Facebook - The Comport Case
January 31, 2020
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Facebook is currently a stock dearest past times both growth together with value investors alike. It is an esteemed fellow member of the FANG social club - an aristocrat of the modern digital era. Everyone seems to ain it. I don't similar it. I call back the stock is much riskier than most investors appreciate - peculiarly at this indicate inwards the cycle. (I am a twenty-four hr menses belatedly inwards publishing this article, every bit the stock is downwards 6% to US$210 postal service its 4Q19 results - albeit this is pocket-size fry compared to the aggregate potential downside; I tweeted the WSJ Casper article referenced below over the weekend, together with inwards related comments referenced the risks to Facebook, together with began writing this postal service on Sunday. Unfortunately I was also ho-hum to consummate it).
The things to similar most FB are trivially obvious. Unlike most of it media-industry brethren, its content comes from UGC (user generated content) together with is thus produced for gratis past times its billions of active users, together with the society is so able to sell ads against the important traffic this UGC generates. The persistency of its UGC is also supported past times the well-discussed (read 'excessively discussed') 'network effect'. Furthermore, the amount of coin it tin build from selling digital ads is beingness supported past times rising digital advertising penetration, every bit good every bit the company's powerfulness to target users, due to its trove of user data. The society has move a putative duopoly with Google inwards the online digital advertising space, together with is seen every bit a reliable, incumbent FCF compounder. Investors ain the stock every bit they call back (1) the society tin hold growing at high rates; together with (2) the company's earnings together with growth outlook is depression risk, every bit it is supported past times durable, structural drivers.
As is e'er the instance inwards markets though, obvious merits are good known together with good priced in. To build coin inwards markets yous receive got to prod for outcomes that are less probable but soundless possible, together with are non beingness priced in, together with I call back at that topographic point are many things to live legitimately concerned most for FB inwards this honor at the acquaint time. As I receive got pointed out many times inwards prior posts, it does non thing that the below analysis powerfulness non live a base of operations instance likelihood. It only matters that it is a not-negligible potential scenario that is beingness excluded from investors base of operations instance render expectancies. That is plenty to conclude the risk/reward associated with owning the society is poor.
Although FB is a large together with of import company, the heart drivers of its value are genuinely extremely simple: (1) the number of users it has together with the amount of fourth dimension those users pass on its platforms (what I telephone band 'eyeball-hours'); together with (2) the story to which it tin monetise those eyeball-hours through selling digital ads, which is a combination of the advertizement charge (number of ads per hour), together with the average charge per unit of measurement bill of fare (cost per ad). The powerfulness of the society to successfully customise/target ads to specific demographics also contributes importantly to the latter. The company's cost dependent champaign also matters, but is a somewhat less interesting together with of import number on a stand-alone footing than the company's revenue outlook. If revenues grow a lot, costs thing less; if revenue disappoints, they thing a lot more.
With honor to #1, the company's global DAUs/MAUs proceed to steadily grow. However, the society has already captured the vast volume of the world's high-value users - those that tin afford a smartphone together with access to the internet, together with tin afford to pass a lot of coin on products together with services advertised on its online platforms, justifying the advertizement spend. However, precisely every bit of import every bit the number of users is the amount of fourth dimension they pass on the platform (the other of import determinant of eyeball-hours), together with transparency on this all-important metric is significantly lower.*
One of the problems/headwinds for the latter is something I receive got discussed inwards past spider web log articles - the increasing saturation of the 'attention market'. Although tech investors are accustomed to believing inwards limitless growth horizons, the reality is that at that topographic point are only 24 hours inwards a day, seven days inwards a week, together with 52 weeks inwards a year, together with so at that topographic point is a finite amount of available attending for the world's online media companies (encapsulating social media, gaming, streaming, together with other sinks for our attention) to compete over. Furthermore, the penetration of 3G/4G-enabled smartphones roughly the ground is right away high - peculiarly with affluent/high value users. The void of previously unused attending of people roughly the ground waiting at double-decker stops, or queueing at the banking enterprise or airport, has right away been filled. In other words, the available eyeball-hour marketplace position has right away already move largely saturated.
One of the of import consequences of this is that time to come growth inwards the attending marketplace position is going to move 'zero sum' inwards nature, every bit the amount of white infinite uncaptured attending disappears. This is an of import alter vis-a-vis the past, where all novel online media companies could simultaneously grow past times capturing some of this previously unutilised attention. If at that topographic point is i thing that is virtually certain, it is that novel together with interesting online apps/ways to pass our fourth dimension volition proceed to emerge over time. The recent rapid ascent inwards TikTok, for instance, is a instance inwards indicate worth noting. Out of nowhere, it has come upwards to capture a not-negligible portion of the attending market. That excogitation volition proceed is a given, together with has e'er been the case, but what has changed is that from here, the success of i novel platform volition move cannibalistic and come upwards at the expense of the success of another, rather than beingness only additive to the overall attending industry.
On some metrics, the effect this is having on old-hands similar Facebook is already becoming tangible - at to the lowest degree with honor to the company's heart Facebook platform (i.e. excluding Instagram together with WhatsApp & Messenger). The below infographic is something I shared on Twitter a calendar month or so ago, together with is interesting on many levels. It highlights that FB's heart Facebook belongings has already entered into a fairly rapid pass upwards inwards usage inwards recent years, together with an of import contributor to this has probable been the increasing saturation of the attending market, together with cannibalistic effect of competing social media together with other mobile application platforms get-go to live felt. This is a work non precisely for Facebook's all-important eyeball hr share, but also for its network effect flywheel, every bit it depends on UGC. Less visits equals less UGC, which leads to less frequent visits (and scrolling dwell-time), every bit at that topographic point is less UGC to consume, leading to fifty-fifty less visits, etc.
Luckily for FB, they were smart plenty to purchase Instagram for a vocal ($1bn), together with Instagram is soundless on the upwards together with up, keeping FB's combined user metrics on a positive incline. However, the rapid recent pass upwards inwards the heart Facebook platform's see frequency nevertheless serves to highlight that right away that the attending marketplace position has been saturated, permanent incumbency inwards the social media space/attention marketplace position - allow lonely permanent growth - should non live automatically assumed. New platforms volition e'er live launched - the Instagram, Snapchat together with TikTok's of tomorrow - together with the marketplace position volition proceed to mutate, evolve, together with fragment, together with at acquaint the popularity of the heart Facebook platform is clearly trending inwards the incorrect direction - peculiarly because history suggests that in i lawsuit a platform's popularity is past times its peak, comebacks are rare.**
The bulls may admit that the attending marketplace position is becoming increasingly saturated, but they volition counter past times controversy that FB's attending is soundless significantly under-monetised. A major element of this declaration is pointing out that the company's US ARPU is soundless substantially inwards a higher house the ARPU generated inwards international markets. However, what if the actual truth was non that FB is under-monestising abroad, but rather that it is actually over-monetising its US user base?
Relevant inwards this regard was an splendid recent WSJ article most VC-backed online mattress society Caspers (see here - paywall). Like a large number of hyped, VC-backed Unicorns, Caspers has been growing rapidly, but chalking upwards considerable losses. The article notes that i of the challenges the society has faced is that almost all of its key draw of piece of work concern functions are outsourced (most notably all mattress procurement/manufacturing), spell the society is sourcing customers past times paying for online ads. All of these draw of piece of work concern functions are easily replicable, together with hence the society has seen the emergence of hundreds of immitators sourcing products from the same suppliers, together with competing for the same Google keywords together with Facebook demographics. This had driven marketing together with CACs through the roof, hammering profitability.
All these companies are losing money, every bit FB together with GOOG are capturing all of the value. It makes feel - if yous tin purchase together with receive got delivered a mattress from a third-party manufacturer for say $200, together with sell it online for $400, it makes feel non precisely to pay FB together with GOOG $20 to larn a customer, but also $50, $100, $150, together with ultimately $200. Indeed, it fifty-fifty makes feel to pay $250 if yous are beingness valued on revenue growth rather than profitability, every bit most VC-backed Unicorns are. Growth at all costs is their mantra.
Market together with economical history is replete with examples of companies together with industries that grew speedily but incinerated capital, because if render grows faster than demand, together with companies lack whatsoever sustainable competitive advantage, it doesn't thing how fast demand grows - everyone loses money. This has happened inwards everything from railways inwards the 19th Century; automobiles inwards the 1920s; fibre-optic cable inwards the belatedly 1990s; wireless networks inwards the 2010s (at to the lowest degree with honor to novel investments to upgrade networks, which receive got non been monetised); solar panels inwards the early on 2010s; shale stone oil & gas inwards the 2010s; together with to a greater extent than recently, inwards cannabis together with lithium. Stocks typically surge every bit investors anticipate a blast inwards demand, only to collapse after every bit render grows faster than demand together with losses mount.
Companies similar Caspers are no different, together with their large losses also reverberate their extremely depression story of organisational competencies. Caspers is non a mattress company. They receive got no manufacturing; no mattress technology; nothing. All they practice is larn manufacturers to to create mattresses for them; laid upwards an online storefront; together with so pass a tonne of coin branding together with marketing those mattresses through online channels. They are simply marketing businesses. Because they receive got really fiddling value-add; no unique organisational competences; together with no competitive advantages, they don't receive got the necessary ingredients for robust economical returns - namely, being able to practice something other people/organisations can't easily do. They are facing lots of contest from other well-funded start-ups willing to lose money, together with it is thus no surprise they are losing money. Anyone tin pay to purchase ads online, together with build together with sell products manufactured past times existent companies with existent capabilities (designing together with manufacturing mattresses, which requires some science together with installed capital).
In an era of unprecedentedly unloosen majuscule marketplace position weather condition inwards the VC space, at that topographic point are many, many companies similar Caspers out at that topographic point - essentially online marketing businesses that spell growing fast, are losing a tonne of money, because they receive got depression lineament draw of piece of work concern models that are easily replicated, together with at that topographic point is an excess render of majuscule inwards their manufacture chasing growth. This is unsustainable, together with when the VC funding spigot is turned off - which volition occur when the really high render expectations of their cease investors are inevitably disappointed, dampening the appetite for to a greater extent than (particularly from investors such every bit large pensions/endowments that tin ill-afford the losses) - a large fraction of these businesses volition fail, together with massive consolidation volition occur (much every bit occurred inwards 2000-03). Indeed, at that topographic point are some signs nosotros may already live reaching this point, every bit the WeWork blow-up has severely damaged Masayoshi Son's credibility, which is reducing his powerfulness to heighten additional capital.
This fourth dimension is seldom different. Every unmarried growth blast inwards history that has featured a vast number of novel entrants supported past times a moving ridge of majuscule all vying for a piece of the pie, receive got eventually seen the footstep of render growth outpace demand; mounting losses; together with an eventual severe downturn that leads to mass bankruptcies together with eventual consolidation. It happens every time, without exception.
The ground I hash out the Caspers of this ground here, however, is that the risks relate non precisely to Caspers, but also to the likes of Facebook, every bit it has been an of import marketing together with customer-acquisition channel for the said loss-making start-ups. How much of FB's advertizement revenue is driven past times wastefully-unsustainable marketing dollars beingness thrown roughly past times VC-backed startups desperate for growth without whatsoever regard for profitability is unknown, but it could good live substantial. Caspers lonely is spending to a greater extent than than $100m a yr on online marketing. Facebook's revenues are the other side of the unsustainable marketing together with CAC expense draw items of the said loss-making VC-backed Unicorns.
What this agency is that inwards a severe retrenchment inwards VC start-up land, a really considerable amount of online advertising pass could all of a abrupt disappear, every bit many of Facebook's key customers all of a abrupt substantially cut their online advertizement spend. Furthermore, when cease markets eventually consolidate (e.g. if Caspers ends upwards the winner past times raising IPO majuscule together with buying out all of its competitors for unopen to zero), at that topographic point volition also live less bidding contest for key words (relevant also for Google) together with key advertizement slots, which could cut prices every bit good every bit bidding volume.
How much of FB's US ARPU is beingness driven past times unsustainable CAC spending is unknown, but at that topographic point is a notable gap betwixt FB's monetisation inwards Europe together with the US & Canada ($13.21/quarter vs. US$41.41/quarter, respectively, inwards 4Q19), despite Europe also beingness a relatively high-income region. The bulls receive got argued this is due to FB beingness under-monetised inwards Europe together with the RoW (FB's global average was US$8.52/quarter inwards 4Q19), but the gap could also reverberate FB beingness heavily over-monetised inwards the US, reflecting rampant Valley financing of worthless tech start-ups willing to pass billions of dollars on Facebook together with Google ads to larn customers together with sustain rapid top-line growth at whatsoever cost.
When yous call back most it, US$41.41 per user inwards the US & Canada - a user base of operations that includes kids with express fiscal resources - is a staggering amount of money. It would receive got to influence several chiliad dollars of incremental annual production together with services pass a year, for every unmarried user (including kids, together with the many really lite users of FB), for that to live sustainable together with economically justified. That's a tall monastic tell to sustain, allow lonely grow at rapid rates, together with it is exclusively possible inflated Unicorn CAC pass is a key ground the metric is so high.
If inwards a major tech bust, FB's US ARPU was to autumn to European levels, the company's revenues together with pre-tax earnings earnings could autumn catastrophically, past times every bit much every bit US$20bn, reducing pre-tax income from US$30bn to US$10bn. Impossible yous say? FB's revenue was only US$56bn (vs. US$71bn inwards 2019) every bit late every bit 2018, together with US$40bn (US$30bn less than electrical flow levels) every bit late every bit 2017! US$10bn is also most every bit much coin every bit the society was making inwards 2016, together with the company's cost base of operations has meaningfully inflated since then, every bit compliance/content moderation spending has grown (although at that topographic point may live some downside flexibility inwards a bust scenario given how much costs receive got risen).
One of the major mistakes investors made inwards the late-1990s tech bubble was to ignore the cyclicality of information technology majuscule spending. It was argued together with believed that the secular growth trends driving rising cyberspace adoption together with networking would live so strong that it would overwhelm whatsoever conceivable cyclical factors. People were wrong. There was a collapse inwards corporate information technology spending for several years; fiber networks were so significantly overbuilt that excess capacity remained for every bit much every bit 10-20 years postal service bust, wiping out many leveraged long-distance fiber companies together with forcing consolidation; together with online dot.com advertising pass (less important/systemic at the time) also collapsed.
Analogously, today investors are assuming the secular trends towards higher online activity together with digital marketing are so strong that cyclical factors tin live ignored, together with yet (1) advertising has e'er been a notoriously cyclical industry, every bit marketing pass is i of the foremost things companies cutting inwards a recession when they demand to shore upwards cash flow; together with (2) digital marketing has right away already grown to a relatively large part of total global advertising spend, which agency the extent to which secular growth drivers (digital pass rising every bit a per centum of total advertising spend) tin overwhelm cyclical factors (the aggregate rising together with autumn of marketing pass through all channels) is also naturally declining.
If nosotros move through a severe tech VC/Unicorn bust, which I call back is virtually inevitable together with receive got called for multiple times on this blog, I call back investors could easily live surprised past times the extent to which this dents FB together with GOOG's marketing revenues (the trends discussed inwards this article are also relevant to GOOG's marketing revenue, but dissimilar FB, it has a to a greater extent than durable long term heart draw of piece of work concern monopoly, together with also has a valuable together with speedily growing cloud draw of piece of work concern (supported past times its AI capabilities), YouTube, etc, which move far less risky than FB long term, but soundless really vulnerable brusque term).
If FB's advertizement revenues were to unexpectedly drop by say 20% - peculiarly if FB is unable to larn its cost base of operations nether control, every bit it continues to invest heavily inwards 'content moderation' to comply with increasingly strident calls for online content moderation past times regulators - the company's earnings could easily halve (increasing the stock's P/E to 50x), together with the stock could live absolutely massacred. If it roughshod to 15x reduced earnings that would live a 70% decline. Sound impossible? A 20% driblet inwards the company's advertizement revenue would only receive got its move past times draw dorsum to levels seen inwards 2018, and a autumn inwards the multiple volition live amplified past times the electrical flow story of crowding into tech names, together with the faux expectations many holders receive got (that FB is a 'low risk' structural grower immune from cyclical risks). Falling prices also boot into gear diverse self-reinforcing psychological together with momentum/flows forces, which is why historically, the gravity of the bust is commonly inversely proportional to the gravity of the preceding boom. And all this is earlier considering whatsoever fears that may emerge most FB losing marketplace position part to other competing social media platforms such every bit TikTok.
At this point, I volition inevitably live asked, does that hateful I'm brusque FB? No it doesn't. I don't similar shorting stocks for reasons I receive got discussed inwards past spider web log articles, together with to a greater extent than importantly, I never receive got 100% confidence that whatsoever of my views are right. That's non the way I think/invest; I don't grade a fixed persuasion of what I call back is going to occur inwards the future, together with so invest on the supposition that I am right, which is what most investors do. The time to come is radically indeterminate, together with trying to predict the shape of time to come online advertizement pass is extremely difficult, together with it would live foolish to endeavour to practice so with whatsoever story of certainty - peculiarly for a generalist, non-specialist such every bit myself, that has non dedicated whatsoever serious query fourth dimension to the issue. I receive got spent a pocket-size fraction of i percent of my query fourth dimension thinking most these issues, every bit I am focused on regain promising opportunities inwards odd corners of global markets, together with don't waste materials my fourth dimension on areas that are already good picked over/expensive/crowded.
I instead consider a diversity of potential futures, to grade a probability distribution of sorts, together with so expression at what's priced in/generally believed. In the instance of FB, I encounter a province of affairs where everyone is long together with has signed upwards to the persuasion that this is a bulletproof structural growth story, together with that this volition inevitably stay the instance for many years. They powerfulness live right. But I am much less sure, together with receive got concluded from my analysis that at that topographic point are of import run a hazard factors that appear to live under-appreciated past times investors. That's all I demand to know to know the stock is non a purchase on an expectancy footing - I don't demand to know for certainly what happens. However, if I brusque the stock, I do need to know for certainly what's going to happen, together with also demand to live certainly the stock doesn't move parabolic inwards the interim - something that happened inwards the dot.com bubble together with wiped out many brusque sellers who were forced to comprehend (and is currently happening with Tesla), even though they were ultimately correct inwards their key views.
So I won't live going short, but I definitely won't live going long.
LT3000
*Also notable hither is that fourth dimension spent on messenging apps is of considerably lower value than on Facebook together with Instagram, every bit it is really hard to effectively monetise the former.
**Incidentally, the other notable collapse inwards spider web traffic has been from Baidu - some other pop stock owned past times many value investors, which appeared inexpensive relative to Google, but which never succeeded inwards making together with distributing whatsoever cash of note, every bit it squandered its prosperity on many loss-making upstart ventures - perchance because it recognized vulnerabilities inwards its heart draw of piece of work concern that most investors overlooked, which are right away becoming manifest. Unlike Facebook's part price, however, which has continued to rising together with rise, Baidu's has sharply declined.
The things to similar most FB are trivially obvious. Unlike most of it media-industry brethren, its content comes from UGC (user generated content) together with is thus produced for gratis past times its billions of active users, together with the society is so able to sell ads against the important traffic this UGC generates. The persistency of its UGC is also supported past times the well-discussed (read 'excessively discussed') 'network effect'. Furthermore, the amount of coin it tin build from selling digital ads is beingness supported past times rising digital advertising penetration, every bit good every bit the company's powerfulness to target users, due to its trove of user data. The society has move a putative duopoly with Google inwards the online digital advertising space, together with is seen every bit a reliable, incumbent FCF compounder. Investors ain the stock every bit they call back (1) the society tin hold growing at high rates; together with (2) the company's earnings together with growth outlook is depression risk, every bit it is supported past times durable, structural drivers.
As is e'er the instance inwards markets though, obvious merits are good known together with good priced in. To build coin inwards markets yous receive got to prod for outcomes that are less probable but soundless possible, together with are non beingness priced in, together with I call back at that topographic point are many things to live legitimately concerned most for FB inwards this honor at the acquaint time. As I receive got pointed out many times inwards prior posts, it does non thing that the below analysis powerfulness non live a base of operations instance likelihood. It only matters that it is a not-negligible potential scenario that is beingness excluded from investors base of operations instance render expectancies. That is plenty to conclude the risk/reward associated with owning the society is poor.
Although FB is a large together with of import company, the heart drivers of its value are genuinely extremely simple: (1) the number of users it has together with the amount of fourth dimension those users pass on its platforms (what I telephone band 'eyeball-hours'); together with (2) the story to which it tin monetise those eyeball-hours through selling digital ads, which is a combination of the advertizement charge (number of ads per hour), together with the average charge per unit of measurement bill of fare (cost per ad). The powerfulness of the society to successfully customise/target ads to specific demographics also contributes importantly to the latter. The company's cost dependent champaign also matters, but is a somewhat less interesting together with of import number on a stand-alone footing than the company's revenue outlook. If revenues grow a lot, costs thing less; if revenue disappoints, they thing a lot more.
With honor to #1, the company's global DAUs/MAUs proceed to steadily grow. However, the society has already captured the vast volume of the world's high-value users - those that tin afford a smartphone together with access to the internet, together with tin afford to pass a lot of coin on products together with services advertised on its online platforms, justifying the advertizement spend. However, precisely every bit of import every bit the number of users is the amount of fourth dimension they pass on the platform (the other of import determinant of eyeball-hours), together with transparency on this all-important metric is significantly lower.*
One of the problems/headwinds for the latter is something I receive got discussed inwards past spider web log articles - the increasing saturation of the 'attention market'. Although tech investors are accustomed to believing inwards limitless growth horizons, the reality is that at that topographic point are only 24 hours inwards a day, seven days inwards a week, together with 52 weeks inwards a year, together with so at that topographic point is a finite amount of available attending for the world's online media companies (encapsulating social media, gaming, streaming, together with other sinks for our attention) to compete over. Furthermore, the penetration of 3G/4G-enabled smartphones roughly the ground is right away high - peculiarly with affluent/high value users. The void of previously unused attending of people roughly the ground waiting at double-decker stops, or queueing at the banking enterprise or airport, has right away been filled. In other words, the available eyeball-hour marketplace position has right away already move largely saturated.
One of the of import consequences of this is that time to come growth inwards the attending marketplace position is going to move 'zero sum' inwards nature, every bit the amount of white infinite uncaptured attending disappears. This is an of import alter vis-a-vis the past, where all novel online media companies could simultaneously grow past times capturing some of this previously unutilised attention. If at that topographic point is i thing that is virtually certain, it is that novel together with interesting online apps/ways to pass our fourth dimension volition proceed to emerge over time. The recent rapid ascent inwards TikTok, for instance, is a instance inwards indicate worth noting. Out of nowhere, it has come upwards to capture a not-negligible portion of the attending market. That excogitation volition proceed is a given, together with has e'er been the case, but what has changed is that from here, the success of i novel platform volition move cannibalistic and come upwards at the expense of the success of another, rather than beingness only additive to the overall attending industry.
On some metrics, the effect this is having on old-hands similar Facebook is already becoming tangible - at to the lowest degree with honor to the company's heart Facebook platform (i.e. excluding Instagram together with WhatsApp & Messenger). The below infographic is something I shared on Twitter a calendar month or so ago, together with is interesting on many levels. It highlights that FB's heart Facebook belongings has already entered into a fairly rapid pass upwards inwards usage inwards recent years, together with an of import contributor to this has probable been the increasing saturation of the attending market, together with cannibalistic effect of competing social media together with other mobile application platforms get-go to live felt. This is a work non precisely for Facebook's all-important eyeball hr share, but also for its network effect flywheel, every bit it depends on UGC. Less visits equals less UGC, which leads to less frequent visits (and scrolling dwell-time), every bit at that topographic point is less UGC to consume, leading to fifty-fifty less visits, etc.
Luckily for FB, they were smart plenty to purchase Instagram for a vocal ($1bn), together with Instagram is soundless on the upwards together with up, keeping FB's combined user metrics on a positive incline. However, the rapid recent pass upwards inwards the heart Facebook platform's see frequency nevertheless serves to highlight that right away that the attending marketplace position has been saturated, permanent incumbency inwards the social media space/attention marketplace position - allow lonely permanent growth - should non live automatically assumed. New platforms volition e'er live launched - the Instagram, Snapchat together with TikTok's of tomorrow - together with the marketplace position volition proceed to mutate, evolve, together with fragment, together with at acquaint the popularity of the heart Facebook platform is clearly trending inwards the incorrect direction - peculiarly because history suggests that in i lawsuit a platform's popularity is past times its peak, comebacks are rare.**
The bulls may admit that the attending marketplace position is becoming increasingly saturated, but they volition counter past times controversy that FB's attending is soundless significantly under-monetised. A major element of this declaration is pointing out that the company's US ARPU is soundless substantially inwards a higher house the ARPU generated inwards international markets. However, what if the actual truth was non that FB is under-monestising abroad, but rather that it is actually over-monetising its US user base?
Relevant inwards this regard was an splendid recent WSJ article most VC-backed online mattress society Caspers (see here - paywall). Like a large number of hyped, VC-backed Unicorns, Caspers has been growing rapidly, but chalking upwards considerable losses. The article notes that i of the challenges the society has faced is that almost all of its key draw of piece of work concern functions are outsourced (most notably all mattress procurement/manufacturing), spell the society is sourcing customers past times paying for online ads. All of these draw of piece of work concern functions are easily replicable, together with hence the society has seen the emergence of hundreds of immitators sourcing products from the same suppliers, together with competing for the same Google keywords together with Facebook demographics. This had driven marketing together with CACs through the roof, hammering profitability.
All these companies are losing money, every bit FB together with GOOG are capturing all of the value. It makes feel - if yous tin purchase together with receive got delivered a mattress from a third-party manufacturer for say $200, together with sell it online for $400, it makes feel non precisely to pay FB together with GOOG $20 to larn a customer, but also $50, $100, $150, together with ultimately $200. Indeed, it fifty-fifty makes feel to pay $250 if yous are beingness valued on revenue growth rather than profitability, every bit most VC-backed Unicorns are. Growth at all costs is their mantra.
Market together with economical history is replete with examples of companies together with industries that grew speedily but incinerated capital, because if render grows faster than demand, together with companies lack whatsoever sustainable competitive advantage, it doesn't thing how fast demand grows - everyone loses money. This has happened inwards everything from railways inwards the 19th Century; automobiles inwards the 1920s; fibre-optic cable inwards the belatedly 1990s; wireless networks inwards the 2010s (at to the lowest degree with honor to novel investments to upgrade networks, which receive got non been monetised); solar panels inwards the early on 2010s; shale stone oil & gas inwards the 2010s; together with to a greater extent than recently, inwards cannabis together with lithium. Stocks typically surge every bit investors anticipate a blast inwards demand, only to collapse after every bit render grows faster than demand together with losses mount.
Companies similar Caspers are no different, together with their large losses also reverberate their extremely depression story of organisational competencies. Caspers is non a mattress company. They receive got no manufacturing; no mattress technology; nothing. All they practice is larn manufacturers to to create mattresses for them; laid upwards an online storefront; together with so pass a tonne of coin branding together with marketing those mattresses through online channels. They are simply marketing businesses. Because they receive got really fiddling value-add; no unique organisational competences; together with no competitive advantages, they don't receive got the necessary ingredients for robust economical returns - namely, being able to practice something other people/organisations can't easily do. They are facing lots of contest from other well-funded start-ups willing to lose money, together with it is thus no surprise they are losing money. Anyone tin pay to purchase ads online, together with build together with sell products manufactured past times existent companies with existent capabilities (designing together with manufacturing mattresses, which requires some science together with installed capital).
In an era of unprecedentedly unloosen majuscule marketplace position weather condition inwards the VC space, at that topographic point are many, many companies similar Caspers out at that topographic point - essentially online marketing businesses that spell growing fast, are losing a tonne of money, because they receive got depression lineament draw of piece of work concern models that are easily replicated, together with at that topographic point is an excess render of majuscule inwards their manufacture chasing growth. This is unsustainable, together with when the VC funding spigot is turned off - which volition occur when the really high render expectations of their cease investors are inevitably disappointed, dampening the appetite for to a greater extent than (particularly from investors such every bit large pensions/endowments that tin ill-afford the losses) - a large fraction of these businesses volition fail, together with massive consolidation volition occur (much every bit occurred inwards 2000-03). Indeed, at that topographic point are some signs nosotros may already live reaching this point, every bit the WeWork blow-up has severely damaged Masayoshi Son's credibility, which is reducing his powerfulness to heighten additional capital.
This fourth dimension is seldom different. Every unmarried growth blast inwards history that has featured a vast number of novel entrants supported past times a moving ridge of majuscule all vying for a piece of the pie, receive got eventually seen the footstep of render growth outpace demand; mounting losses; together with an eventual severe downturn that leads to mass bankruptcies together with eventual consolidation. It happens every time, without exception.
The ground I hash out the Caspers of this ground here, however, is that the risks relate non precisely to Caspers, but also to the likes of Facebook, every bit it has been an of import marketing together with customer-acquisition channel for the said loss-making start-ups. How much of FB's advertizement revenue is driven past times wastefully-unsustainable marketing dollars beingness thrown roughly past times VC-backed startups desperate for growth without whatsoever regard for profitability is unknown, but it could good live substantial. Caspers lonely is spending to a greater extent than than $100m a yr on online marketing. Facebook's revenues are the other side of the unsustainable marketing together with CAC expense draw items of the said loss-making VC-backed Unicorns.
What this agency is that inwards a severe retrenchment inwards VC start-up land, a really considerable amount of online advertising pass could all of a abrupt disappear, every bit many of Facebook's key customers all of a abrupt substantially cut their online advertizement spend. Furthermore, when cease markets eventually consolidate (e.g. if Caspers ends upwards the winner past times raising IPO majuscule together with buying out all of its competitors for unopen to zero), at that topographic point volition also live less bidding contest for key words (relevant also for Google) together with key advertizement slots, which could cut prices every bit good every bit bidding volume.
How much of FB's US ARPU is beingness driven past times unsustainable CAC spending is unknown, but at that topographic point is a notable gap betwixt FB's monetisation inwards Europe together with the US & Canada ($13.21/quarter vs. US$41.41/quarter, respectively, inwards 4Q19), despite Europe also beingness a relatively high-income region. The bulls receive got argued this is due to FB beingness under-monetised inwards Europe together with the RoW (FB's global average was US$8.52/quarter inwards 4Q19), but the gap could also reverberate FB beingness heavily over-monetised inwards the US, reflecting rampant Valley financing of worthless tech start-ups willing to pass billions of dollars on Facebook together with Google ads to larn customers together with sustain rapid top-line growth at whatsoever cost.
When yous call back most it, US$41.41 per user inwards the US & Canada - a user base of operations that includes kids with express fiscal resources - is a staggering amount of money. It would receive got to influence several chiliad dollars of incremental annual production together with services pass a year, for every unmarried user (including kids, together with the many really lite users of FB), for that to live sustainable together with economically justified. That's a tall monastic tell to sustain, allow lonely grow at rapid rates, together with it is exclusively possible inflated Unicorn CAC pass is a key ground the metric is so high.
If inwards a major tech bust, FB's US ARPU was to autumn to European levels, the company's revenues together with pre-tax earnings earnings could autumn catastrophically, past times every bit much every bit US$20bn, reducing pre-tax income from US$30bn to US$10bn. Impossible yous say? FB's revenue was only US$56bn (vs. US$71bn inwards 2019) every bit late every bit 2018, together with US$40bn (US$30bn less than electrical flow levels) every bit late every bit 2017! US$10bn is also most every bit much coin every bit the society was making inwards 2016, together with the company's cost base of operations has meaningfully inflated since then, every bit compliance/content moderation spending has grown (although at that topographic point may live some downside flexibility inwards a bust scenario given how much costs receive got risen).
One of the major mistakes investors made inwards the late-1990s tech bubble was to ignore the cyclicality of information technology majuscule spending. It was argued together with believed that the secular growth trends driving rising cyberspace adoption together with networking would live so strong that it would overwhelm whatsoever conceivable cyclical factors. People were wrong. There was a collapse inwards corporate information technology spending for several years; fiber networks were so significantly overbuilt that excess capacity remained for every bit much every bit 10-20 years postal service bust, wiping out many leveraged long-distance fiber companies together with forcing consolidation; together with online dot.com advertising pass (less important/systemic at the time) also collapsed.
Analogously, today investors are assuming the secular trends towards higher online activity together with digital marketing are so strong that cyclical factors tin live ignored, together with yet (1) advertising has e'er been a notoriously cyclical industry, every bit marketing pass is i of the foremost things companies cutting inwards a recession when they demand to shore upwards cash flow; together with (2) digital marketing has right away already grown to a relatively large part of total global advertising spend, which agency the extent to which secular growth drivers (digital pass rising every bit a per centum of total advertising spend) tin overwhelm cyclical factors (the aggregate rising together with autumn of marketing pass through all channels) is also naturally declining.
If nosotros move through a severe tech VC/Unicorn bust, which I call back is virtually inevitable together with receive got called for multiple times on this blog, I call back investors could easily live surprised past times the extent to which this dents FB together with GOOG's marketing revenues (the trends discussed inwards this article are also relevant to GOOG's marketing revenue, but dissimilar FB, it has a to a greater extent than durable long term heart draw of piece of work concern monopoly, together with also has a valuable together with speedily growing cloud draw of piece of work concern (supported past times its AI capabilities), YouTube, etc, which move far less risky than FB long term, but soundless really vulnerable brusque term).
If FB's advertizement revenues were to unexpectedly drop by say 20% - peculiarly if FB is unable to larn its cost base of operations nether control, every bit it continues to invest heavily inwards 'content moderation' to comply with increasingly strident calls for online content moderation past times regulators - the company's earnings could easily halve (increasing the stock's P/E to 50x), together with the stock could live absolutely massacred. If it roughshod to 15x reduced earnings that would live a 70% decline. Sound impossible? A 20% driblet inwards the company's advertizement revenue would only receive got its move past times draw dorsum to levels seen inwards 2018, and a autumn inwards the multiple volition live amplified past times the electrical flow story of crowding into tech names, together with the faux expectations many holders receive got (that FB is a 'low risk' structural grower immune from cyclical risks). Falling prices also boot into gear diverse self-reinforcing psychological together with momentum/flows forces, which is why historically, the gravity of the bust is commonly inversely proportional to the gravity of the preceding boom. And all this is earlier considering whatsoever fears that may emerge most FB losing marketplace position part to other competing social media platforms such every bit TikTok.
At this point, I volition inevitably live asked, does that hateful I'm brusque FB? No it doesn't. I don't similar shorting stocks for reasons I receive got discussed inwards past spider web log articles, together with to a greater extent than importantly, I never receive got 100% confidence that whatsoever of my views are right. That's non the way I think/invest; I don't grade a fixed persuasion of what I call back is going to occur inwards the future, together with so invest on the supposition that I am right, which is what most investors do. The time to come is radically indeterminate, together with trying to predict the shape of time to come online advertizement pass is extremely difficult, together with it would live foolish to endeavour to practice so with whatsoever story of certainty - peculiarly for a generalist, non-specialist such every bit myself, that has non dedicated whatsoever serious query fourth dimension to the issue. I receive got spent a pocket-size fraction of i percent of my query fourth dimension thinking most these issues, every bit I am focused on regain promising opportunities inwards odd corners of global markets, together with don't waste materials my fourth dimension on areas that are already good picked over/expensive/crowded.
I instead consider a diversity of potential futures, to grade a probability distribution of sorts, together with so expression at what's priced in/generally believed. In the instance of FB, I encounter a province of affairs where everyone is long together with has signed upwards to the persuasion that this is a bulletproof structural growth story, together with that this volition inevitably stay the instance for many years. They powerfulness live right. But I am much less sure, together with receive got concluded from my analysis that at that topographic point are of import run a hazard factors that appear to live under-appreciated past times investors. That's all I demand to know to know the stock is non a purchase on an expectancy footing - I don't demand to know for certainly what happens. However, if I brusque the stock, I do need to know for certainly what's going to happen, together with also demand to live certainly the stock doesn't move parabolic inwards the interim - something that happened inwards the dot.com bubble together with wiped out many brusque sellers who were forced to comprehend (and is currently happening with Tesla), even though they were ultimately correct inwards their key views.
So I won't live going short, but I definitely won't live going long.
LT3000
*Also notable hither is that fourth dimension spent on messenging apps is of considerably lower value than on Facebook together with Instagram, every bit it is really hard to effectively monetise the former.
**Incidentally, the other notable collapse inwards spider web traffic has been from Baidu - some other pop stock owned past times many value investors, which appeared inexpensive relative to Google, but which never succeeded inwards making together with distributing whatsoever cash of note, every bit it squandered its prosperity on many loss-making upstart ventures - perchance because it recognized vulnerabilities inwards its heart draw of piece of work concern that most investors overlooked, which are right away becoming manifest. Unlike Facebook's part price, however, which has continued to rising together with rise, Baidu's has sharply declined.