For the shark tank that is the media, Facebook’s recent $19 billion acquisition of WhatsApp has been a week full of fresh meat. Opinions fly from all directions: equity analysts, venture capitalists, and other startup founders. The diversity of these opinions is in itself revealing: people are struggling to find a “framework” for how to assess these companies and acquisitions.

As I write this, Facebook has a market capitalization of $179 billion, which makes it 8.5% larger than Amazon, only 15% smaller than Proctor and Gamble, and only 25% smaller than Walmart. While I believe that Facebook is one of only a few public companies that that is well-positioned under Andreeson’s “Software is Eating the World” hypothesis, the current valuation levels don’t make sense to me. This is a change of view from my assessment that Facebook was “cheap”, written in December 2012 at $28/share. The “institutional ownership” hypothesis that underpinned that article came to fruition and now stands as a risk (see financial assessment below).

The core of my hypothesis rests on three pillars: Zuckerberg’s social agenda, the importance of consumer valuation segmentation, and a few traditional financial metrics.

“Zucktopia”

Mark Zuckerberg deserves commendation for his lofty goals, one of which has been to connect and bring transparency to the world. While Facebook’s goals have changed over time, this “connection” has been at the heart of Facebook’s strategy.

This mission has not been without criticism. Facebook’s pushes towards transparency saw the ire of many of its users. This had two-fold impacts: the first has been some brand damage, and the second has been the rise of “less transparent” applications, such as Snap Chat, and Telegram.

Most recently, Facebook announced that it is aiming to bring free, basic internet to the world. This is a project of serious magnitude. And while one can certainly make the case for the revenue opportunities that this may open up, it is also a risky venture with a long-term payoff. It’s far from clear as to whether this is the most beneficial financial decision the company can make. It does, however, fit within the company’s ideals.

While Facebook is not officially a “B-Corporation”, they have made “social good” decisions whose financial results are unclear.

The Emerging Market Consumer

Given the lack of large-scale monetization within the social media space, most analyses estimate the average lifetime value per customer. The primary problem with this sort of analysis is the massive underlying variability of each customer’s lifetime value. For example, the average GDP per capita in Norway is nearly 15 times that of India. Averages make no sense in this framework: per country analyses need to be completed. Think how asinine it would sound to make real-estate decisions globally based on the “average cost per acre”. Why then, do we do it with users?

Most commonly, people believe that we are seeing a normalization of wages between developed and emerging countries. While this has been occurring, these changes take much longer than anticipated, and may not be strongly profitable once the cashflows are properly discounted. Furthermore, large declines in emerging market equity indices, coupled with high housing valuations and volatile currency moves, suggest than there are outsized risks for many of these economies.

A few financial metrics

My previous post (over a year ago), made the case that Facebook was cheap due to lack of institutional ownership. The hypothesis went that, portfolio managers had very few public companies to allocate “social media” money to. At the time, financial ownership was around 36% of outstanding shares, or about $10 billion in cash value. Presently, they own around 65% of outstanding shares, or about $90 billion in cash value. The natural rebalancing that is likely to occur should prevent substantial upward pressure.

Furthermore, of the companies listed above (Amazon, P&G, and Walmart), Facebook has an extreme lack of diversification in its cash flows. While they appear to be targeting a “house-of-brands” conglomerate approach, monetization will need to follow “eyeballs”.

Some of the analyses that I’ve read go as follows: Facebook’s current user base is valued at $150 per user. WhatsApp has 450 million users, and, growing at 1 million users per day, will have 815 million users by the end of the year, or $23 per user. This analysis totally disregards correlation, a key facet to any good analysis. Even Facebook has admitted to not knowing how much overlap there is with the existing WhatsApp user base. At WhatsApp current growth rates, the amount of “overlap” is sure to increase with growth. Currently, WhatsApp has $20 million “paying users”. I presume that most of the others are in the “12-month free trial”. Thereafter, will they pay the required $1? It’s not clear. What is clear is that both acquisition and churn rates are not constant over time, and need to be treated as such.

Conclusion

I’m not trying to hate on Facebook. I actually think they are an amazing and innovative company, that contributes social good, open-source software, and connectedness. That doesn’t mean at current valuations I can’t consider them overvalued.