Do Not Short Facebook Stock

| About: Facebook (FB)

On November 1, 2013, Facebook (NASDAQ:FB) stock closed out the trading session at $49.75, which did calculate out to $121 billion in market capitalization. According to Wall Street, Facebook is now deserving of a valuation comparable to leading semiconductor company Intel (NASDAQ:INTC), which also carries a $121 billion market capitalization price tag. Over the past five years, Intel has averaged $9 billion in annual net income upon $44.7 billion in annual revenue. Going forward, Intel is likely to close out this 2013 fiscal year with $10 billion in net income, which would mean that the company now trades at an estimated 12 times current earnings. For the sake of comparison, Facebook may close out this 2013 fiscal year having banked $1.5 billion in net income upon $7 billion in revenue. According to this estimate, Facebook stock would now trade for 80 times current earnings. Be advised that Facebook and Intel fiscal years both coincide with calendar years.

Facebook bears may make the case that this social networking company is wildly overvalued and attempt to short the stock. Practitioners of modern portfolio theory, however, should recognize the idea that financial assets may not be rationally priced, in the short term. Famed British economist John Maynard Keynes famously declared:

"The market can remain irrational longer than you can remain solvent."

With interest rates effectively at zero, shorting the majority of technology stocks may be a fool's errand. Amazon (NASDAQ:AMZN) stock now trades for $360 per share, or $165 billion in market capitalization, despite the fact that this business has remained barely profitable off tens of billions of dollars in annual revenue. Over time, the much-maligned Henry Blodget was proven right, for what may appear to be all of the wrong fundamental reasons. Facebook shorts may wander off into a similar trap.

The Mechanics of Shorting Facebook

A trader opening a short position in Facebook would borrow shares from another investor, before immediately selling those shares for cash. At a later date, this trader would re-enter the market and buy-to-cover Facebook stock to make good upon the original stock loan. This series of transactions would have turned a profit, if Facebook stock were to have actually declined, after the trader opened up his initial short position. After a rocky IPO, however, Facebook stock bottomed out at $18.75, on August 20, 2012, before rebounding sharply to trade near $50 per share throughout October 2013. Facebook did debut at $38.

As of September 30, 2013, Facebook reported 2.4 billion shares of common stock outstanding. Of this amount, Yahoo Finance estimated that traders had sold a mere 30.9 million shares of Facebook short, as of October 15, 2013. On a relative basis, Facebook short interest is significantly down from the prior month, when traders had shorted 40 million shares of stock. Most likely, the Facebook short positions were promptly closed out when shares spiked from $45 to $55, between October 9, 2013, and October 21, 2013. The sharp move to the upside was not necessarily a short squeeze because of the minimal short interest in Facebook. Regardless of definition, this recent advance in price exposed the volatility and risks involved with shorting Web 2.0 stocks.

For the sake of comparison, Yahoo Finance also estimated that BlackBerry short sellers have opened up positions with more than 160 million out of the 515 million shares outstanding of this company. BlackBerry, because of its relatively small float, is more so susceptible to speculation than Facebook. Still, shorting any stock can be a risky proposition, as share prices may theoretically appreciate towards infinity. Facebook bulls, of course, would argue that the social media company is still in hyper-growth mode and is therefore fairly valued.

Web 2.0 Business Model

Facebook is a key pillar of the Web 2.0 movement. In broad terms, the Web 2.0 revolution integrated numerous websites and computer workstations within all-encompassing global ecosystems for entertainment, research, politics, and business. The Web 2.0 business model generally calls for each website to generate revenue through direct sales and online advertising. To improve profits, each Web 2.0 outfit will attempt to attract a loyal user base, in order to target advertisements towards that particular marketing segment. In effect, Web 2.0 companies operate as broker-dealers between the business community and mass consumers.

Facebook has emerged as the world's largest social media business, after literally originating from within the confines of a Harvard dorm room. Beginning in 2004, founder Mark Zuckerberg has taken on the "mission to connect the world." According to its latest Q3 2013 financial report, Facebook now operates with 728 million daily active users (DAUs) and 1.19 billion monthly active users (MAUs) visiting this website through September 30, 2013. Facebook MAUs and DAUs have increased by 18% and 25%, respectively, upon a year-over-year basis. Perhaps even more importantly, Facebook revenue increased 33% from $3.5 billion to $5.3 billion, between the first three quarters of 2012 and 2013. Facebook also swung from an $11 million loss to $977 million in net income during this same time frame. Facebook turned in its strongest financials as a publicly traded corporation during this latest Q3 2013, when it banked $425 million in net income upon $2 billion in revenue.

Going forward, Facebook business performance is likely to track the secular Moore's Law shift away from desktop computers and towards mobile devices. On October 9, 2013, research firm Gartner issued a report indicating that the PC market declined by 8.6% through calendar Q3 2013, in terms of year-over-year unit shipments. Gartner estimated 80.3 million in total Q3 2013 PC shipments. Meanwhile, IDC has forecast that tablet shipments will outpace PC shipments through Q4 2013 and annually by 2015. IDC also estimated 1 billion in total smartphone shipments for 2013. As part of this trend, Facebook managers have already highlighted the fact that the company's mobile monthly active user tallies increased by 45% through September 2013, upon a year-over-year basis.

The Bottom Line

Facebook is nominally overvalued. Facebook closed out its latest third quarter of 2013 with $14.9 billion in assets above $1.885 billion in total liabilities on the books. This social media company did include a mere $36 million in deferred revenue as liabilities. This amount will ultimately be booked as revenue, trickle down to net income, and transfer off balance sheet liabilities. Facebook would then be left with $14.9 billion in assets above roughly $1.8 billion in liabilities, which calculates out to $13.1 billion in intangible book value. Facebook would then carry $5.39 of intangible book value, on a per share basis.

Facebook's growth within the mobile space is also a Catch-22 event. Smartphones and tablets will obviously offer less screen space for advertising links than desktop and laptop computers. Facebook revenue growth has decelerated sharply while the company has shifted towards embracing mobile. The Facebook S-1 registration statement revealed 154% and 88% revenue growth for 2009 to 2010 and 2010 to 2011, respectively. Facebook may close out its 2013 books with 55% year-over-year revenue growth. Although impressive in its own right, 55% annual revenue growth does not justify paying $50 for Facebook stock at 80 times current earnings.

Facebook shareholders should consider selling out of positions now and taking profits. Beyond that, selling Facebook stock short does not offer a favorable balance of risk versus rewards, in this environment. With interest rates at zero, capital is flowing into speculative stocks. Former Federal Reserve Chairman Alan Greenspan may refer to Web 2.0 as the second coming of "irrational exuberance."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Tagged: , Internet Information Providers
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here