Bullish on Facebook, while bearish on Twitter and Big Tech
In retrospect, Facebook’s fall to 166 early last week was a clear capitulation low on the shares. Normally, I avoid momentum stocks like the plague when earnings or margins disappoint and a stock tanks. This principle made total sense with, say, Netflix or Twitter. However, I violated my own principle in the case of Facebook for multiple reasons.
One, the shares fell 23 per cent from their 217 pre-earnings peak. Two, valuations are far too cheap relative to 30 per cent revenue growth prospects at only 17 times earnings ex-cash. Three, these valuation metrics simply do not capture the billion active user monetisation engines that are Messenger, WhatsApp and Instagram. Four, the revenue miss was due to the cost of data privacy regulatory compliance, Europe’s GDPR restrictions on video sharing and investments in video context, artificial intelligence and global growth.
Five, Facebook is a money-making machine on capitulation selling, as the world learnt in March and last week. The ecosystem of fund managers and the mathematics of market stress relative to earnings make this happen. Six, Facebook’s guidance pattern is to underplay revenue acceleration, then watch valuations readjust when good news hit the tape, as it will in the third quarter. Seven, Facebook trades at almost a 28 per cent valuation discount to Google/ Alphabet despite higher operating margins, revenue growth and messaging monetisation. Last week’s price action only reinforced my
the Fed’s shift in language means much higher interest rates in the next two years... [and] this will have a seismic impact on the valuation of every asset in the world
conviction that Facebook is undervalued relative to the S&P 500 index and will meet my near term target of 200.
I am far less bullish on Twitter, despite its public execution on the Nasdaq. Twitter’s revenue growth and profits will be hit by the sheer cost of running its platform, given the exponential rise in the salaries of software engineers in Silicon Valley and acquisition of video content. Unlike Facebook, Twitter’s valuation is a joke (the shares are 32 as I write) at 50 times forward — I repeat forward — GAAP earnings. After all, Facebook’s revenue growth has been almost double Twitter, which trades at a 60 per cent premium to Google despite a similar revenue rate. Facebook has 2.3 billion active user worldwide and Twitter is simply not positioned for growth or in the same global scale league as Facebook and Google. So I cannot smoke a 50 times forward valuation multiple in my philosopher’s pipe, despite Jack Dorsey’s hirsute reassurances.
I expect Twitter to lose at least 30 per cent of its value in the next six months, making it a classic short in a pair trade with Facebook. Who says Mr Market rationally prices social media shares (or any other asset for that matter!). Twitter still needs to deliver credible user growth/engagement data and the strategy for video monetisation that will not bankrupt the company. This is not a blip from the fake account purge but a far deeper strategic and structural malaise.
Apple’s trillion-dollar valuation was a seminal “era-defining” moment, such as the doomed Time Warner-AOL merger deal in 1999, the failure of Lehman Brothers in September 2008, the UK Brexit vote and Trump’s election in 2016. However, the Federal Reserve’s shift in language means much higher interest rates in the next two years, despite the mediocre July payrolls data.
This will have a seismic impact on the valuation of every asset in the world, including houses, used cars, home mortgages and auto loans even here in Dubai. Despite the shocks in Netflix and Facebook, technology is a “crowded trade”, even a mini-speculative mania. This rise of passive investing makes indices like the Nasdaq or even the S&P 500 hostage to the fate of a half-dozen stocks, as the FANG phenomenon proves. Valuations are no longer cheap for most large cap tech companies at a time when higher interest rates will hit high valuation multiples. It is ominous that the tsunami of inflows on tech exchange traded funds may well have peaked. This is probably a natural reaction to higher rates and a peak in earnings valuations.
With the US Dollar index again at 95 and a hawkish Powell Fed, the higher US dollar will definitely hit the EPS growth of Big Tech. At a time when Microsoft trades at a market cap of $830 billion, I can easily envisage King Dollar and a 3 per cent Fed Funds rate finally make a Nasdaq market meltdown highly probable. It is, after all, better to be approximately right than precisely wrong.