Dangerous FANGs: One Year Later
A year ago we wrote an analysis of the five titans of social media: Facebook, Amazon, Netflix, Google and Twitter, also known as the “FANG+T” stocks. We warned that they not do not pay any dividend worth mentioning but worse they were highly overvalued. One year later let’s look in on these five companies to see how far they have come:
Facebook; then $47, and today trades at $77.
Amazon; then $392, and today trades at $332.
Netflix; then $365, and today at $350.
Google; then $558, and today at $537.
Twitter; then $41, and today at $41.
Now you might think we were correct on four out of the five. If the mission for STI was to predict short term winners then we would have missed on Facebook. However, we still believe that Facebook’s monetization plans and strategy is a flawed model which will underperform the market over the long term. Facebook has many users and many of them bought the stock thinking it will perform like an Apple someday. Facebook is just as famous they reason, so it should perform just as well as an investment. We disagree and have the results to prove it.
One popular strategy for investing in tech stocks is to buy an equal amount of the so-called “FANG+T” companies consisting of Facebook, Amazon, Netflix, Google and Twitter. The belief is that these four companies will control the social media space for years to come, and by owning all of them you can assure yourself of realizing the combined value of the future growth of this sector.
On its surface this idea makes a certain amount of sense, as all five have become industry giants with very strong brands. While each one of these companies has its own unique brand and corresponding business model, in truth they all share a common element of generating revenue by leveraging the number of users who interact with their websites on a regular basis, primarily in the form of advertising revenue.
What makes social media companies so very appealing today is simply the amount of traffic they produce. Many people are going to their sites, so there is an opportunity to monetize this traffic via advertising revenue and ancillary product sales. Therefore, the first question we need to ask is which of these companies has a sustainable reason for viewers to return to their sites and is not just the most recent fad that is hot today but gone tomorrow.
The IPO of Twitter (NYSE: TWTR) last year brought renewed attention to this concept, and the family has been expanded to include it in the FANG+T pantheon of social media companies. Until it went public in November of 2013, Twitter was the quiet giant casting a long shadow over this group of stocks, but now that its financial records are public information, we can make an accurate assessment of its investment potential.
More to the point, Twitter’s IPO has shifted the focus on social media companies in the tech sector to an all-time high, drawing substantial investor attention (and dollars) with it. Though that “shiny metal” may sell airtime on network television, we would like to frame how these companies could eventually become valuable in your portfolio, what it will take for social media companies to become long-term “keepers” and which ones are on the road to sustainable value.
The billionaire Barry Diller rendered his verdict when he stated that only the early investors will do well with Twitter. He asked rhetorically, “Is Twitter going to be here in 75 years?” He answered he didn’t know and therefore could only evaluate Twitter on its present state and value. Allow us to go deeper in answering the value questions associated with each of these companies.
The Missing Link
Oddly, the exclusive club of FANG+T companies does not include what we believe is the absolute best-in-class of the social media companies. Unlike the others, LinkedIn (NYSE: LNKD) provides a clear-cut reason it could still be here in another 10 years. Similar to Facebook and Twitter, LinkedIn has walls where its users can wax eloquently on their latest thoughts and deeds – but LinkedIn is very different in more substantial ways.
LinkedIn is where the workers within the information age hang out their shingles as to experience and skills. Companies looking for skilled tech workers both advertise on LinkedIn and scour it for qualified candidates for their companies. What is critical in this dynamic is that LinkedIn already has a reason for why users will want to see the advertising and even pursue it. LinkedIn will ramp up its advertising revenue over time while not being under the gun to reinvent itself.
Conclusion: LinkedIn will be around for years to come and should be able to increase its revenue stream without having to reinvent itself – but its price will need to come down substantially before we’d rate it a ‘buy.’
The Twin Towers of the Blogosphere
In stark contrast to LinkedIn are Facebook (NASDAQ: FB) and Twitter. Both of these sites began as free social forums which now must be converted to advertising revenue streams. While LinkedIn does not have to invent a new algorithm to find what interests its users, both Twitter and Facebook are required to invent new algorithms that can measure users’ interests and then apply accurate price tags to those interests.
LinkedIn is built on the rational premise that someone looking for a job is willing to invest money to find employment. If LinkedIn would bother to renovate their posting process they could extinct Twitter almost overnight! Further, both Facebook and Twitter have users whose activity consists primarily of discussions on just about anything and everything – much of which has no monetary value whatsoever.
Which begs the question, if the content has little or no financial attraction, then how much will their users be willing to spend to access it? What Facebook and Twitter have accomplished is the creation of significant brands. If you want to follow a specific celebrity or industry “thought leader” then Twitter is the best site for this purpose. Tweeting has become trendy, so much so that even traditionally staid users such as political candidates and religious groups now have Twitter accounts.
Facebook, on the other hand, has a much more tenuous grip on its users and they know it. During the last year Facebook has been on a veritable buying spree, spending: $2B on Oculus Rift (virtual reality headset for gamers); $19B on WhatsApp (messaging app); and $1B on Instagram (another photo post site).
The young CEO is desperately seeking ways to continue making Facebook the “it” place on the Internet. The converse thought is that becoming a billionaire at such a young age has made Mark Zuckerberg lose any sense for the value of money and investments, clouding his judgment on the strategic value of these acquisitions. But the fact that Zuckerberg is simply throwing very expensive darts at the board feels more like the explanation which has many analysts scratching their heads on these outsized purchases.
People go to Facebook mostly because it has become the popular place to connect with friends and share content, such as vacation pictures and cookie recipes. However, Facebook has not innovated better advertising for its users, nor (unlike LinkedIn) has it staked out a claim on a specific niche or user group, so it could easily be supplanted as the “it” place to be in the future. Hence the large purchases on messaging, virtual reality and PC gaming companies.
Conclusion: It remains to be seen if either one of these companies will still be around in ten years, and at current values they are both grossly overvalued. Avoid Facebook and Twitter until there is much more clarity regarding their long-term revenue models or some coherent innovation and integration strategy for Facebook.
It’s a Jungle out there
The list of social media sites that have come and gone is well known. Not that long ago, MySpace was the “it” place, but is now virtually extinct. Facebook currently lives in fear of becoming the next MySpace and losing its status as the place to be. Even worse, it must reinvent its site while retaining those elements that made it popular in the first place.
If just being the “it” social media place was all that was required to become a successful business, then Amazon or Google would have purchased one of them and folded it into their company a long time ago. Instead, Amazon (NASDAQ: AMZN) and Google (NASDAQ: GOOG) have played with the social media space but have not been willing to bet their futures on it. Ironically, Amazon advertised for its latest social media exec on LinkedIn, but has done little else recently in this market space. Google has created its own rival offering to Facebook, but true to Google’s heritage, the place is something only engineer nerds could love, so its potential for monetization is very limited.
Clearly, Amazon and Google have taken a different approach to social media than Facebook and Twitter. They want to build differentiated social media ecosystems where there is a compelling reason to return to their offerings on a continual basis and to sell products which leverage their own technologies. Both now sell TV plugin (HDMI) sticks that allows you to send you to see your PC’s screen on your big flat screen TV.
That is also why Google purchased YouTube, and why both Google and Apple are working on developing TV and movie media sites that are differentiated so that everyone will live on their social sites all day every day. Both have low-priced set-top boxes which they are tinkering with to find the right blend of functionality and cost.
Conclusion: Amazon and Google have very robust revenue streams that are not at risk of being usurped by a competitor. However, Amazon must prove it can consistently turn a profit to earn a ‘buy’ rating from us, and Google needs to start rewarding its shareholders with a dividend to justify its current valuation.
If you think of what makes trendy restaurants and nightclubs popular, it’s that they share the same market barrier as social media sites – that is, how to attract customers in the first place and generate a lot of “buzz.” For that reason many restaurants in New York and Los Angeles have paid actors, musicians and other celebrities to greet people at their establishments.
For this same reason, Twitter has a leg up on Facebook: Celebrities know that if they want to be instantly heard and reported, then Twitter is the forum in which to do it. One downside for Twitter is that the news media outlets are able to reprint the celebrity tweets and therefore users don’t have to go to Twitter in order to get the latest hot celebrity gossip.
What Amazon, Apple and Google share is their desire not to create the content but to resell the best content available. This stands in stark contrast to Netflix (NASDAQ: NFLX), HBO and Cinemax, where they are essentially betting that they will become the next MGM through content that is so rich that users must pay them to see it.
However, if Netflix guesses wrong about what type of programming will attract large numbers of viewers on a consistent basis, then there won’t be much backing them up in terms of future revenue. It may find itself being squeezed out of the reselling business by its better-capitalized competition, and unable to produce enough quality content to survive as a producer. Netflix benefitted significantly during the transition from physical delivery of programming content to online delivery (think the now-defunct Blockbuster Video), but it is now operating in a very different environment against much stronger competition.
Conclusion: Netflix pays no dividend and is trading at over 80 times earnings, so any hiccup in the execution of its business plan will most likely result in the continued decline in its share price.
As the U.S. economy gradually attempts to wean itself off of zero interest rates as Quantitative Easing has now gone by the boards, we believe that only the very best tech companies are worthy of investment. To be clear, the social media space is here to stay, and at more reasonable valuations, some of these companies represent good investment opportunities. But current price levels are far too high, reminiscent of the frothy levels popular tech stocks enjoyed prior to the “dotbomb” collapse a decade ago.