New Castle News

Columns

July 30, 2012

DEAR READER: Facebook’s fiscal slide looks familiar

NEW CASTLE — Remember the 1990s?

Those were heady, high-flying financial times, with the tech stocks booming on Wall Street.

Portfolio values were on a seemingly endless upward path. Serious people (at least in some eyes) were talking about the end of the business cycle with its inevitable ups and downs. Growth, we were told, was destined to be permanent.

It was the time to sweep out the old and bring in the new. That dusty old fogey, Warren Buffett, was being dismissed as a financial has-been. His corporation, Berkshire Hathaway, refused to invest in tech companies, because Buffett had the audacity to say he didn’t understand what they did or how they made money.

How quaint. And how accurate.

When the dot-com bubble burst, Buffett was standing tall, while many of those Internet companies collapsed and vanished.

Why? Because the business cycle hadn’t gone away, it was just waiting to re-establish itself. The excess and greed of the era meant many investors were operating with blinders. They ignored the reality that Buffett easily understood: Even the most modern of corporations have to make a buck in order to survive.

When the bottom fell out of the tech market, hard lessons were learned. People investing in these companies demanded results — profits and real growth. That’s the way it’s supposed to work.

But then came Facebook. Here was an Internet behemoth with literally hundreds of millions of customers creating billions of hits on its website. How could it not make money for investors?

Well, here’s how:

Last week Facebook released its first quarterly earnings report as a publicly owned company. While the report met Wall Street estimates with a 32 percent increase in revenue, that figure represented a slide in growth of 45 percent from the prior quarter.

Meanwhile, as Facebook invests in ways to generate revenue, its costs in the latest quarter rose 295 percent.

No matter how you slice it, those aren’t encouraging numbers. And the stock was hammered as a result, hitting a new low on Friday. The stock price dipped below $27 per share, well below its initial public offering high of more than $38 per share.

These figures do not indicate Facebook is on the verge of collapse. But for prudent investors, they are a warning. And the generally downward trend of Facebook’s stock since it first went public in May suggests buyers were attracted to the glamour of the company, rather than the bottom line.

A big problem with Facebook is its size. With so many users already in place, what is the company’s real growth potential?

And it’s worth noting all those users pay nothing to be Facebook members. Money is made only when businesses agree to post ads on the site, hoping to attract attention from Facebook’s massive membership.

But some companies question whether ads on Facebook really pay off, while some users worry about privacy and related concerns that occasionally crop up regarding the website.

Yet Facebook does have the potential to reverse its fiscal course. Its base of users represents a lucrative potential market — if truly effective ways can be found to tap into it.

On the other hand, the basic nature of modern technology poses a constant threat to high-tech firms such as Facebook. There was a time when a company called MySpace was the hot spot for social networking. Is there something out there poised to replace Facebook?

Personally, I’m inclined to follow Warren Buffett’s lead on such matters.

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