Weakening moat – Google Inc (NASDAQ:GOOG) has effective monopoly power in online search, and the company enjoys a huge head start on the competition. The search engine giant has not sat idle, instead using that time to refine and perfect its algorithms before competitors even thought about entering the market. Google Inc (NASDAQ:GOOG)’s search is the central station of the internet – the way to get to where you want to go. A Yellow Pages that is enormously profitable, extremely useful, and inexpensive to maintain. Facebook is a destination at which visitors end their online hunts, and where few purchases are ever made.
Niche competition – Facebook’s $1 billion acquisition of Instagram signaled that the company was now on the defensive. Pictures, not status updates or “likes,” are the social network’s bread and butter. New competition in the space continuously threatens Facebook’s competitive advantage in picture content for nosy heavy users. New apps like SnapChat and WhatsApp have added millions of users interested in features that are central to Facebook’s dominance – pictures and free messaging between friends. The message is making its way through the grapevine; Facebook is losing its “cool factor” with teens and 20-somethings.
New devices – Google Glasses may be a far-off consumer product, or just another prototype better suited for science fiction than modern reality, but they represent a real risk in that if the platform changes, Facebook is at risk. Google Inc (NASDAQ:GOOG) Glasses will be seamlessly integrated with the company’s lagging social network, Google+, invigorating it with more video and picture content from launch day. This risk, though slight, would completely change the game for Facebook’s social media position.
The bottom line
At $28 per share, Facebook appears tremendously overvalued. Removing the company’s $9.5 billion in cash and marketable securities ($3.80 per diluted share) gives a valuation of $24.20 based on nothing more than 9 cents in GAAP quarterly earnings. The company’s best year was in 2010, when it earned $0.43 per diluted share. Since then, the company has posted two lackluster years of a single penny in diluted GAAP EPS.
Given growing competition, little-to-no margin expansion from mobile advertising, and a cost structure that seemingly implies there are few economies of scale at the existing cost base, Facebook is a high-priced stock just waiting for correction. Like Apple Inc. (NASDAQ:AAPL), that correction will come when the top line music stops and investors are left cheering on slowing sales with minute margin expansion. The only people benefiting from this gravy train of a momentum stock are the insiders who receive stock option compensation conveniently ignored in non-GAAP accounting Facebook executives push onto analysts.
Facebook is a lottery ticket at best, a business that cannot be justified as anything beyond a lottery ticket for a future that can be seen only through rose-colored glasses.
The article Mobile Ads: Good but Certainly Not Great originally appeared on Fool.com is written by Jordan Wathen.
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