A week after the debut of the most awaited initial public offering since the 2008 financial crisis, shareholders of Facebook reacted with shock and horror as it floundered. True-to-form Wall Street die-hards sued the social networking website and the lead bankers who took the stock public, alleging selective disclosure of weaker-than-expected future earnings. Still, irrespective of allegedly being misled, investors who believed the website could really be worth 100 times earnings are, simply put, gamblers. It’s somewhat hard to feel sorry for those losing at the casino.
For a start, here is the number math. Facebook, with 900 million users, generated barely $4 billion in revenue last year. As of March, its income stood under $1 billion. At the stock price of $38 a piece, the company was valued in excess of $100 billion.
Even if Facebook touches 1 billion users, which it could well do this year, there is really no guarantee that its new users will spend exponentially more than existing ones to take those earnings and sales numbers up manifold. If anything, revenue growth at Facebook has slowed in the past few quarters.
While it is still early to establish if bankers to Facebook did warn only some institutional clients about a future slowdown in revenue, it’s going to be pretty easy to prove that those who were buying Facebook were willing to pay record high premiums to hold the company’s stock. This, despite the fact that Facebook couldn’t realistically demonstrate that it could make good those high valuations. Such investors aren’t really value-conscious investors, peeling back each detail in the prospectus for likely red flags.
Facebook’s biggest problem in staying fashionable, and one that dogs other such Internet sites that sell experiences, not goods, is that it’s hard to tell how long the users will want to have the same experience before moving onto something else. So, even if investors are hoping for returns. it’s based on the whim of millions of users whose behaviour even Facebook has no way of accurately predicting.
Users, unless they spend, are of little value to websites or their primary clients — the advertisers. In what was an early warning sign that display advertising could be losing friends on Facebook, America’s leading automaker, General Motors, pulled the plug on paid advertising on the site ahead of the listing. Investors who missed that cue were pretty much hoping that sheer market hysteria, instead of a convincing revenue model, would keep Facebook’s stock price high.
There were other hints for those looking for value through their holdings. Billionaire investor Warren Buffet, who also advised Facebook founder Mark Zuckerberg on the share sale, said he was not investing in the social networking company because he simply could not understand how the company would make money. Buffett, famous for investing in Coca Cola because enough people want sugared water, couldn’t quite tell how a free interface could generate billions of dollars for years to come.
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To be fair, Facebook is a phenomenon that has changed social habits and spawned the odd revolution. However, its unrivalled popularity and recall needs to walk in tandem with the basic rule of equity investing — it’s only going to go up if it is underpriced and the market always determines the price.
In fact, when the investing guru to billionaires, the value-seeking Bruce Greenwald, a professor at Columbia Business School, was asked about investing in Facebook, he famously told Fortune magazine, “Facebook has 1 billion users. Air has over 7 billion users. It’s a lousy investment.”
Those who didn’t pay attention were lousy investors.
Anjana Menon is a Delhi-based business writer bsshoptalk@gmail.com
