I’ve never been in love with Facebook (FB) stock. I’ve always been suspicious about the company’s ability to create a sustainable business model. Some people may laugh at me for missing out on the big run-up, but when it comes to FB stock, I believe it trades more on momentum than bottom-line earnings growth.
So does private equity manager Ovadia Ovi Levy, managing member of KPL Capital, LLC, in Naples, Florida. We had a conversation recently about a number of stocks that he thinks are wildly overvalued, including Facebook stock.
Levy, however, puts his money where his mouth is. He is short Facebook stock. I’m always wary of short-sellers, because they are often hyperbolic with their arguments. Ovadia Levy is not. He has articulated some very specific reasons why he believes FB stock is overvalued, and why he is short.
“The greatest inventions, and long-term sustainable businesses, in history all begin with a simple question: what problem do they solve?” Ovadia Levy says. “FB does not solve any problems. It doesn’t solve problems for users, and it doesn’t solve problems for advertisers.”
The Problem for Facebook Stock
I think he’s right. FB makes staying in touch, and reconnecting with people, easier. It does not, however, solve problems in those areas. If FB disappeared tomorrow, the world would survive. The fact is that FB is more likely a problem-creator than anything else, because at its core, it is nothing more than a time-wasting distraction. It’s just another form of media to consume.
Ovadia Levy goes on. “Strip away all the hype from FB stock and what do you have? It sells advertising. 74% of its revenue is from mobile advertising, and 95% of total revenue is advertising. That’s all it is! A seller of ad space!”
And Levy points out that, at its peak, global advertising juggernaut WPP (WPPGY) was valued at $20 billion on sales of $15.6 billion — or 1.3x sales. Meanwhile, FB stock price represents a $289 billion market cap based on trailing-12-months sales of about $16 billion — or 18x sales.
Levy acknowledges that Facebook stock is enjoying significant revenue growth, but that growth is slowing. Analysts estimate $5.36 billion in revenue for Q4, which would bring it to about $17.5 billion for FY15, or about 40% year-over-year — down from 58% growth in fiscal year 2014. If Facebook stock continues its TTM trend of 18% net margins, net income for the TTM will come in at $3.08 billion — barely a 5% YOY increase.
“And yet it trades at a P/E of 96,” Levy says.
I have to agree with him on all counts. FB has been around for many years. I have no objection to building an advertising business, but FB now generates as much as WPP did at the top of its game. Yes, FB continues to grow revenues at a faster rate, but there is no rationale for the market to give a value 13 times in excess of WPP’s.
This is especially true when you realize that Facebook’s monthly active user base is increasing at only a 4% annual rate. If FB solved a problem, that growth would be higher. Instead, consider all the vulnerabilities FB stock price has, according to Levy:
- One revenue stream: ads
- What happens when the economy cools and ad spending decreases?
- What happens if people get bored of Facebook?
- What happens if advertisers move on to other media?
Facebook stock is outrageously overpriced, according to Ovadia Levy, and I agree. It is nothing more than a pure-play advertising seller.
I see no reason to own FB stock at these crazy levels and I think Levy’s idea about shorting is a good one.
Lawrence Meyers has no position in any stock mentioned. Ovadia Levy, interviewed for this article, is short FB.
