Short and Hold?! Facebook?
Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors waited eagerly for Facebook (NASDAQ: FB) shares to finally trade on the open market. It had been only eight years since the website was initially launched, and the company was already expecting to fetch a valuation of nearly $100 billion, making it the largest IPO in history.
The company’s price was set at $38 per share on the date of its IPO. After the market opened, shares of Facebook began pushing higher. Shares reached a high of $45 and closed the day at $42. The next day, the company opened at a price below the prior days open, and shares have continued spiraling down ever since, despite its growth in users.
Growth and Potential Valuation
Facebook has gained tremendous traction in an extremely short period of time. The company boasts an active user base of over 800 million, and that number is continuing to grow.
The average revenue per user (ARPU) for Google (NASDAQ: GOOG) search is about $24 per year. Facebook has an ARPU of only $4.81 per year. If Facebook is able to grow its ARPU to $24 and maintain its high margins of 13.34%, then the company will earn $2.7 billion. Even if the company is able to increase its user base to a billion monthly active users, grow its ARPU to $30 per user, and grows its profit margin to 15%, the company will only earn $4.5 billion. A valuation of ten times earnings would give the company a valuation of $45 billion, right around its current valuation. In order for the company to receive a higher valuation it would need to be able to grow its numbers by more than that.
Even if Facebook is able to boost its user base to a billion people (over 1/7th of the world’s population!) it will need to grow its revenue per user substantially. There are several things the company could do to grow its ARPU. Adding more games, increasing advertising, making ads more targeted, and adding a payment system to allow purchases from third parties to be made on Facebook would all help to grow revenues. It is difficult, however, to see how Facebook would be able to manage seeing a five-fold increase in ARPU, especially considering the trend toward mobile advertising that is occurring.
Mobile Advertising
Ever since Apple released the original iPhone, sales of smartphones have been skyrocketing. It has been projected that there will be more than one billion smartphones in the World by 2016.
Needless to say, this change in technology has had broader implications. Companies such as Facebook and mobile game maker Zynga (NASDAQ: ZNGA) have emerged to take advantage of this trend. With games like “Words with Friends” and “Zynga Poker,” the company has been able to profit from the number of mobile users in the world. Unfortunately, Facebook does not benefit from mobile users. Unlike games that are meant to be played on the desktop, such as “Farmville,” from which Facebook gets a 30% cut of all sales, Facebook is not able to make money off of apps.
In addition to problems associated with using games to monetize mobile users, Facebook will have problems with mobile advertising. Facebook currently does not have any advertising on their mobile platform. Because of the small screen size on phones, ads will necessarily have to take up a significant portion of the screen to be visible and clickable. When Facebook places ads on its mobile app, it will likely repel some users, at least initially. This may make Facebook hesitant to monetize the app. Additionally, mobile ads tend to receive less per click than desktop ads do. This makes it difficult for Facebook to monetize its mobile users successfully.
Conclusion
With Facebook’s growth it is easy to see why some investors ‘like’ the company. However, it will be difficult for Facebook to become profitable enough to warrant its current valuation. Given the difficulty associated with monetizing mobile users, as well as the current valuation of the company, it is very likely that shares of Facebook will continue to fall slowly over time. While I would not necessarily be short the stock, being long the company doesn’t make sense at its current valuation.
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Kyle has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Facebook, and Google. Motley Fool newsletter services recommend Apple, 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.
