Tuesday, May 08, 2012

Don't Bet on Vaporware

Unless, of course, you have money to lose.

I keep seeing articles suggesting that ordinary investors should not try to purchase Facebook stock at the time of its IPO. You know, as if an ordinary investor will have the opportunity. Facebook is selling a small amount of stock, not because it needs the money but because it has too many shareholders to remain private. It is clearly hoping that by keeping the offering small the shares will be picked up by investors who see the company as worth a roll of the dice - in three years will they be Google or will they be MySpace?

The thing about Facebook is that for years now we've been told that their data will allow them to sell advertisers high-value advertisements, targeted based upon exceptionally granular demographic information, resulting in high conversions. CJR offers a reminder of what that presently means, in practice. Ads do not appear to be well-targeted, ad revenues are dropping, and any suggestion that it can grow its income to justify its present, ostensible valuation (as opposed to identifying and implementing new income streams - the type of revenue streams we've been promised will inevitably appear because of the amount of traffic and data that Facebook enjoys) is simply not credible. It's more credible, I suppose, than the similar valuation of Internet companies during the first Internet bubble, due to improved online advertising technologies, but not by a large margin.

The recent action that should have investors scratching their heads about Facebook is the acquisition of Instagram. Not in the sense of "CEO's Gone Wild". To some degree you have to credit Facebook for seeing a potential competitor on the horizon and buying it before it became much more costly - recognizing that such acquisitions are a gamble. It was Facebook's promise to own and manage Instagram without folding it into Facebook that was telling. If Facebook can only maintain its dominant position by acquiring upstart social networks, it's going to be buying a lot of small companies for a lot of money.

If Facebook can only keep the users of acquired social networks happy by maintaining them separately from Facebook, even if it offers a level of integration by allowing people to log in to all of its services through their Facebook account, it's headed toward an expensive form of fragmentation, having to support and maintain a lot of marginal or obsolete properties - or at times cut their losses and make users angry. Facebook's strength is in being Facebook, singular, not in being an agglomeration of sites. And let's not forget we're actually talking about a platform war - you don't want to reduce your operations to an app on somebody else's platform, and you certainly don't want to reduce it to a panoply of apps. You want to be the platform.

A year ago Facebook released numbers that, although not justifying its pie-in-the-sky valuation, were impressive. More recently they have reported that they have more users than ever - and that their profits have declined. Neither that nor the potential fragmentation of their platform is the type of thing that I would be looking for in an investment. But heck - if I were getting an annual fee and a percentage of the profits to invest your money (or your pension's money) I can see why I might roll the dice.

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