3 Reasons Why I Bought Calls on Facebook

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

“This business is living organism, multiplying constantly, surrounded by predators. There's no rule for idle time or second guessing.  New discovery was made hourly. New ideas are ready to be devoured and redefined. This business is binary you are a one or a zero, alive or dead…There is no second place.” - Gary Winston from the movie Antitrust.

That binary future is what awaits Facebook (NASDAQ: FB) investors.  They’ll either succeed in monetizing mobile or they won’t.  They’ll either figure out creative ways to monetize their nearly billion active user base or they won’t.  The real question you need to be asking yourself is which side of the debate are you on?

I’ll be quite honest with you, newly minted Facebook at a hundred billion dollar market cap didn’t interest me one bit.  However, a Facebook that’s plummeted by over 40% and still called overvalued and said to be worth as low as $15 a share does interest me.  That’s why I bought calls both personally and publically.

The Genius Factor

While some might say that it’s a bit a stretch to call founder and CEO Mark Zuckerberg a genius at this point, we have to remember that he’s not yet 30 and already built the world’s largest social network.  Some people are just born to change the way we’ve always done things. 

Take Apple’s (NASDAQ: AAPL) Steve Jobs, he created a computer company.  Over time that company became the world’s most valuable company and has revolutionized how we listen to and buy music, how we use our phones, and just for fun he’s also changed the way we surf the internet and enabled it to be much more mobile. 

How about Amazon’s (NASDAQ: AMZN) Jeff Bezos?  He started with selling books online and now his company has changed the way we read those books.  Now with “earth’s biggest selection” you can buy almost anything from their online store.  Not only that but they are challenging Apple with a cheaper tablet and have innovated many brick and mortar stores out of business. 

To say that Mark and the team of brilliance he’s assembled can’t follow in either of their steps is not a bet I’m willing to make.  Now that they’ve been publically maligned in the wake of the poor IPO you can bet that the team is driven to show their detractors that they’re wrong.  We know that Facebook employees are working feverishly on social search and e-commerce platforms, along with many more possibilities that only engineers can dream up, but it’s tough to put a value on the hope that at least one of these will work.

All Valuations Are Relative

So where do you value the company?  I’m going out on a limb and say more.  When Google (NASDAQ: GOOG) went public it was valued at $27 billion and traded at 142 times trailing net income and 12 times revenue.  Facebook’s hundred billion dollar market cap at its IPO valued the company at 107 times earnings and 26 times revenue.  Both are nosebleed valuations by any metric, but big G has gone on to return nearly 700% since they went public.

Yet for every Google that dominates there is a Yahoo! that stagnates.  With about half the global monthly active users as both Facebook and Google, Yahoo’s been the poster child for a company that’s unable to monetize their massive user base.  I’d say Facebook is well ahead of Yahoo! in monetizing their user base.  In the last two quarters they’ve had revenue of $1.18 billion and $1.06 billion while Yahoo’s revenue was just slightly higher at $1.22 billion and $1.22 billion.  Yahoo! has about a decade on Facebook, you’d think they’d be a little bit farther along by now.  Still, it does give you an idea as to the other side of that binary future that investors need to watch.

Options Minimize Risk

When a company has such a binary future I prefer to minimize my risk whenever possible.  That’s why I prefer to buy call options.  I know what you must be thinking, aren’t options more risky?  Not when used properly. 

If I were convinced that it was worth the risk to buy 100 shares of Facebook it would set me back about $2,200.  If I ended up being wrong and Facebook botched their opportunities that value could dwindle down to whatever cash was still left on their balance sheet. 

With options I can invest about a quarter of that amount and still bask in all the upside past my breakeven point.  While my breakeven point is bumped up from $22 a share to closer to $27.50 when you’re looking at a future that could be many multiples of that, the higher breakeven won’t matter.  However, if again they do botch the opportunities before them I’d have lost a lot less.  In buying calls I have more than a year to see which side of this binary future they’re likely to follow before adding any more capital.

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latimerburned owns shares of Apple and has the following options: Apple. The Motley Fool owns shares of Apple, Amazon.com, Facebook, and Google and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Amazon.com, 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.

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