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I wrote HERE on June 5th that my target stock price for Nasdaq darling (and overhyped IPO of the year) Facebook (NASDAQ:FB) was $7.30 a share. Results yesterday saw the share price slide again and they are now $26.84 down from a $38 IPO just a couple of months ago. At the time ex-penny share tipster Luke Heron set a $50 target price. That was a good a sell signal as you would normally get. But on this occasion the fundamentals were an even bigger sell. If anything yesterday’s results make me think my target price may be a tad optimistic. This remains a great one way bet.
The headline loss of $157 million is irrelevant. That is down to non cash accounting for staff option expenses. Ignore it. The underlying numbers are that on a 32% increase in sales to $1.18 billion underlying net income grew by $10 million to $295 million. Admittedly there seems an unusually big tax charge in this quarter so perhaps a $515 million vs. $477 million profit from operations gives a better idea of bottom line growth. However I would note that capex in the quarter was $413 million plus another $52 million spent on buying items on lease. The capex number is a 213% increase on 2011. It rather implies that facebook is not exactly chucking off cash.
The company flags that it has almost a billion accounts. While I accept that there are enough morons in this world to want a Facebook account and make that number plausible I wonder how many are active. Daily Active Morons (sorry users) were 522 million, an increase of 32% on 2011. But here is where I start to worry. It strikes me that there are three worrying trends in these numbers.
- Facebook generates nearly all of its income from advertising. But ad income per user is actually going down. And remember this period (to 30th June) is when lots of folks would have wanted to advertise during the IPO hype. The crummy returns they generated makes me think some of them will go away. The rapidly slowing world economy will make others go away.
- A lot of the growth in user numbers comes from places where disposable income is not that high. I have made the point before that adding a user who is of little or no use whatsoever to an advertiser does nothing for the bottom line.
- The real concern is that the users who advertisers really want increasingly go to moronbook via mobile applications and it just seems very hard to sell adspace effectively via this medium. It may actually encourage greater usage and no doubt Facebook will blather on about that but advertisers are not daft. So you have a trend of “losing” your best customers as advertising targets while gaining customers who have no value to replace them.
And so it strikes me as increasingly impossible to say that Facebook has any earnings visibility at all on a two to three year view which makes the valuation – even today – absurd.
Back on June 5th I concluded:
Charitably you might hope that on a 50% margin if Facebook doubles its revenues in 3 years it might just be making $2 billion after tax in 2015. But you do not know that. It could well be making more but it could easily be making a lot less. Which is why anyone paying an historic price earnings ratio of 104 at the IPO was simply barking mad. Even today, at $26.90 the historic PE is 73. That discounts a hell of a lot of growth which is just not something that you can bank on.
Historically the DJIA as (this century) traded on historic PEs of between 13 and 22. Right now it is towards the bottom of that range. Now I accept that Facebook has the potential to grow its earnings at a far greater rate than most Dow components. But it also has the potential to grow at a far slower rate and there should also – I believe – be a heavy risk weighting for the legal threat.
On that basis an historic PE of 20 does not seem that miserly. If markets as a whole are weak and sentiment towards this company gets even more bearish as the lawsuits start to fly and if there is any hint of advertising weakness, the idea that Facebook merits a rating which is still a hefty premium to other US giants is not that ludicrous. On an historic PE of 20 Facebook shares would trade at $7.30. I am not saying this will happen but I would certainly not even consider putting them on my personal buy watch list until the shares were trading at sub $10.
I do not think the legal threat has gone away. Serve up bad Q3 numbers, wait for the stock to halve from the IPO price and the lawsuits will flood in. My only change since then is in thinking that given everything that is happening in the world, might not an historic PE of 20 be a tad generous?
Facebook remains a slam dunk short sell. Target price $7.30
