It's Not Enron, It's Facebook

NEW YORK (TheStreet) - The phrase "When it rains it pours" seems to be the prevailing theme these days when discussing the current plight of social media giant Facebook (FB).

As the stock continues to plummet from what was a $38 egregiously overhyped IPO price to where it sits under $20, investors have started to wonder if the company is the "house of cards" that Enron was discovered to be. Enron ultimately went to zero. Where is Facebook heading?

One of the things that has made Wall Street seem a scary place is that corporations have become highly skilled at pretending to be something they are not. It goes without saying that there is no better example of this than Enron, but is it fair to place Facebook in this category? Some investors have already taking it to Twitter and in the comments section of several articles. But is it fair?

As far as the comparisons are concerned, for Facebook, not only is it in a continuous cycle of defending the fundamentals of its business, but there are now growing concerns about the legitimacy of its 955 million user base. Investors want to know if they are real or if the company has been lying.

As Enron brought more scrutiny to corporate disclosures, Facebook is now feeling the effect of the need to prove its foundation is not only stable but extremely transparent. As a way to appease the recent breed of investors filled with pessimism and mistrust, the company has made some acknowledgements regarding its reported users.

In a recent SEC filing Facebook has admitted that as of June 30 approximately 8.7% of its 955 million accounts worldwide are, in fact, duplicates or have erroneously been created -- essentially 83 million of them. In its recent filing the company revealed the following:

We estimate that "duplicate" accounts (an account that a user maintains in addition to his or her principal account) may have represented approximately 4.8% of our worldwide MAUs as of June 30, 2012.

As of June 30, 2012, we estimate user-misclassified accounts may have represented approximately 2.4% of our worldwide MAUs (monthly active users) and undesirable accounts may have represented approximately 1.5% of our worldwide MAUs.

We believe the percentage of accounts that are duplicate or false is meaningfully lower in developed markets such as the United States or Australia and higher in developing markets such as Indonesia and Turkey.

However, these estimates are based on an internal review of a limited sample of accounts and we apply significant judgment in making this determination, such as identifying names that appear to be fake or other behavior that appears inauthentic to the reviewers.  As such, our estimation of duplicate or false accounts may not accurately represent the actual number of such accounts.

First, Facebook deserves a considerable amount of credit for its acknowledgement of its user base discrepancy. This suggests that it is nothing like Enron. What's more, the company has waged an unrelenting commitment to improving its ability to spot these false user accounts and put corrective actions in place.

However, this is not the first time this issue has come up. Prior to going public, the company disclosed in SEC documents that of its 900 million users reported in the first quarter, 5% to 6% of them were also false or duplicates, or 55 million to 60 million.

As much as I appreciate the company's openness about this issue, I continue to wonder why it insists on reporting figures that include what it knows to be somewhat misrepresented. In this case, it just reported 955 million active monthly users when according to its own investigation the real number is possibly 100 million fewer.

The answer is simple. Its business model relies on targeted advertising. The higher the number the more it can charge.

As Enron changed the world of auditing and corporate ethics, it seems Facebook will have a similar impact in the way investors view future initial public offerings. What's more, the company has created a much-needed pessimism toward anything that is built up as "larger than life."

Facebook's continued stock decline will likely change the way future IPOs are viewed and scrutinized and become public issues in the same way Enron brought corporate change with Sarbanes-Oxley.

But that's where the similarities end. Facebook is not Enron. Where it was clear with Enron that criminal acts had taken place, Facebook's only crime in this situation is that it has failed to live up to investors' expectations.

At the time of publication, the author held no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Saintvilus is a private investor with an information technology and engineering background and has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.

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