Memo To Snapchat: Take The Facebook Money And Run

| About: Facebook (FB)

On November 13, 2013, a harried Silicon Valley and financial press were abuzz digesting news of a $3 billion acquisitions offer out of Facebook (NASDAQ:FB) for messaging application company Snapchat. Shortly thereafter, Google (NASDAQ:GOOG) entered the fray of a short-lived bidding war, with a $4 billion bid of its own for Snapchat. Perhaps even more shockingly, was the fact that Snapchat and its 23-year old co-founder and CEO Evan Spiegel went on to promptly reject the acquisition offers out of both Facebook and Google. At the time, Snapchat was a 20-employee operation that had yet to turn one penny in sales. Ironically, the Web 2.0 movement may best be described as the second coming of irrational exuberance.

As such, any recommendation towards Snapchat that the company entertain and accept the Facebook buyout may be derided as somewhat Machiavellian. Business is business, of course. That being said, Snapchat should cash out at the top of the market, rather than risk slogging through an embarrassing scandal and severe asset price correction, going forward. Alternatively, Facebook shareholders should remain cognizant of the idea that the social media company is willing to both open up its checkbook and leverage overpriced stock to acquire side businesses with no sales, let alone net income. Conservative investors should consider cashing out of Facebook stock, taking profits, and never looking back.

Irrational Exuberance 2.0

A 1913 Act of Congress established the Federal Reserve as an institution tasked with the contradictory goals of managing the domestic economy towards full employment, while also preserving a stable price level. Federal Reserve officials and economists have often cited Bureau of Labor Statistics unemployment and consumer price index (CPI) data as guidelines confirming the effectiveness of monetary policy. Be advised that nominal BLS unemployment rates generally do not account for the underemployed and those who have literally dropped out of the workforce, altogether. Alternatively, CPI statisticians may strip out volatile food and energy costs from the presented inflation data. Certainly, the accelerated rise in grocery, gasoline, and tuition costs have eroded middle class purchasing power in recent years. Meanwhile, investor Peter Schiff has actually thrown around the term "hyperinflation" to describe the advance in recent gold and stock market valuations.

In calendar Q4 2008, the U.S. central bank actually lowered its federal funds target rate to an unprecedented zero amid the depths of a credit crisis and housing bust. From there, The U.S. Treasury and Federal Reserve then went on to introduce Troubled Asset Relief Program (TARP), Operation Twist, and reverse purchase facilities as new programs and terminologies within the financial lexicon. In summary, each new program was designed as means to purchase government bonds on the open market, in order to ramp up money supply liquidity and drive down interest rates. Last December, Ben Bernanke and the Federal Reserve Board announced a plan to taper, or curtail monthly bond buying purchases by $10 billion, to $75 billion. Fed officials have taken care to differentiate between tapering and tightening. Going forward, The Federal Reserve will throttle back upon its newfangled stimulus programs, but will maintain the target rate at zero, until the unemployment rate falls significantly beneath 6.5%. Still, Federal Reserve Bank of New York President William C. Dudley already admitted:

"We don't understand fully how large-scale asset purchase programs work to ease financial market conditions."

If anything, a strong case may be made that the Web 2.0 economy has been the primary beneficiary of speculative capital originating out of the Federal Reserve System. The Nasdaq Composite Stock Index collapsed to 1,398.07 towards the tail end of 2008, before rebounding sharply to close out the January 3, 2014 trading session at 4,131.91. Online retailer Amazon (NASDAQ:AMZN), as a Nasdaq component, traded above 1,000 times earnings throughout the course of 2013. Wall Street traders now value Facebook itself at approximately $135 billion in market capitalization, despite the fact that the social media empire had only taken down a mere $977 million in net income through the first nine months of 2013. Expensive stock does grant Facebook somewhat of a Catch-22 wherewithal to make acquisitions. On April 9, 2012, Facebook announced that it would purchase Instagram for a then $1 billion in cash and stock. Facebook has already proven its willingness to buy out the competition at the top of the market, in order to protect its empire.

The Social Media Market

The Web 2.0 economy may be defined as an interlocked group of companies that add social networking above the original dot-com construct. As such, the Web 2.0 business may be described as a broker-dealer, or a middleman, that matches an established user base to advertisements, goods, and services. Facebook, with its reported 1.2 billion in monthly active users, reigns supreme as the current King of social media. For the sake of comparison, Twitter (NYSE:TWTR) made its public debut on November 6, 2013, with 218 million monthly active users upon its rolls. Twitter, of course, is notable for limiting user posts to a maximum of 140-characters. The rise of Twitter parallels the literal shortening of Web 2.0 attention spans. Web 2.0 is home to the "TL;DR" meme, which is an acronym for too long; did not read.

Photo sharing and messaging applications are now emerging as the next frontier beyond Twitter shorthand. Legions of Web 2.0 users are apparently satisfied to click through images and skim brief messages, rather than slogging through paragraphs upon paragraphs of arcane text. Last October, English actor Ralph Fiennes mocked the Web 2.0 social media complex for "dumbing down" language and critical thought. Fiennes, however, should take note of the secular shift away from desktop computers and towards mobile devices, before he attempts to mount his high horse. Research firm International Data Corporation (Pending:IDC) has already estimated that annual tablet shipments will exceed annual personal computer shipments by the end of the year 2015. For 2017, IDC estimated 2.1 billion and 319.7 million in mobile (tablet+smartphone) and personal computer shipments, respectively. Mark Zuckerberg had already defined Facebook as a "mobile company," before Menlo Park reported a 45% year-over-year increase in mobile monthly active users through Q3 2013. Mobile devices are obviously less suitable for perusing rows of dense text than are 27" Apple (NASDAQ:AAPL) iMac computers.

Facebook executives may have been eyeing both Instagram and Snapchat photo sharing and messaging applications as operating at the most recently constructed off-ramp from the Information Super Highway. According to The Wall Street Journal, sources familiar with the matter indicated that Facebook actually approached Snapchat with an acquisition offer above $1 billion, before returning back to the bargaining table willing to pay $3 billion for the messaging application company. Business Insider did estimate that Snapchat users shared 400 million snaps, or daily photo and video messages, through November 2013. Meanwhile, Facebook and Instagram users were to have uploaded 350 million and 50 million daily photographs, respectively, through the same time frame. Taken together, Snapchat, Facebook, and Instagram dominated 99% of the online photo-sharing market through November 2013.

The Bottom Line

In July 2008, Google laid out a $200 million offer for news aggregator Digg on the table. Michael Arrington and Tech Crunch, however, were to later report that Google walked away from the deal at the eleventh-hour of due diligence because of issues that were described as "personality driven." At the time, Google was apparently impressed with Digg's financials and growth potential, but remained wary of a prospective culture clash between top managers at both firms. Digg was to ultimately sell itself off to Betaworks for a mere $500,000, four short years after the Google talks had ended. Certainly, Snapchat executives must be very well familiar with the rapid turn of events at Digg and Silicon Valley at-large.

A recent security breach at Snapchat rocked the Web 2.0 world. Last December, hackers who built website were brazen enough to grant access to 4.6 million Snapchat user names and eight out of ten digits of their associated phone numbers. This information may also be patched together to mine Facebook and Twitter accounts. Language posted on the website attempted to portray the hacker group as somewhat of an underground consumer protection agency. The creators of this website justified their work by arguing that Snapchat programmers had not responded quickly enough to close a gap in security already exposed by Gibson Security. did post up a link to take up Bitcoin donations.

On top of this latest debacle, Snapchat has already been recognized as a preferred medium for sexting, or the exchange of provocative messages and photographs between users. Jemima Kiss and The Guardian have thoroughly ripped Snapchat, the Facebook poke application, and sexting as "dirty" and "smut." Numerous surveys, including a Fall 2013 report out of investment bank Piper Jaffray, have indicated that teenagers have swiftly migrated towards Snapchat, at the expense of Facebook. Expanding teenage use alongside the explosive growth of the sexting movement may present ongoing legal, social, and moral challenges at Snapchat. As such, Snapchat should quit while it is ahead and sell itself off, before the aforementioned issues force the messaging application mission to crash and burn. Again, the move may be described as Machiavellian, but business is business.

Prospective technology investors, of course, should at least be willing to recognize and debate the idea that shares of Facebook stock are overvalued. Facebook carries a $135 billion market capitalization, yet may close out its 2013 year with $1.5 billion in net income, at best. At current levels, Facebook trades for 90 times estimated earnings. Facebook closed out its Q3 2013 with $9.3 billion in cash and investments on the books above a mere $1.9 billion in liabilities. Year-over-year cash flow from operations did improve from $931 million to $3.0 billion through the first nine months of 2013. Facebook swung from an $11 million loss to $971 million in net income through this same time frame. Still, Facebook must continue to grow exponentially into the near future to justify its current market valuations. Talks of opening up the Facebook checkbook to overpay for perceived threats, however, may be yet another symptom of fissures within the social media growth story. Facebook investors may consider immediately dumping stock and taking profits, in order to skirt the risks of a significant price correction in shares.

Disclosure: I am long AAPL. 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.

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