Kass: Egg on Your Facebook

Following the merger, AOL's shares commenced a steady, multiyear price decline from the high $70s to nearly $10 a share.

Superlatives, not substance, provided the backdrop of the discussion leading up to the Facebook IPO, as it was with America Online 13 years ago.

I speculated that a rich valuation, fundamental issues plus a continuing and discouraging Greek situation served to provide a poor backdrop for the Facebook IPO.

To me, Facebook continues to face philosophical, business, operational, financial and valuation headwinds.

• Philosophy: The company is run by a 28-year-old who favors a social mission above profits.
• Business trends: The rate of revenue growth is decelerating -- the first quarter experienced 45% growth in sales, down from 55% growth in the prior quarter. Advertising, in particular, is slowing, with a 37% growth rate in the first quarter. Google's (GOOG) display ad business (which competes directly with Facebook) is growing faster than Facebook.
• Profitability: Facebook's 50%-plus operating margin seems vulnerable. With nearly 1 billion current users, the low-hanging fruit -- and I am being somewhat facetious -- might have already been picked. I suspect the next 1 billion users will be less profitable to Facebook.
• Financial: Facebook is cash flow negative now as the company spends to grow (on data centers, more employees, etc.).
• Valuation: Back then I went through the exercise of supposing that Facebook's revenue growth accelerates modestly to 50% and that operating margins are sustainable. In this example, Facebook will achieve almost $5.5 billion in sales in 2012 and $8.25 billion in sales in 2013; EPS will be $0.60 in 2012 and $0.95 in 2013. At the offering price of $38 a share, these are high multiples, both absolutely and relative to other leading tech companies such as Apple (AAPL) and Google (at 10x to 11x, respectively).

All this said, I would continue to stay away from the shares of Facebook.

My only regret was that I didn't short Facebook during the first week of its IPO launch, as I did successfully with Groupon (GRPN).

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