Facebook Teen Exodus Should Keep Investors Away From Stock

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As report after report continues lamenting the fact Facebook (NASDAQ: FB) is losing the younger generation, investors have turned content with the stock. Does a disconnect exist between older investors and the younger crowd? Or is it possible that Facebook can overcome the loss of the younger crowd unlike other social networks in the past such as MySpace?

The social network leader is now facing pressure from numerous sources that are attracting users especially in the younger generation. Teens are flocking to micro-blogging sites like Tumblr and Pheed and to image sharing sites like Instagram and Snapchat. Not to mention, users around the world are moving to messaging alternatives such as Kik and WhatsApp in the US to WeChat in China and KakaoTalk in Korea. Users as well are being pulled into social sites that connect them with similar interests such as StockTwits for stock traders and Pinterest for sharing fashion related items.

Another interesting dynamic is that the other CEOs of the social networking sites that went public at the same time as Facebook have already been replaced. Zynga (NASDAQ: ZNGA) just announced the replacement of founder Mark Pincus and Groupon (NASDAQ: GRPN) has soared after replacing its founder several months back. The below chart shows how the lagging sites are quickly outperforming now that new management controls the company:

<img alt="" src="http://media.ycharts.com/charts/9a09831b38f47b66f95ae1ff0dadd459.png" />

FB Total Return Price data by YCharts

Analysts remain bullish

In early June, both Goldman Sachs and Piper Jaffray had bullish notes on the largest social network. In fact, Goldman has a $40 target for Facebook, a level 60% above current prices. To reach that price target, the stock would be valued at an incredibly high $95 billion. The average analyst only forecasts revenue of $6.7 billion this year giving an indication of the bullish gap between analysts and teens. If all of the reports are accurate about the network losing the most prized user base, then why do analysts remain so bullish on the stock?

The main point used by analysts is that the company can continue increasing monetization of existing traffic. While true, more ads could lead to a faster exodus of users. Stocks typically don’t maintain lofty revenue multiples when the user base has peaked or is even in decline. Another interesting concern with the analyst group is that the typically older user base is still growing, suggesting that potentially the analysts are biased by what could be higher usage by their group of friends on the network.

Bottoming with new management

With the huge gains of Groupon over the last 8 months, one has to wonder if Zynga isn’t the better investment now. This group of stocks set the IPO market on fire at the end of 2011, yet the public market investors have suffered nothing but pain from the group. Each stock has lost more than 28% over the time period that Facebook has been public.

The daily deals site fired its founder back at the end of February and the stock has seen nothing but positive returns since that event. Only July 1, Zynga hired Don Mattrick, president of the Xbox division at Microsoft, as CEO to allow Pincus to focus on product development. In both cases, the founder of the company wasn’t ready for running a multibillion dollar public firm. Facebook appears to be the third such scenario and favors investors staying out of the stock until Zuckerburg is replaced.

Bottom line

In reality, the biggest issue with this set of stocks and especially Facebook is that the pre-IPO hype was impossible to live up to as a public firm where every corporate detail is scrutinized more. On top of that, the individual business models ran into turbulence whether due to a decline in social games hitting Zynga or an overly competitive market crashing the daily deals sector. Now Facebook is facing the dilemma of the prime user group fleeing the social network for the newest networks. Networks where their parents don’t reside and the teens are free to interact with friends without parental scrutiny.

Investors shouldn’t get the impression that Facebook will fold up tomorrow, but the key with any stock is the entry price for any position. Paying nearly 10 times current year revenue estimates can only be justified if teen users were still flocking to the site. A more reasonable 4 times revenue would only value the stock at around $25 billion and that’s what should concern investors.

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Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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