Social media stocks represent the very essence of the bicoastal Bubble Finance prosperity of Wall Street and Silicon Valley.
The truth is, Facebook — along with Instagram, Whatsapp, Oculus VR and the 45 other testaments to social media drivel that Facebook founder Mark Zuckerberg has acquired with insanely inflated Wall Street play money during the past few years — isn’t simply a sinkhole of lost productivity and low-grade self-indulgent entertainment.
It is also a colossal valuation hoax, and one that is heading for another “faceplant” when the third great financial bubble of this century comes crashing down.
Users Love Free Stuff
Basically, Facebook is just an Internet billboard. It’s a place where the idle mostly idle their time, like millennials in or out of their parents’ basement. Whether they grow tired of Facebook or not remains to be seen, but one thing is certain.
Facebook has invented nothing, has no significant patents, delivers no products and generates no customer subscriptions or service contracts. Its purported 1.8 billion monthly average users are fiercely devoted to “free stuff” in their use of social media.
As a result, virtually all of its revenue comes from advertising. But ads are nothing like a revolutionary new product such as Apple’s iPhone, which can generate tens of billions of sales out of nowhere.
The pool of advertising dollars, by contrast, is relatively fixed at about $175 billion in the U.S. and $575 billion worldwide. It is subject to severe cyclical fluctuations. For instance, during the Great Recession, U.S. advertising spending declined by 15 percent and worldwide expenditures dropped by 11 percent.
Because of its sharp cyclicality, the trend growth in U.S. ad spending during the last decade has been about 0.5 percent a year. Likewise, global ad spending increased from about $490 billion in 2008 to $575 billion in 2015, reflecting a growth rate of 2.3 percent annually.
Yes, there has been a rapid migration of dollars from TV, newspapers and other traditional media to the digital space in recent years. The digital share of the U.S. ad pool rose from 13.5 percent in 2008 to an estimated 32.5 percent last year.
But even industry optimists do not expect the digital share to gain more than a point or so per year going forward. After all, television, newspapers, magazines and radio and highway billboards aren’t going to disappear entirely.
Consequently, there are not remotely enough advertising dollars in the world to permit the endless gaggle of social media space entrants to earn revenue and profits commensurate with their towering valuations and the sell side’s hockey stick growth projections. In social media alone, therefore, there is more than $1 trillion of bottled air.
In a milieu built around the concept of “free stuff,” the massive amount of speculative VC capital that has entered the social media space is certain to drive customer acquisition and service costs ever higher and margins to the vanishing point.
Dot-Com Bubble Redux
So, the big shift to digital is already over and you can’t capitalize a one-time gain in sales of this sort with even an average market multiple.
Meanwhile, Facebook’s recent $360 billion market cap represented a preposterous multiple of 225 times its $1.6 billion of March 2016 last-12-month free cash flow.
For the June 2016 last-12-month period, its multiple was infinite because free cash flow was actually negative $1.5 billion.
None of the social media competitors, not even Facebook, has a permanently defensible first-mover advantage.
That is evident in the current tally of 140 so-called venture capital “unicorns.” Each has a private pre-IPO “valuation” of $1 billion or more. Or at least they did until the drought of initial public offerings began to puncture the fantasy. The group is still “valued” at $500 billion in the rarified precincts of Silicon Valley.
But the unicorns are sowing forces that will eventually eviscerate Facebook’s massively bloated valuation.
First, they are hatching new competitors for advertising dollars like there is no tomorrow. Online advertising revenue, in fact, is the business model of virtually the entire social media space.
Secondly, and more importantly, they are burning money from venture capital firms by the tens of billions attempting to find “users” by paying for mobile ads on, you guessed it, Facebook!
As we learned from the dotcom bust, when freshly minted companies start taking in each other’s laundry in Silicon Valley things get way out of whack. Capital morphs into revenue and “burn babies” temporarily and deceptively appear to be a booming new customer base.
That is, until the bubble implodes, new capital flows dry up, start-ups disappear en masse and revenue from their purchases of equipment, services (such as Amazon’s cloud services) and advertising vanishes.
Wall Street Fantasy
That gets us to the ludicrous hockey sticks on which Facebook’s current valuation is based—even as the end-of-bubble handwriting is already on the wall.
Start-up company office space, for example, is being vacated all over the place in San Francisco and real world consumer products companies like the mighty Procter & Gamble have already decided to stop paying exorbitant rates for Facebook’s ineffective targeted mobile advertising.
Nevertheless, Merrill Lynch is currently projecting that Facebook’s $16.6 billion of ad revenue in 2015 will grow 84 percent to $30.5 billion by 2017.
But what would happen if it turns out that the central banks have not abolished the business cycle with endless amounts of monetary stimulus after all?
Assume that the growing signs of global recession materialize in a downturn between now and then, and that results in an advertising reduction of about half as severe as the Great Recession.
Perhaps global ad spending would drop by only 5 percent, not 10 percent to 15percent, to about $545 billion. Let’s also assume optimistically that the digital’s market share gains another 2 points a year from 26 percent in 2015 to 30 percent by 2017.
In this perfectly sober assessment, digital spending would rise by about $15 billion over the next two years from the $150 billion level achieved in 2015. And the non-search share of that gain where Facebook competes — that is, the portion outside of Google’s near monopoly — would be about $7.5 billion.
In short, the Wall Street hockey brigade is essentially projecting that Facebook will pick up 200 percent of the available new ad dollars that would likely materialize under an even moderate global recession scenario.
Even a hint of recession would knock the props right out from under the monumentally bullish financial market bubble that the Federal Reserve and other central banks have fueled since the 2008 crisis.
History leaves little doubt about what happens then. The massive amount of venture capital pouring into Silicon Valley and the social media space would dry up in no time; and the “burn baby” advertising spending from the unicorns and other start-ups would quickly vanish.
Instead of growing at 40 percent a year, there is a very distinct possibility that Facebook’s sales will slump to the single-digit range not too many quarters down the road.
Stated differently, Facebook is a valuation train wreck waiting to happen. It is spending tens of billions on acquisitions of companies that don't even have revenues and ramping up its internal operating costs at staggering rates.
This means that when ad spending hits the recessionary skids in the months ahead — look out below. Its stock price will crater.
Mark Zuckerberg Is No Bill Gates
Bubble-finance hype is the essence of Facebook’s crazy valuation and its modus operandi. But its founder, controlling shareholder and chief executive, the brash young Mark Zuckerberg, is no Bill Gates. Not by a long shot.
Microsoft founder Gates was a true business genius who created an essential component — desktop operating systems — of the personal-computing age. By contrast, Zuckerberg happened to be hanging around a Harvard dorm room just as the central bankers of the world were cranking up their printing presses to warp speed.
The hallucinatory sense of grandeur that accompanied Facebook’s IPO eight years later in May 2012 has been on display ever since.
Wassup with Whatsapp?
Zuckerberg’s madcap M&A frenzy — culminating in the insane Whatsapp deal — may well become the defining moment for the third and final bubble of this century.
To wit, Zuckerberg paid the stunning sum of $22 billion for a social media outfit that had just $10.2 million of revenue. The purchase price thus amounted to 2,150 times of sales.
And let’s not forget that Whatsapp actually lost one-half billion dollars during the year prior to the deal’s close in October 2014.
The way you lose such staggering amounts of money on virtually no sales is quite simple. That is, you adopt a business model that even the most intellectually challenged hot-dog stand operator wouldn't have contemplated before the age of bubble finance.
Namely, plow headlong into a huge business operated by the biggest telecom companies in the world. In this case, one that generates $20 billion in annual billings for the wireless carriers. And the key to grabbing market share in that brutal neighborhood: offer your service for free!
That’s right. Whatsapp is just a text messaging service that challenged the paid SMS services of AT&T, Sprint, Verizon, etc., by reducing the transmission charge from $10-$20 a month to, well, nothing.
The CEO of a competitor succinctly explained why this tactic works:
“It always comes down to the economics,” said Greg Woock, chief executive of Pinger. “Free is a compelling price point.”
Yes, it is. Not surprisingly, the Whatsapp free messaging service had gone from a standing start in 2009 to 400 million users by 2014. Now that’s the kind of “growth” that social media bubble riders can get giddy about.
And it amounted to this: Facebook paid $55 a user for a business that had 13 cents a user of revenue.
But never mind. Having virtually his own legal printing press — Facebook issued $17 billion of freshly minted stock to pay for most of the deal — Zuckerberg explained it this way:
“Our strategy is to grow and connect people. Once we get to 2-3 billion people, there are ways we can monetize.”
Whatsapp now has nearly 1 billion users, but still no revenue and has actually eliminated a minor annual user charge.
If this sounds vaguely like the dot-com mania in early 2000, it is and then some.
David Stockman was the Director of the Office of Management and Budget under President Ronald Reagan. To read more of his insights, CLICK HERE NOW.
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