The Problem With Facebook

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

In theory, Facebook, (NASDAQ: FB) should be the perfect company. Over a billion users, great branding, decent margins and a product moat, (it would be almost impossible to re-create what they have done). Facebook is lacking one thing however and that’s its product. You could say, "well Facebook, has Facebook, that’s its product." But no. Facebook relies on advertising for the majority (80%) of its revenue, with Facebook credits and Zynga's (12%) games contributing the rest. Facebook, is a giant billboard, with the worlds largest exposure.

Facebook’s story has been fantastic. Revenues have grown at a 5 year average of 100% a year and are forecast to grow at an average of 30% for the next 3. Since its inception in 2004 the user base has grown a staggering 172% a year! (A more reasonable 50% a year over the past 3). Of course this rate is unsustainable, even at 50% growth a year, Facebook’s users would total 10 billion by 2018.

 

As we can see from the chart, historically Facebook’s revenue has increased in line with users. 2012 profit is lower due to the expense of listing on NASDAQ. 2012-2014 are estimates and rather conservatively I have used a much lower 25% average user growth, (still 250 million per year) rather than the actual, 5 year or 3 year historic averages.

From these estimates it seems Facebook will have to squeeze more and more revenue out of its users, finding more inventive ways of making money, in order to increase revenues as user growth slows. How accurate will these forecasts become as Facebook drives its profit machine too far, pushing users away from the platform? A problem already being seen with Zynga, whose players are getting bored and moving away.

Constant revenue growth from constant user growth is not possible because:

  1. At  current rates by mid-2015 everyone on earth will have FB. (Also not possible as the age limit is 13.)
  2. As of 12/31/2011 only 32.7% of the world had internet access 

Facebook’s recent drive to monetize mobile revenue has driven it to new lengths of dominating users news feeds with ‘Sponsored Stories’ targeted at the user. The problem for Facebook is correctly targeting the user. What someone likes on Facebook, will not necessarily translate into purchases and these invasive tactics are already turning users against Facebook.  There is also the newest drive to profit of charging users a monthly fee to remove the adverts. This damages the motto, ‘free and always will be’.

Revenue is also impacted with a constant stream of privacy issues. Not to mention other rumors and speculations surrounding the firm.

Facebook’s IPO was simply overpriced, at a P/E of 91.2. Now down at $19.21 the stock is starting to look well priced, suitable for growth, if the firm can reach its lofty targets.

 

The problem with Facebook is that there is too much speculation and hype around the company. It is hard to view FB as a decent investment. It has all the right characteristics to be able to build one of the biggest and most influential businesses in the world. However it is being pushed to monetize its platform and extract as much revenue as possible from its users. Ultimately this could lead to a complete reversal of the trend, as users are pushed away, in favor of less invasive social networking sites such as Google and Twitter.

In my opinion the high growth multiples attached to Facebook do not take into account the risks going forward. Although Facebook has been an amazing growth story so far I believe there will be significant speed bumps going forward.


rupert12345 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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