Which Social Media Stock Is Undervalued? Overvalued?

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

It never ceases to amaze me how despite social media--or, more broadly speaking, Internet media--having few barriers to entry, analysts continue to see the leading giants as unstoppable. Even the giants that have fallen are still regarded as relevant after little changes have taken to improve the upside story. In my view, the best Internet media companies are those that are well diversified and are still not resting on their laurels--that is to say, they are increasing diversification. Social networks, in my view, will be replaced by the "next best thing," so movement and heavy R&D investments are central to creating long-term value for shareholders. With this in mind, I review several stocks below.

Yahoo! (NASDAQ: YHOO): An Uphill Battle

Although the iconic search engine business has been targeted by activist investor Dan Loeb and underwent a management turnover, it still isn't any more undervalued. If anything, it is more overvalued. The series of changes that were supposed to unlock value have done very little to transform the business fundamentally. After implementing several catalysts, there is little potential left to generate investor excitement. ROE is anticipated to decline from 9% to 7.7% in 2012. EPS is anticipated to decline by 6.5% during the same time period.

Moreover, the changes were not exactly cheap. The hiring of Henrique de Castro as COO will cost the firm ~$56 million over just the next 4 years.

Nevertheless, free cash flow is expected to grow to around $1 billion this year, and net cash will hit $2.6 billion--up $1 billion from a year ago. In my DCF model, I forecast (1) revenue growing by 11.5% annually over the next half decade or so and then (2) 2.5% into perpetuity, (3) a 10% discount rate, and (4) consistent operating metrics. Based on these inputs, I calculate a price target of $17.76. This implies a weak upside story from here.

With the core business under attack from the top market leader, Google, and decreasing space in relevant markets, I believe the growth curve is relatively weak. So, regardless of how much changes Yahoo! makes, it's an uphill battle from here.

Google (NASDAQ: GOOG) Vs. Facebook (NASDAQ: FB)

In contrast to Yahoo!, Google is both fundamentally strong and undervalued. It has succeeded in everything from email, mobile to, of course, search. While it is the undisputed leader in search and won't have any competitor challenging it any time soon, it is now the leader in both email and mobile operating systems. It has 66.8% of the search market (up 62 bps from 2 years ago) versus 13% for Yahoo! and 51% of the domestic smartphone market. 80% of the major ordinal OEMS distribute Android phones. This provides a huge economic moat that can be leveraged to sustain the core technology business. 

Ironically, while analysts keep talking about Facebook's large economic moat, the biggest economic moat in the space comes from Google. Analysts keep talking about the threat that the top social network poses on Google; but, in my view, "facebook.com" is a very ephemeral social experience. Investors myopically forgot how hot Myspace was before Facebook. Should we not expect Google+ to outstage Facebook in time?

I believe we should. Sergey Brin and Larry Page have appropriately reduced Google+ to just an add-on feature of Gmail accounts. Slowly, it has brought users into its social network through leveraging Android apps that automatically sync with Google apps, whether they be calendar, maps, or photo uploads. This is almost certainly the reason why Facebook was earlier hinting at releasing a mobile phone--because it is a critical accessory for sustaining its core business. With that power now in Google's control, Facebook, like Yahoo!, also faces an uphill battle from here.

TakeoverAnalyst 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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