2 Web 2.0 Companies To Buy Cheap, 1 To Avoid

Anjali is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Most of the companies which were considered cheerleaders of Web 2.0 revolution a couple of years ago have seen their stocks plummet after listing. The current situation is eerily similar to the post 2001 dot com bust. Companies like Amazon and Yahoo had corrected ~95% from their peak value by 2002. To some extent this was justified as they were significantly overvalued to begin with. However, the market reacts in an extreme manner both on the upside and downside. When things are going right, investors forget about any risks and stock price reflects an overly optimistic scenario which is almost impossible to achieve. On the other hand, when things go wrong, investors become overly bearish, even on good companies with sound fundamentals. Both Yahoo and Amazon gave 600-700% return in the years following their lows in 2001-02. I scanned three companies from the current web 2.0 bust to find if similar opportunity exists in the current market.

Company Name

% Correction from the peak to trough

My Take

Facebook (NASDAQ: FB)

 61%

Buy

Groupon (NASDAQ: GRPN)

 87.2%

Buy

Zynga (NASDAQ: ZNGA)

 86.1%

Avoid

I like Facebook and Groupon among above stocks. However, I would recommend avoiding Zynga, even at its current low valuation. Here are my reasons.

Facebook was the biggest tech IPO in the stock market history. However, it disappointed investors who valued the company at $100 billion in the hope that it would be able to topple Google’s leadership position in online advertising markets in the near term. This was too much to expect from a company with annual revenues of $3.7 billion vs. Google’s $37 billion. Another investor mistake was their incorrect assessment of mobile phone usage. Given the low CPM from mobile users, Facebook was not able to benefit increased user base and increased engagement from mobile.

After the recent correction, I believe the stock is trading at reasonable levels. Given Facebook’s reach and engagement levels, I believe it will at least be able to reach the number two position in the online advertising market in the next 4-5 years. Facebook is also working on developing an ad network similar to Google’s Adsense that will enable it to show client advertisements on third party sites. This can be a significant near term catalyst for the stock. As far as threat from mobile is concerned, Facebook’s CEO Mark Zuckerberg has himself said that Facebook is more likely to make money from mobile than desktop. This may take some time, but for long term investors mobile should be an opportunity rather than threat.   

Facebook is currently trading at ~30x forward PE. Although it is a bit on the high side compared to old tech companies, I believe Facebook has excellent long term growth potential which justifies it premium valuations. I believe the stock can give good returns to patient investors.  

Groupon is another good buy candidate. Although many skeptics have questioned Groupon’s business model and sustainability of its pricing power, the company’s fundamentals have so far proved them wrong. Groupon posted positive EPS in both the March and June quarters and I believe the company will see improved profitability going forward. According to sell side estimates, the company is expected to post $0.18 EPS in this year and $0.36 next year. Its topline is expected to grow 44.80% this year. At current valuation, the company is trading at a forward PE of 14.64 which is cheap given its growth profile. Its current market cap is also lower than the buy-out offer it received from Google before it became public. I believe the company is significantly undervalued and recommend buying it with a medium to long term horizon.

Zynga at first glance appears cheap. At the current market valuation of $1.8 billion, the company is approaching its cash value. However, I still won’t recommend buying it. My biggest concern is the risk posed by copyright infringement lawsuits. Zynga may end up paying hefty fines for copyright violations just as Samsung ended up paying Apple. So, we cannot say that the cash holdings will provide a good cushion for Zynga’s stock price. Also, the company’s core gaming business will likely prove to be cash burning machine and is unlikely to turn around anytime soon. If we go by consensus analyst estimates from Yahoo Finance, the company is expected to post losses in the current quarter and the next. Given these worries, I won’t be surprised even if company’s market cap goes below its cash value.

To sum up, Facebook and Groupon appear attractive after correction. Long term opportunities in online advertising and mobile markets make me positive on Facebook, while Groupon’s low valuation and high growth rate makes it attractive. Zynga, despite the correction, still appears risky given its declining core fundamentals and copyright infringement lawsuits.

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AnjaliPaliwal has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and Google and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Facebook and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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