Facebook has dominated the talk on Wall Street since going public on May 18. But after the hype and excitement surrounding the $100 billion deal, the chatter has been for all the wrong reasons. The stock plummeted from its offering price of $38 a share. Technical glitches, overvaluation and questions about the business model created disarray and confusion. Former star technology analyst turned investor Dan Niles expected all that. Today he is among the happiest Facebook investors because he bet against the company. I caught up with the manager of the AlphaOne Capital Partners $100 billion-plus fund to find out how he knew to stay away. Our interview follows, edited for clarity and length.
Q: I'm calling you the happiest Facebook investor because you made a bet against this stock.
A. That's probably true.
Q: Why did you short the stock at the highest level, and how did you know not to buy?
A: I shorted it the moment it opened for trading at $42 dollars a share. If you look at Facebook, the good news is you had a very public comparable company with a lot of the same issues and good things going on, which is Google.
To some extent, it's like two houses on the same block, and one house, which is Google, you say, "Oh, that house is appreciating at 24%, and revenues were growing 24% year-over-year in the most recent quarter." Then you look at Facebook and say, "This house is maybe twice as big. In this case, their growth rate was 45%. OK, that makes sense. Maybe I should pay twice as much for it." But you look at Google, and investors were valuing it at roughly six times annualized revenues; and you look at Facebook, and despite it growing at 45% vs. Google at 24%, they valued it at about 24 times if it goes public at $38.
Secondly, they reported on April 23 how revenue growth was declining. On May 10, they pointed out that growth in their users was growing faster than the amount of money they were generating off of them. Immediately, they were signaling that Q2 prospects were going to be a little weaker, and a lot of this is due to the growth in mobile users.
Q: Why is the mobile piece of this so important?
A: About half the people access Facebook through their cellphones, and advertisers just don't pay as much to advertise on a piece of display that's a couple of inches by a couple of inches vs. on your PC. They're having trouble making money off of that.
The final piece was (General Motors), the day before the IPO, said, "We don't see the benefits of advertising on Facebook, so, we're pulling out." You had a lot of warning signs that business was slowing further. They're having to deal with the fact that when you move into emerging markets, they just don't spend as much on advertising.
Combine all of that, and you can get into the characteristics of the deal where the underwriters increased the size of the deal, over half of the sellers were selling shareholders, and to me, this looked like a recipe for disaster, and that's why we shorted at the open.
Q: Valuation and fundamentals — it was too expensive, priced too high and the business is slowing.