Facebook: claimed by bulls and bears
Assessing a company’s prospects at the point of IPO is fraught with difficulty; Facebook is a case in point.
The first question I was ever asked at an interview for an investment role was “what has happened to the share price of company X today after its IPO yesterday”?
Having been at the company’s offices since before market opening, and in the days before mobile internet, there was no way of knowing, but my cynicism led me to the fortunately correct answer “it fell… IPOs are always overvalued”. Okay, perhaps not fair, but we were in the technology bubble and it seemed a sensible answer. I will not name the company but suffice to say I am not entirely certain it ever recovered its initial IPO price.
It is no great surprise, I am sure, that the above anecdote acts as an introduction to a discussion over Facebook. Its IPO remains a topic of heated debate across the media, and recent sales by senior members of the business do not generate much confidence. Is this fair? And is the business really being priced rationally or do we just see the market veering from bull case to bear case without settling at some point in between? Perhaps, but it is worth reminding ourselves of both sides of the argument first.
On the bull side, Facebook has market penetration globally at a level unprecedented by all but a small number of companies. Perhaps even more importantly as a standout feature, this penetration is particularly strong in the younger demographics that the majority of businesses struggle to engage with. User numbers might ebb and flow these days but ultimately this is a globally dominant business, an incredibly well-known brand, and while hardly favourable in its story, has a successful feature film about its inception. What is not to like?
Well, the bear case is perhaps equally compelling. The business does not have a clearly articulated plan on how to monetise the vast number of users to any great degree (the oft-quoted in technology stock analysts RPU, or revenue per user, is minimal). And we know that such monetisation can be very difficult to implement in the “new world” of the internet, where users expect everything for nothing – a characteristic particularly evident in the younger generation, where, as mentioned, Facebook is particularly dominant. Introducing a paid for service, for example, while either removing or limiting the current service, is probably business suicide, yet advertising revenues alone are quite possibly insufficient to build a long term business model that comes even close to justifying the company’s current valuation.
The problem is, therefore, that current valuation depends on the ability of management to develop and execute an as-yet unknown strategy for increasing revenue. This is not easy to assess, and probably brings the cynic in many of us to the fore. However, before we write off the company’s prospects, we should remember that not long ago Google was in a similar predicament, with a globally dominant brand, not well-monetised, and an eclectic management style which perhaps typifies technology start-ups, however large they become. But the same people who successfully create these types of businesses might just – over time – be able to adapt them from “growth” businesses (in terms of number of customers) to “compounders” who monetise the customers they have to create year-on-year added value. In hindsight, I certainly wished I had backed Google at the point of IPO, however much this might have been more hunch than rigorous analysis.