Why Facebook is Still in the Blues?

By Rahul Agarwal - October 26, 2012 | Tickers: FB, GOOG, LNKD | 0 Comments

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After the recent earnings release, Facebook (NASDAQ: FB) shares are seeing a lot of action. The Bulls are talking heavily about the increasing number of users and the recent monetization initiatives from Facebook. The stock has been called undervalued many times as analysts talk about how Facebook, with its over 1 billion users, has literally the third largest population after India and China. What the analysts are overlooking is the state of the Facebook economy and the level of patriotism shown by the residents.  

We are Here but Just Because Everyone Else Is

The above statement briefly describes the state of mind of the citizens of the Facebook Nation. While the Population has seen rapid growth as it has grown 26% YOY, their usage has declined substantially. According to recent ComScore research, the total minutes spent by US users dropped by 5% to 108 billion in September compared to July as the total time spent on desktops reduced by 13% to 61 billion. And the point to note here is that this is despite the Facebook community growing by leaps and bounds. If I take myself as a user and believe in investing in what I know, I would derive the following opinions about Facebook:

1. I visit Facebook daily but I may as much visit 9gag or any such site to see funny status messages.
2. While the fun of knowing new people mattered in the start, I believe that the whole idea is losing its luster and I am getting a little bit bored on all the antics and sharing on the platform.
3. I generally post status messages once a month.
4. I am fed up of all the “Ville” games.

The reason I still bother checking the FB page is that my friend circle is here and while many analysts find this as the power of Facebook, I just see it as the lack of any other platform to go to. The eagerness to migrate from the nation is such that when Google (NASDAQ: GOOG) launched Google +, it received record traction. While Google + turned out to be a disappointment as its similarity to Facebook has eventually discouraged the users to change platforms, the traction it gained goes on to show that the users are still waiting for a change.

I believe that Facebook can never reach the level of user stickiness its close neighbor LinkedIn (NYSE: LNKD) enjoys. LinkedIn has developed a community that will be hard to replicate. While you can easily shift all your friends from Facebook to another social network, it would be a hard task in LinkedIn considering that LinkedIn provides much higher level connections than Facebook.

The Monetization Efforts are Showing Results. Really?

While the GDP for Facebook has grown, the per capita GDP has essentially remained the same which questions the viability and success of the monetization steps taken by the Facebook government. If we look at the earnings report we can see that Facebook has essentially flat revenue per user for the past 4 quarters.

 Source: 10Q report

While the analysts are revving on the innovative spree going on in Facebook, they are forgetting that innovation comes at a cost. Looking at the expenses, Facebook’s non-GAAP spending has increased by 57% YoY to $737 million mainly driven by the R&D expenses which were up ~150% YoY. With the Instagram deal supposed to close in Q4, I believe that the expenditures will continue to increase in Q4 also, which will eventually affect profit margins.

The Bottom Line

Facebook has reached a point where it needs to show results. The next few months might possibly decide what is to become of it. While the tug has been strong from both bulls and bears, I believe that Facebook is still overvalued keeping in mind the high risks. With the stock currently riding on inflated hopes, and the lockup expiration of 243 million shares approaching on October 29, I believe that this is an absolute sell. 

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