Two Traders Reserve analysts share their thoughts on the social media industry.
By Michael Shulman and Jim Woods
Social media giant Facebook is going public. The company recently filed its S-1 docs for a $5 billion IPO, and that’s created a huge amount of buzz for related social media stocks such as Zynga (ZNGA), LinkedIn (LNKD), Groupon (GRPN) and Pandora Media (P). The ubiquity of Facebook, and the social phenomenon that it’s become, has nearly everyone talking about the potential for the soon-to-be publicly traded shares, and for the other stocks in this new sector. To determine if Traders Reserve readers should “Like” social media stocks, two analysts, Michael Shulman and Jim Woods, recently convened to weigh the pros and cons of the nascent industry.
Jim: When I look at what Facebook has accomplished in just a few short years, I am truly stunned. The company’s metrics are staggering. Facebook boasts of having 845 monthly active users, or MAUs, during December. That’s up nearly 40% over the past year. About 425 million used mobile products during the month, and there were more than 100 billion friend connections. On a daily basis, users average 2.7 billion “Likes” and comments. CEO Mark Zuckerberg is just 27 years old, and he owns 28.2% of the company. This means he’s worth about $28 billion based on the estimated IPO valuation of $100 billion. I am of the opinion that Facebook is a game-changing company in an industry that’s only going to continue growing exponentially. In fact, you might compare Facebook to the likes of Google (GOOG), Amazon.com (AMZN) and even Apple (AAPL) in terms of its impact on business, the importance of the role it plays in society, and more importantly to both of us, the company’s profit potential and share price upside. So Michael, are you as bullish as I am on the future of FB?
Michael: I wrote, edited or otherwise contributed to a couple of S-1s during the first Internet bubble, so I am by experience a bit cautious. The key metric I wanted to see in the Facebook S-1 is missing: the growth in revenue per “user” (not overall, not per page view). The average, the median, and how much revenue it is getting from its top 5%, 10% and 20% of users. Where am I going with this skepticism? If Facebook is getting too much revenue from its addicts – four hours or more in a recent survey – it is not going to grow its business as fast as everyone hopes. And this is all about growth. Can Facebook grow into the proposed valuation? Microsoft (MSFT) did. Google did. Yahoo (YHOO) did not. There are two ways for Facebook to grow revenue: advertising, and some form of value-added services where Facebook functions as a middleman selling stuff to its users. On ads, it has to compete against Google. As a middleman, it has to compete against Amazon. And there is no evidence whether Google or Amazon ever increased overall spending in those categories. Rather, they took it from traditional advertisers and stores. That means Facebook has to take revenue share from Google and from Amazon. Will it? Yes. Will it do so at a pace where it can quickly grow into its valuation? That hardly seems likely, does it? Google crushed Yahoo, a poorly managed and arrogant company. Amazon crushes everyone in sight by out-managing them. It is hard to see Facebook out-managing Google AND Amazon.
Jim: I, too, have doubts whether Facebook can quickly grow into its valuation. Moreover, it’s hard to see Facebook out-managing two of my favorite companies, Google and Amazon. However, I do think that the organic growth potential of Facebook’s user base, as well as the potential growth of its business and more and more users come online, is something nobody should bet against. I think that from a pure buzz standpoint, the stock is destined to be a bona fide winner right out of the gate. This is one of those stocks that everyone will want to own, from hedge-fund manager down to the smallest Main Street dabbler. On sheer demand alone, I expect the stock to soar out of the gate. And, unlike so many of the companies we both worked with during the 1990’s dot-com bubble, Facebook has proven it can make money with a targeted audience that advertisers will pay for. In terms of comparing it to existing entities like Google and Amazon, I don’t think it’s fair. Fair, that is, to Google and Amazon. Facebook is a game-changer, and in a class by itself in terms of its identity. I think this niche makes it the kind of company that five years from now everyone will regret not owning back in 2012. As for other social media stocks, I think the jury still is out. On Wednesday, Feb. 15, we saw Internet-gaming firm Zynga beat on both the top and bottom line. Unfortunately, the company warned of slower growth going forward. The shares dropped sharply on the news, although they had been up some 50% year-to-date before taking an 18% one-day hit. Michael, is this the kind of growth scenario disappointment you fear with Facebook? Also, do you not agree that Facebook’s niche market dominance will make it the kind of company that everyone will want to own?
Michael: I agree the stock will come out of the gate fast and probably will do well for a while, perhaps until the lock-up on shares ends, which is usually six months after an IPO. But I doubt what they can do after that. Facebook cannot grow as fast as Google. Google’s grown fast, and continues to grow reasonably fast by taking more ad dollars from other media. Facebook has not proven it can intrude on the quasi-privacy it has created for its members and sell ads at the rate Google has. And Facebook certainly cannot cannibalize traditional retail sales the way Amazon has — and continues to do — at a rapid clip. I guess you can say I am mildly bearish on the business over the long haul compared to others because it has too much to prove, and too many things have to go right for the company and the stock to be the next Google or Amazon. I must go back to my previous comment, that while I believe most businesses, including Google and Amazon, live by the 80/20 rule, you get 80% of your business from 20% of your customers or users, I fear Facebook may be looking at a 95/5 rule and that means growth will slow sooner than expected. As for everyone owning it, yes, at the institutional level, you’re absolutely right. So, I completely agree, it is going to do very well for a while as every fund manager under the sun will have to buy shares.
Jim: Over the long term, you may be correct about the 95/5 Facebook model. Still, with just 5% of such a big pool of users, that’s a whole lot of targeted eyeballs that advertisers will be willing to pay for handsomely. As for the short term, it seems we both agree that Facebook will be a stock to “Like” at least for the first six months of its public life. Well, Michael, our time is up, but before you go, be sure to “friend” me on Facebook. After all, it pays to have friends in high places.