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Social networking mania...

Written by Subject: Internet
It's all so familiar...

Facebook is valued at $50 billion. Information on the company is hard to come by, but as far as anyone can tell, that's somewhere around 50 times sales. Not profits... Not cash flow... sales.

Facebook shares, though not publicly traded, have been on a tear for a few years...

Last fall, shares of Facebook traded privately for $76 each, implying a valuation of $33 billion. Last June, a hedge fund called Elevation Partners invested at an implied valuation of $23 billion. In May 2009, a Russian entrepreneur paid $200 million for 2% of Facebook, implying a $10 billion valuation. Microsoft famously paid $240 million for 1.6% of Facebook in October 2007, valuing the whole thing at $15 billion. So depending on which valuation you trust, Facebook is up fivefold in less than two years, or more than threefold in just over three years.

Does anyone doubt an army of desperate souls out there right now is destined to pay way, way too much for Facebook and lose most of what they put into it?

Last November, Groupon, a coupon website, was valued around $6 billion, based on an offer by Google of $5.3 billion plus $700 million future milestone payments. That's almost 4.5 times the valuation assumed by a $130 million financing Groupon did in April 2010 – just seven months before Google made its offer.

And now the professional networking website LinkedIn is contemplating an initial public offering (IPO) as early as the first quarter of this year. It has hired investment bankers from Bank of America, MorganStanley, and JPMorganChase... but nobody at LinkedIn or the three banks will comment.

Folks are paying through the nose for social networking businesses. But when has anything like this ended well for the gullible, fleece-able hordes of desperate gamblers in the stock market? I can see them all lining up to get their Facebook, Groupon, and LinkedIn IPO shares – sold by investment bankers whose job is to get the most absurdly high valuation possible for their clients' stakes.

What about competition? Is there some reason a dozen smart kids with computers can't replicate these businesses in a week or two? There are no barriers to entry. There is no reason for a premium valuation. There's no intellectual property, licensing, FDA trials, or anything else to prevent competitors from springing up like mushrooms after the investment bankers make it rain.

Anyone who knows anything about business valuations knows it's difficult, and sometimes impossible, to value a young business in a new industry. And don't tell me the investment bankers are experts at this. They're not. They specialize in commission generation, not business valuation. Trusting their valuations is like driving blindfolded. You will crash, guaranteed.

Look at the best online business... eBay. It had a market cap of more than $80 million in late 2004/early 2005. Today, it's worth less than $37 billion, about 19 times trailing free cash flow, and a little more than two times sales. That strikes me as a fair valuation for a really good business... not 50 times sales.

Amazon is probably the single greatest online success story (at least the greatest one I can understand). It's valued today at $83 billion, about 59 times trailing 12-month operating earnings.

That sounds lofty, but Amazon might be worth it. Sales have more than doubled since 2007. Net profit is up 70% in that time. Profit margins are as slim as a grocery store (23% gross, 5% operating, 3% net). But if Amazon can keep doubling sales every three years, it'll justify its current valuation in a few years. Management is positively brilliant. Amazon could grow into its current valuation.

But few of the dot-coms turned out like Amazon. It's the only one that turned out so well. If you think Facebook is the Amazon of social networking, maybe you would pay 50 times sales today.

Facebook's got 500 million users, about 8% of the Earth's population. Maybe it can double in size, maybe not. Maybe it can figure out a way to make more than $1 billion in sales, maybe not. But would you really want to bet on it? Would you really want to bet a half-dozen other such sites won't become even more popular?

Put another way... Would you have bet on Yahoo before Google took over? What if Facebook is more like Yahoo than Google? Do you really want to make that bet?

Social networking is the new thing. A few smart (but mostly lucky) individuals at the top will make enormous fortunes from social networking. Meanwhile a whole bunch of Johnny-come-lately stock market rubes will get in at the top and lose a fortune. I figure in a few years, social networking will start to look like rare earth elements today...

"Molycorp is up 100% since December."

Yesterday, Brian Hunt, our editor in chief, and I were discussing the insane run-up in rare earth element stocks. Rare earth elements are types of metal that serve as key components in products like car batteries, high-end electronics, and wind turbines. China produces around 95% of the world's supply. The market cap of Molycorp (the largest rare element company) has passed $5 billion.

We've been following the "rare earth mania" for months. In the October 28, 2010 Digest, we pointed out the unwarranted valuations of industry bellwethers Rare Element Resources (REE) and Molycorp (MCP). Since then, things have only gotten crazier...

On December 30, 2010, China announced it would export 35% less rare earth elements than it did the year before, giving the stocks an extra boost. Take a look at the one-year chart below (note that Molycorp didn't begin trading until July 29, 2010). The percent gains have been astronomical...

Today, both Rare Element and Molycorp are plunging (Both are down about 13%). We can't say for sure this is the top in rare earth elements. But we can say these stocks are absurdly expensive. We'll leave you with Brian's warning from last October...
Like all manias, this one will end badly... with ridiculous valuations, awesome marketing hype, and massive share declines. If you're in this move, don't forget your stop losses.
If you're still short the euro, hold on... John Taylor, CEO of FX Concepts, the biggest currency hedge fund in the world, had his best year since 2006 shorting global currencies as governments flooded the market with money. Taylor is reversing his opinion on the dollar. He expects the dollar to rally mid-year as Republican efforts at fiscal responsibility kick in and the government ends its quantitative easing. (Taylor notes ending QE isn't a definite.) But he's still short the euro, which he says is going to par, and "probably below par." He's also short British pounds.

Taylor agrees with us... The crisis in Europe is too large. And there's no way the many countries involved can navigate it successfully. Eventually, the massive debts will lead to countries being thrown out of the euro and a collapse of the currency.

We're sure Mr. Taylor knows more about this stuff than we do, but we can't help wondering why you'd ever be long dollars in an environment like this. Republicans will want to cut taxes. Komrade Obama will want to keep spending. That can't go anywhere good. It'll lead to higher deficits, filled with more funny money, and the dollar will look worse a year from now than it does today. Also, folks who hang around in Washington, D.C. tell me they're already talking about QE3, 4, 5... Money-printing is like heroin. Once you start, it's hard to stop.

New highs: Automatic Data Processing (ADP), Arch Coal (ACI).

In the mailbag... questions about gold coins and how to use our advice. Send your e-mail to .

"From whom or where is the best place to purchase gold and silver?" – Paid-up subscriber Jeremy Michels

Goldsmith comment: We recommend our readers use either Van Simmons with David Hall Rare Coins ( note the positive feedback he received yesterday) or Rich Checkan with Asset Strategies International. You can find their contact information here.

For bullion purchases, just go to any coin shop and ask what the premiums are on various bullion coins. For example, I hear Mexican 20 Pesos are cheap these days. Bullion shouldn't require any special insight, especially if you're buying a widely recognized coin like a Krugerrand, American Eagle, or Maple Leaf.

"Although I have been a subscriber for a short time, and implementer of the advice for an even shorter time, and with a small portfolio (what was left after the market debacle and job layoff) we are seeing positive activity in our portfolio. By small I mean around 50K. I have been an investment advisor myself for many years and although I have been blessed with working with stable companies, I seemed to have always found reason to divert income from investments to paying current liabilities.

"Since that was obviously doing nothing for my situation I realized that now is the time to take serious action to attempt to recover what had been essentially lost. Working with such a small portfolio, the investment strategies presented offer solid fundamentals even for a small potato like me. Thanks for the sound advice. I realize it is not the thing that most people want to hear, but with all the media fluff being bandied about these days, it is actually quite refreshing." – Paid-up subscriber Skip Kern

Ferris comment: Before you go "investing" anything, pay down your credit cards. Nobody ever got rich paying 18% for money.

"At the bottom of your report you issue the recommendation list. Is this a look back at performance or a recommendation to buy? What does the column "pub" mean?" – Paid-up subscriber T Daniel Neveau

Goldsmith comment: I assume you're talking about our "Top 10" at the bottom of every Digest. The Top 10 is a list of the 10 highest-returning open recommendations across all our portfolios. You shouldn't interpret this list as a recommendation to buy. We just use it to recognize our editors for outstanding work. The "pub" column is the publication the recommendation comes from.


Dan Ferris and Sean Goldsmith
Medford, Oregon and Baltimore, Maryland
January 6, 2011

Stansberry & Associates Top 10 Open Recommendations

Stock Symbol Buy Date Total Return Pub Editor
Paramount Gold & Silver Corp PZG 4/14/2009 414.59% Phase I Sjuggerud
Silver Wheaton SLW 7/6/2009 351.48% Resource Rpt. Badiali
Silvercorp Metals SVM 6/1/2009 270.93% Resource Rpt. Badiali
Northern Dynasty Minerals NAK 3/2/2009 242.34% Resource Rpt. Badiali
EnCana ECA 5/14/2004 189.59% Extreme Value Ferris
Rite Aid 8.5% 767754BU7 2/6/2009 177.78% True Income Williams
MAG Silver MVG 7/6/2009 158.29% Resource Rpt. Badiali
Exelon EXC 10/8/2002 144.96% PSIA Stansberry
Alexander & Baldwin ALEX 10/11/2002 129.21% Extreme Value Ferris
Auex Ventures Inc XAU-T 10/28/2009 128.62% Phase I Badiali

Top 10 Totals
4 Resource Rpt.Badiali
2 Extreme ValueFerris
1 Phase ISjuggerud
1 True IncomeWilliams
1 PSIAStansberry
1 Phase IBadiali

Stansberry & Associates Hall of Fame

Investment Sym Held Gain Pub Editor
Seabridge Gold SA 4 years, 73 days 995% Sjug Conf. Sjuggerud
JDS Uniphase JDSU 1 year, 266 days 592% PSIA Stansberry
ATAC Resources ATC 313 days 542% Phase 1 Badiali
Jinshan Gold Mines JIN.TO 290 days 339% Resource Rpt. Badiali
Medis Tech MDTL 4 years, 110 days 333% Diligence Ferris
ID Biomedical IDBE 5 years, 38 days 331% Diligence Lashmet
Texas Instr. TXN 270 days 301% PSIA Stansberry
MS63 Saint-Gaudens
5 years, 242 days 273% True Wealth Sjuggerud
Cree Inc. CREE 206 days 271% PSIA Stansberry
KHD Humboldt Wedag KHD 6 years, 7 months, 22 days 268% Extreme Value Ferris