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Facebook taking a shotgun approach to capital allocation
With technology companies much in the news recently, RECM’s Paul Whitburn says valuing companies such as Facebook involves more questions than the asset manager is comfortable answering.
Facebook’s persistent appetite for acquisitions was clearly not sated by the R206 billion acquisition of WhatsApp in February, with the company spending a further R21 billion on virtual reality company Oculus late in March.
“They seem to be taking a shotgun approach to capital allocation,” says Paul Whitburn, a Portfolio Manager at RECM. “It’s something Microsoft did for ages – they’ll do a hundred different things across multiple technologies in the hope that one of them comes off.”
“My gut feel is that Facebook’s recent acquisition of WhatsApp was more of a defensive move than a strategy to monetise the app,” says Whitburn. “I think they’re looking to shut down anything that could break into their market. We saw Facebook do it with Instagram, maybe they are worried that WhatsApp could morph into a social media space. I don’t think the WhatsApp transaction is a game changer for Facebook, but it does help them to maintain their advantage for a little while longer.”
“We’re always wary of hype,” says Whitburn. “There are many good technology companies out there and we’ve owned several of them for our clients, including Microsoft, Dell, Hewlett Packard, and Intel. These are excellent businesses that are dominant in their areas, but they were hugely hyped in the late 1990s and early 2000s and seriously overvalued so we couldn’t invest in them. It took nearly a decade for them to get to prices sufficiently below their intrinsic value to justify investing in them.”
But Whitburn points out that it’s not that easy to pin down an objective fair value for a company like Facebook. “It’s difficult to say just how big Facebook’s potential market is. Internet advertising is still a fairly new phenomenon so there’s no telling what it will become. We’ve seen internet businesses disrupt established sectors – Craigslist wiped out billions of dollars of classified advertising revenue for newspapers in the US.”
The question is how sustainable any advantage is likely to be in a relatively new industry, says Whitburn. “We look for companies that have a competitive advantage over their peers – what Warren Buffett calls an economic moat.
“We believe Facebook has that through the network effects of their 500 million users. With social networking businesses, first mover advantage is massive and tends to stay in place for a while. But it’s difficult to pick the ultimate winners. There’s always someone in a dorm room somewhere dreaming up the next big thing and if they develop a good product it can compete very quickly – we saw how quickly MySpace became irrelevant. It’s much harder to disrupt established businesses that have built up customers, products, and brands over decades,” he concoludes.