Slowly, it is sinking in. Facebook (FB) was floated in May as a growth stock. Forecasts and valuations were based on extrapolating historic trends. But in the new media world, that is impossible. My bear case against Facebook was always that the rating was too high based on historic numbers and that one had to be the metric used given that forecasting was impossible. Rather more quickly than I had expected, recent data is starting to vindicate my stance. I argued here on 28th August that the shares were worth $5, and I stand by that view.
The issue for Facebook has always been its inability to effectively monetize its user base. To that end, we see an endless stream of announcements about new offerings (Facebook gifts, etc) but that serves merely as a reminder of the core issue: advertisers earn low returns on Facebook because most of its users have a low disposable income (teenagers, students, 3rd world dwellers) and nearly all seem reluctant to view it as a portal to purchase.
The only way that Facebook has convinced Wall Street that its valuation was fair was to point to the rapid growth in user numbers. I shall ignore for now the issue of bogus accounts but focus instead on two issues which are thrusting themselves to the fore: ennui and the switch to mobile applications. Recent data from Comscore for August, summarized by Forbes, illustrates both points.
- Mobile users rose 4% sequentially to 90M in August.
- Mobile average daily visitors were up 6% sequentially to 52M, while average minutes per user rose to 3% to 517.
- Total minutes fell by 5% from July to 108B.
- Desktop minutes dropped 13% to 61B.
- Mobile usage now accounts for 43% of total minutes or 47B.
- Desktop unique users were up 9% year-over-year, but down 2% sequentially.
This data related just to the U.S., but this is the mature Facebook market. Other markets will follow that trend in due course. The total minutes number is the devastating metric. It raises the very real fear that ennui is setting in. Facebook was hot. It was a trendy thing to do. It could be that the botched IPO and stream of negative stories about the company and Mark Zuckerberg have damaged the brand and given less cache to being a Facebook user. Or it could be that boredom has simply started to set in. Once your parents start talking about something, kids do something else. I have always wondered, what was the appeal of posting photos and having inane chats with quasi-friends? I suspected that appeal would wear off. Maybe that process is now starting.
Maybe not? It could be August was just a blip. But I note that in August 2011, total minutes in the US rose by 1% (so this is not entirely seasonal) while in July 2012 minutes were flat. I am minded to believe that this is the start of a very real and damaging trend for Facebook.
The second big issue is that while mobile users increased sharply in August ( average daily visitors were up by 6% to 52 million and the average minutes per user rose by 3% to 517) desktop minutes slumped by 13% to 61 billion. Mobile usage now accounts for almost half of total minutes and that percentage will increase. And the fact, admitted by Facebook, is that it is a lot harder to sell advertising click-throughs over a mobile unit than via a desktop (not that Facebook is a great success at the latter).
The smart money has to be on these trends from the US accelerating and being followed worldwide. On that basis it is hard to see how anyone can make any accurate forecasts about growth in advertising revenues. Q2 earnings forecasts of 12 cents were met. The company might just meet Q3 estimates of 11 cents (when reporting on 23rd October) but going forward beyond that, forecasting is well nigh impossible.
For what it is worth, analysts currently expect full year earnings of 49 cents for this year and 64 cents for next year. But i would argue that with clear signs that the company is losing customer momentum, this is bound to affect advertising revenues and as such the risks in a material sense are on the downside. Frankly there is very little earnings visibility.
The problem for the bulls (and all those analysts who still rate the stock as one to hold or buy) is that even at $21.55 this is still valued as a growth stock. 34 times 2013 earnings puts it at a huge premium to the internet or technology sectors let alone the S&P. But forget peer group comparators: paying that sort of multiple can only be described as a value investment if the company has both a long track record of delivering consistent and steady profits (not revenue) growth and has very strong forward visibility. Facebook is not that sort of company.
In the short term, traders are all too aware that vast numbers of shares will be freed from lockup during the next three months, and with many of the holders having paid mere cents for their stock, the threat of a major selloff is very real. In the longer term, the fact remains that unless Facebook can somehow reverse its negative usage metrics and also demonstrate how it can monetize mobile users far more effectively, this company has lost all momentum and cannot be viewed as a growth stock.
As such, I stand by my contention that I would value Facebook on a multiple of historic earnings and that the appropriate multiple is at the lower end of the long term Dow average range (13-22). Therefore, my target remains $5.