Stay Away From Facebook, Netflix, And Buy Google Now
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One-time Wall Street darling Netflix (NASDAQ: NFLX) once had it all: a cultish fan base, an authority position in movies, and a growing economic moat. Wait… based on those qualities, I might as well have been referring to Facebook (NASDAQ: FB). Like Netflix, Facebook faces tremendous pressure given how limited the barriers to entry are in internet media.
Indeed, I have often said that Netflix's business model ends where a Google (NASDAQ: GOOG) search begins. Pirating is so rampant that it is becoming increasingly useless to protest it. Meanwhile, the rise of Redbox is taking away what little convenience Netflix had in retaining top titles. Rising content costs have pushed the company into the red - an issue that is so serious that international growth prospects have had to be slowed. The question then is whether Netflix's problem is more serious than Facebook's.
Facebook is different from Netflix in the respect that it has, in my view, much more room to lose than to gain. The company has around 1B users, but they are users of a fad and slowing growth indicates market saturation. Truth is, saying "Friend me" or "Poke me" isn't as cool as it was a few years back. Once everybody is "in", the only way to be cool again is to, well, get out and find the next big fad. That is what social networking users did with Myspace, which predated Facebook. That is also what users of AOL Instant Messenger and various email boxes did before Gmail.
Free cash flow has been uncomfortably wild for the supposed social network king. 2Q12 posted a FCF loss of -$171M versus just a -3M FCF loss in 2Q11. But, for a firm like Facebook, it is important to look at growth. Regrettably, growth has been very weak compared to expectations. For the six months ending 4Q12, Facebook generated sales of $2.1B, or an average of $1B every 3 months. That was basically in-line with performance for 1Q12 and 2Q12. But yet Facebook is priced as if it could be the next "big thing". Analysts are forecasting EPS to grow by 26.9% annually over the next 5 years. Assuming that is correct, 2016 EPS will come out to around $1.39. At a 15x multiple, this translates to a future stock value of $19.35. Discounting backwards by 10% yields a present value of $12 - implying a 33% overvaluation at what I think are aggressive assumptions.
Netflix, for all of its critics, is less overvalued. The firm still has excellent opportunities within mobile and international exposure. The stock trades at 32.8x past earnings - far less than Facebook's PE multiple. FCF over the TTM has, however, fallen precipitously from $294.9M in 2Q11 to $120.7M in 2Q12. Pricing hikes are symptomatic not only of poor management but also of weak fundamentals. Netflix has had to cut off access to great titles through Starz Media as content costs rise and cut into margins. The media business is thus seeking to lower costs alternatives through streaming, which it rightfully sees as the way of the future.
The only problem is that Google is actually best positioned to penetrate this high-growth market. This search engine giant, unlike Facebook and Netflix, has diversified across several mediums ranging from social networking to emailing to video tubes to mobile. This horizontal expansion sets an ideal stage to unlock synergistic value. I believe that Google could even overtake Apple (NASDAQ: AAPL) in apps within the next five years. As demand grows for the cloud, there will be a corresponding greater interest in products that are easily accessible to multiple mediums. Google has thus far built the most coherent model.
Case in point: I just recently purchased my first Android-OS phone. To download various apps, I go to "Google Play". And within Google play, I prompted to connect with Google's various other offerings, like Google+ via the +1 buttons, YouTube in app videos, and Gmail in contacting developers. This type of development can't be built overnight and thus Google has done one of the few things many internet businesses have failed to do: create a competitive sustainable advantage. It is for this reason that I recommend buying Google and staying away from Facebook and Netflix.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Google, and Netflix. Motley Fool newsletter services recommend Apple, Google, and Netflix. 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.