zuckerburg shares.

After a week of the hyping of QE3 by Ben "the Fed" Bernanke and a favorable ruling in Germany on the legality of the EU stimulus program, we think scenario 2 is underway and could ultimately lead to the next and possibly more painful down leg in FB shares regardless of their under or over performance as a company.

Disclosure: I am short FB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.