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Is Facebook A Really Cheap Monopoly?

“I don’t know what a monopoly is until someone tells me.”

-Steve Balmer

 

Takeaway:  On conventional metrics Facebook is expensive and it has a business model in flux, but the sticky and engaged user base may actually be undervalued, even at a $100+ billion market capitalization.


At this point, there should be little debate on whether or not the Facebook IPO will be successful.  The books closed ahead of schedule and the offering was upped in both price and size of issuance.  We’ve also heard reports that in Asia the offering is 25x oversubscribed. These facts suggest that there is ample short-term demand by investors who want to own a piece of Facebook. This will likely ensure that the company gets a sizeable IPO pop tomorrow and in the ensuing days as index-related investors need to balance their portfolios.

 

Currently the most prominent question on investors’ minds relating to Facebook is valuation.  That is, at the IPO price will Facebook be undervalued, overvalued, or fairly-valued?  Based on any conventional valuation techniques, other than perhaps a long-run discounted cash flow valuation, there is no question Facebook is expensive. 

 

Assuming an IPO price of $38 per share, which implies a market capitalization of just under $100 billion based on the fully-diluted share count (the company will also have $10 billion in net cash on a pro-forma basis), Facebook will be trading at 27x 2011 revenue and 19x 2012 projected revenue.  On an earnings basis, Facebook will be trading at 81x 2011 EPS and 65x 2012 EPS.  As the company hasn’t given 2012 guidance, we have simply projected forward the Q1 2012 revenue growth rate for the duration of the year and kept margins stable. 

 

Compared to the five horsemen of technology, Apple, Microsoft, Google, Oracle and Cisco, Facebook will be trading at a massive premium.  In fact, Google, which is the most richly-valued of those five and on some level the best proxy for Facebook given its focus on advertising revenue, is trading at a comparatively palatable valuation of 5.8x 2012 sales and 14.6x 2012 EPS.  The counter case to Facebook being expensive is LinkedIn, which has a valuation of 158x 2012 EPS.

 

Is Facebook A Really Cheap Monopoly? - 1

 

So, yes, Facebook is expensive on actual multiples, but this is also reflected in broad investor sentiment.  In fact, 79% of respondents in a recent Bloomberg Global Poll of 1,252 investors, analysts and traders said Facebook doesn’t deserve a valuation so high.  This was supported by a similar poll from the Associated Press and CNBC in which only 1/3 of respondents feel the value is appropriate.  So, saying Facebook is expensive is far from contrarian.

 

Other than valuation, the other key critique of Facebook is that the company has not figured out its business model.  Once again, there is validity in this criticism.  Currently, Facebook has two revenue streams.  The first is advertising in which advertising revenue is generated from traditional display ads and Facebook is paid based on the number of impressions delivered or the number of clicks per user.  The second revenue stream is fee related.  In effect, Facebook gets a cut of all fees paid from Facebook users to its development community.   The game developer Zynga is by far the largest contributor in this segment and contributed 19% of overall Facebook revenue in 2011 (12% from actual fees and 7% from advertising revenue generated on Zynga’s app pages).

 

Is Facebook A Really Cheap Monopoly? - FB.chart2

 

The dichotomy of these two revenue streams really exemplify Facebook’s key business model challenge.   Facebook’s current advertising revenue stream will likely never enable the company to justify its current valuation, or at least as long as only 13% of advertisements are social based.  Currently, Google’s advertising model is far and away superior to the Facebook advertising model.   According to some estimates, Google’s search advertising revenue is more than 100x more per page view than Facebook’s.  That said, per Nielsen Media, Facebook does generate a superior ROI to advertisers versus more traditional banner advertisements, but it is still nowhere near the return that Google gets.  In fact, some advertisers rave about Facebook, while others, most notably General Motors, have completely pulled their advertising from the social network.

 

The struggle with the current advertising business model and inability to totally monetize the user base is reflected in average revenue per user (ARPU).  In Q1 2012, according to the Facebook Prospectus, global ARPU was $1.21.  This was a 12% decline from Q4 2011, albeit ARPU still grew 6% from Q1 2011.  Clearly, though, ARPU is not yet accelerating at rate that Facebook would like and, as a result, the rate of quarterly year-over-year revenue growth is decelerating.  As a result, in Q1 2012 Facebook grew revenue at 45% year-over-year versus an average year-over-year growth rate of 95% over the prior four quarters.

 

An interesting positive note, though, is that ARPU globally is substantially lower than in the mature markets of the United States and Canada.  Specifically, in Q1 2012 ARPU in the U.S. and Canada was $2.86, in Europe it was $1.50, and in Asia was $0.53.  Arguably, this highlights the potential in ARPU, based on the current business model, to expand over time as global Facebook markets mature and ARPU reverts closer to levels in the U.S.

 

Is Facebook A Really Cheap Monopoly? - FB.chart3

 

As noted above, Facebook’s second revenue stream of payment and fee processing really speaks to the future potential of the business model, which is to create new markets that leverage history’s largest social network / platform.  In Q1 2010, Facebook generated $5 million in revenue from payments and other fees and in Q1 2012, just two years later, Facebook generated $186 million. 

 

To date, games from Zygna have generated the majority of these fees.  A large part of which comes from the purchase of virtual goods as Facebook collects 30% of the face value of user purchases from Zynga games on the Facebook Platform (this agreement expires on May 2015).  Incidentally, the virtual goods industry, which did not exist before Facebook, is projected to have eclipsed $11BN in 2011 according to IDC.  New industries create new revenue opportunities.

 

Ultimately, the true value in Facebook is in its core asset: the user base.  The growth trajectory of Facebook users has been both staggering and, truly, without parallel.   As of Q1 2012, Facebook had 901 million monthly active users and 526 million daily users.   On a monthly basis, almost 40% of the world’s internet users login to Facebook.  Despite anecdotal talk of Facebook fatigue, its daily user count grew 42% y-o-y in Q1 2012, which implies that users are both sticky and not fatigued.  

 

Is Facebook A Really Cheap Monopoly? - FB.chart4

 

Certainly, at a point the law of large numbers kicks in and user growth will begin to slow.  In the U.S. and Canada, penetration is nearing 60%.  Further, according to Facebook’s IPO road show video, 81% of Americans between the ages of 18 – 35 have a Facebook account.  Few businesses in history have gained more than 80% market share.

 

Conversely, on a global basis penetration is much lower.  Most notable is China, which effectively has no Facebook users.  India may be a good proxy for what could happen in China as Facebook users in India have grown from 37 million to 45 million in the last 6 months. At 60 million, roughly 2/3rds of the online population in India will be on Facebook.

 

Most importantly, Facebook users appear very engaged.  The 901 million monthly users have 125 billion friendships.  Meanwhile, the 526 million daily users upload 300 million photos per day and make 3.2 billion comments or “likes” per day.  Further, according to research from Nielsen Media in August 2011, the average U.S. user spent 7 hours and 45 minutes on Facebook per month.   This is almost 4x the time the average user spent on Google and roughly 25% of their total online time of 30 hours per month.  As the chart below from comScore highlights, this engagement is only accelerating.

 

Is Facebook A Really Cheap Monopoly? - 5

 

Even more interesting are the mobile trends related to Facebook.  According to the latest report from comScore, as of March 2012 the average mobile user spent 441 minutes on Facebook’s mobile site and 391 minutes per month on its classic site. Facebook mobile in the U.S. also reached 80% penetration of the mobile market. The downside to growth in mobile, as Facebook noted in its in IPO road show, is that it is more challenging to sell mobile advertisements.  The upshot is that Facebook users are becoming even more engaged and the users who logs in both on the mobile platform and the classic platform are spending almost 14 hours per month on Facebook. 

 

Is Facebook A Really Cheap Monopoly? - FB.chart6 

 

The key consideration when contemplating investing into the Facebook IPO is not the current valuation, but whether Zuckerberg (who controls more than 55% of the voting stock) has truly created a cheap option on the future value of the fastest growing social utility in this history of the world.  Our guess is that most traditional media companies would actually say buying a daily user base of 526 million users, that have almost 7 interactions per day, and spends more than 8 hours per month on the site for roughly $190 per user is actually cheap.  Ultimately, Zuck is going to have to sell these users more than just hoodies to satisfy Wall Street, but with a monopoly like 50%+ plus market share and growing we like his chances.

 

Daryl G. Jones

Director of Research


THE M3: MACAU PENINSULA/COTAI; OKADA DOCUMENT REQUESTS

The Macau Metro Monitor, May 18, 2012

 

 

MACAU PENINSULA OPERATIONS NOT AFFECTED AFTER GAMING SHIFTS TO COTAI Jornal Va Kio, Macau Business

Macau Secretary for Economy and Finance Francis Tam says with the focus of the gaming industry shifting towards Cotai, this does not mean there are hotels and casinos that will withdraw from the Macau Peninsula.  Tam believes casino operators will still develop their business in the Macau Peninsula and seek for more development opportunity in Cotai.  Tam also said that the fact that Wynn Macau received approval for its Cotai project does not mean gaming will totally shift away from the peninsula, even though there is evidence, he says, that the gaming industry is gradually moving to Cotai.

 

The government is now working closely with the casino operators to study the move to remove slot machines parlors out of residential and non-business area after the introduction of administrative regulations.  In addition to the schedule of removing slot machines from residential areas, Tam believes once the related rules and regulations have been completed, it can be implemented prior to the change of the government in 2014.  There are only two slot machine parlors in residential areas: the SJM Yat Yuen Canidrome Slot Lounge in Fai Chi Kei and Mocha Marina Plaza parlour in Rua de Pequim.

 

COURT ASKS MORE DETAILS ABOUT OKADA'S REQUEST Macau Business, Bloomberg

Clark County District Court Judge Elizabeth Gonzalez has allowed Mr. Okada to amend his request for more WYNN documents.  Earlier, Okada’s attorneys had requested that WYNN turn over records related to, among other things, the company entertaining and spending money on Macau officials in connection with its acquisition of a casino license in 2002.

 

The judge set a for June 28 hearing date to decide which, if any, documents WYNN should produce for Okada.


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – May 18, 2012


As we look at today’s set up for the S&P 500, the range is 41 points or -0.14% downside to 1303 and 3.00% upside to 1344. 

                                            

SECTOR AND GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

THE HEDGEYE DAILY OUTLOOK - 3

 

 

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: on 5/17 NYSE -2242
    • Down from the prior day’s trading of -1037
  • VOLUME: on 5/17 NYSE 945.14
    • Increase versus prior day’s trading of 8.33%
  • VIX:  as of 5/17 was at 24.49
    • Increase versus most recent day’s trading of 9.97%
    • Year-to-date increase of 4.66%
  • SPX PUT/CALL RATIO: as of 05/17 closed at 2.30
    • Down from the day prior at 2.34 

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: as of this morning 37
  • 3-MONTH T-BILL YIELD: as of this morning 0.09%
  • 10-Year: as of this morning 1.73
    • Increase from prior day’s trading at 1.70
  • YIELD CURVE: as of this morning 1.43
    • Up from prior day’s trading at 1.40 

MACRO DATA POINTS (Bloomberg Estimates):

  • 11am: Fed to purchase $4.5b-$5.25b notes in 8/15/2020 to 5/15/2022 range
  • Baker Hughes rig count, 1pm 

GOVERNMENT:

  • President Obama welcomes leaders of Germany, Japan, other nations for two days of meetings at Camp David, Md.
  • Obama meets with newly elected French President Francois Hollande at the White House, TBA
  • Obama speaks at Chicago Council on Global Affairs agriculture event, 10:15am
  • House in session:
    • Senate not in session
    • House Financial Svcs. panel holds hearing on heightened capital requirements under Dodd-Frank, 9:30am
    • CFTC holds closed meeting on enforcement matters, 10am 

WHAT TO WATCH:

  • Facebook raises $16b in record technology offering, sold 421.2m shrs at $38 each; set to begin trading at 11am
  • Facebook underwriters said to split ~$176m in fees
  • JPMorgan may lose $5b on derivative trades: WSJ
  • Santander, BBVA among Spanish banks downgraded by Moody’s
  • Greece’s credit rating downgraded 1 level by Fitch
  • Tsipras tells the WSJ he sees little chance EU stops funding for Greece, but if it does, country would have to stop paying creditors
  • Warren Buffett said to have pursued ResCap purchase before bankruptcy
  • American Airlines merger with US Airways is inevitable, a union expert says
  • China home prices fell in a record number of cities last month, car dealers posted inventory levels that foreshadowed deeper price cuts
  • Obama meets today for the 1st time with new French president Francois Hollande ahead of G-8 summit
  • No IPOs expected to price today
  • NATO Summit, China, JPMorgan, Formula 1: Week Ahead May 19-26 

EARNINGS:

    • Hibbett Sports (HIBB) 6:30am, $0.92
    • Donaldson (DCI) 7am, $0.43
    • Foot Locker (FL) Pre-mkt, $0.74
    • ANN (ANN) 8am, $0.89
    • Raven Industries (RAVN) 9:10am $0.89 

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

 

OIL – get the US Dollar right, you’ll get everything else big beta right. We’ve been making this call (Deflating The Inflation) since March and now you’re seeing Oil (Brent in particular) capitulate on the downside (Brent $106.79 = down -15% in a straight line w/ the USD having a record 12 consecutive up day move). Major perf problems in the commodity hedge fund business.

  • Corn Traders Most Bullish Since March on U.S. Heat: Commodities
  • Gold Advances a Second Day as Europe Debt Concern Boosts Demand
  • Oil Heads for Weekly Loss on Debt Crisis; Brent Spread Narrows
  • Japan Aluminum Buyers Said to Face Highest Premiums Since 1996
  • Copper Narrows Third Weekly Drop on Speculation About a Rebound
  • Wheat Seen Declining as Harvest in U.S. May Increase Supplies
  • Robusta Coffee Climbs as Vietnamese Beans Reach Seven-Month High
  • U.S. Farmers Union Demands 30-Day Review of CME Trading Plan
  • YPF Bonds Sink as Buyback Called Into Doubt: Argentina Credit
  • Seaborne Trade in Coal is Seen by SSY Expanding 6.7% This Year
  • Chesapeake Turns to Jefferies’ Eads in $28 Billion Deals: Energy
  • Hong Kong Bourse Should Lose Monopoly If It Wins LME, Rival Says
  • LNG Peak Seen as Mideast Return Meets Japan Need: Energy Markets
  • Corn Traders Bullish on U.S. Heat Concern
  • Soybean Trendline Signals Rally Near Record: Technical Analysis 

THE HEDGEYE DAILY OUTLOOK - 4

 

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 5

 

 

EUROPEAN MARKETS


EUROPE – it’s a race to the bottom now between the biggest Petro-Dollar equity market in the world (Russia) and Spain – both are crashing obviously, and both are down -26% since March. We have immediate-term TRADE oversold signals in pretty much everything that ticks in Europe (other than Greece and Hungary), including the EUR/USD.

 

THE HEDGEYE DAILY OUTLOOK - 6

 

 

ASIAN MARKETS


JAPAN – Japanese Equities hammered again last night (down another -3% making it a -16% draw-down from the down Yen is good for Exports thing?); we still think that the sovereign debt and fiscal crisis in Japan will be consensus news by year-end.

 

THE HEDGEYE DAILY OUTLOOK - 7

 

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 8

 

 

 

The Hedgeye Macro Team


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


It's Done

“I never see what has been done; I only see what remains to be done.”

-Buddha

 

I’ll have to differ with Buddha on the first part of that thought this morning. I can definitely see what has been done out there. After a -8.1% swan dive in the SP500 (-10.9% in the Russell) and a +71% rip in the VIX since the perma-bull March top, It’s Done.

 

Done. As in way oversold in the immediate-term done.

 

Back to the Global Macro Grind

 

We understand, fundamentally, why Asian, European, and US stocks have been going down since February-March. We understand, mathematically, why Commodity prices (and the Equities that track them) have been annihilated.

  1. #GrowthSlowing
  2. #DeflatingTheInflation
  3. #BernankeBubbles

Instead of banging your head against the wall trying to trade Facebook this morning, call up those hash tags on Twitter, and you’ll see that we’ve been leading on these topics for at least 3 months.

 

Way too many people confused Ben Bernanke’s January 25thPolicy To Inflate (commodities and stocks) as growth. Short-term pops in asset price inflation is not growth. It’s precisely that food and energy price inflation that perpetuated Growth Slowing.

 

If you get the Slope of Growth right, you’ll get a lot of other things right. If you get the slope (sequential direction) of both Growth and the US Dollar right, at the same time, you’re done.

 

Done as in, done selling high – going to Cash, done.

 

You can have the best bottom-up “ideas” in the world, but when The Correlation Risk goes to 1.0, that’s when almost everything you are long is done too. Done, as in the bad kind of done.

 

As of last night’s closing prices, here’s the immediate-term TRADE correlation between the big stuff and the US Dollar Index:

  1. SP500 = -0.98
  2. Euro Stoxx600 Index = -0.99
  3. CRB Commodities Index = -0.94

There is no “de-coupling.” There is no risk management in the broken sources who have led you over these cliffs in Q1 2008, 2010, 2011 … and now, again in 2012, either. “Again!” (Herb Brooks)

 

How many times do we have to allow our profession’s consensus brain-trust miss plainly obvious forecasts of rain while the macro data was soaking wet?

 

The short answer is that they are done too. The People don’t trust the Old Wall anymore. And they shouldn’t. It’s going to take a long time before we, as a profession, earn The People’s trust (and inflows into Equities) back.

 

On a cheerier note, this morning I’ll open with our lowest Cash (64%) and highest Equity (36%) positions in the Hedgeye Asset Allocation Model since January (over the course of the Growth Slowing cycle, we’ve moved from 0% US Equities to 24%, and maintained a 0% allocation to Commodities).

 

To be crystal clear on duration, I’m playing this for the bounce. When markets are viciously oversold like this on our immediate-term TRADE duration, that’s just what we do. It’s no different than when I was shorting the SP500 in March-April at immediate-term TRADE overbought signals. We aren’t perma anything. Risk works both ways. The risk now is to the upside.

 

Looking at immediate-term ranges in the LONG positions in the Hedgeye Portfolio, here’s where I stand in terms of immediate-term upside/downside in all 14 of our current positions:

  1. SP500 (SPY) = 1
  2. Consumer Discretionary (XLY) = $42.29-43.74
  3. US Healthcare (XLV) = $36.32-37.07
  4. Apple (AAPL) = $528-560
  5. China (CAF) = $19.41-20.44
  6. Brazil (EWZ) = 50.77-55.34
  7. Melco (MPEL) = 11.84-13.33
  8. Nike (NKE) = $104.14-107.79
  9. Lifepoint (LPNT) = $34.93-36.66
  10. Hologic (HOLX) = 16.81-17.71
  11. HCA Holdgings (HCA) = $25.21-26.19
  12. Urban Outfitters (URBN) = $25.46-27.26
  13. Liz Claiborne (FNP) = 11.78-13.11
  14. Starbucks (SBUX) = 51.63-56.14

It’s Done. I bought a handful of these positions in the last 2-days. #TimeStamped like any position you have taken. I don’t run from them at the lows. I buy them on red. All the while I’m trying to understand each and every factor of each position with my Research Team so that we can handicap the probability of where prices move within our ranges, across durations.

 

These ranges are immediate-term TRADE durations. From an intermediate-term (TREND) to long-term (TAIL) perspective, our models generate wider ranges of risk.

 

Generating good “ideas” is what every good research team in this business should be doing – both long and short. But having great performance on those ideas is highly dependent on getting the timing right. You’ll need a repeatable risk management process for that.

 

Our Research Team, led by our Director of Research, Daryl Jones, has just published their work on Facebook. If you’d like a copy, please email . We won’t have a risk managed view of the stock until it opens and starts giving us price, volume, and volatility data.

 

Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $106.78-111.52, $80.49-81.84, $1.26-1.28, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

It's Done - Chart of the Day

 

It's Done - Virtual Portfolio


NKE: Buying More, Confidence High

Keith bought more NKE in the Hedgeye Virtual Portfolio on this morning's beta capitulation/selloff- NKE remains one name in consumer discretionary where we remain confident that the company is executing, and that numbers are low -- despite European contagion.

 

 

NKE: Buying More, Confidence High - NKE TTT


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