Investing in Facebook as it Disrupted Media and Communication
After Netflix’s story of disrupting linear TV, I want to discuss Facebook’s story of disrupting media. The story of Facebook’s stock is an interesting one because it illustrates how easily herd mentality can grip Wall Street and even broader society and guide everyone to a wrong conclusion. The story of Facebook’s stock is full of entertaining anecdotes.
But as in the other articles, I will start with a short personal story involving Facebook.
In 2007, social media had gripped Silicon Valley. Around that time I was living in Palo Alto and specifically in graduate housing at Stanford. Across from campus, on University Avenue, Facebook had a small office, which I sometimes passed by on my way to get food.
Facebook was a huge phenomenon on most college campuses including Stanford. People’s college lives evolved on and around Facebook. This social revolution seemed huge and the impact of it seemed transformative.
Around that time a friend and I were discussing a startup idea. It was a social marketplace for fitness services. By social marketplace I mean an online marketplace, where buyers and sellers in addition to transactional interactions also had social interactions, online and offline. Nowadays, the closest thing to a social marketplace is AirBnB. One could also imagine a more social version of ClassPass.
In 2007, because of the spread of social, we thought a social marketplace could be useful for sports and fitness. At that time we had no experience with entrepreneurship and understood very little about startups.
In 2007, Facebook had not launched pages yet and was only comprised of people and groups. It had no businesses. We thought that including businesses in this social interaction would be a significant step, which was the premise of our social marketplace. So I began closely analyzing Facebook’s functionality with all its minute details and features and continued to follow how the features evolved.
As my friend and I had other obligations, we were only sporadically working on the idea. After several months Facebook launched pages and started integrating businesses into its platform. To us that naively seemed a blow to our idea. We had little startup experience and naively thought that we were the only ones considering integrating businesses into social.
The longer I analyzed Facebook’s evolution and its features changing, the more I realized how huge and impactful Facebook could be on society. Every functionality challenge that I was thinking about for our marketplace idea, Facebook seemed to solve in a very elegant way.
When pages became mainstream on Facebook, something changed in its spread. Now individual businesses had an incentive to spread Facebook, so one would usually see them spread the Facebook logo or the URL: “facebook.com/business name” on websites or ads.
This is when the network tipped, because in addition to user based network effect, Facebook now had broader economic interests behind its spread.
In 2008, I was back in Los Angeles and met with my friend with whom I was discussing that startup idea. One night we were talking about the web’s evolution and about MySpace and Facebook. That night I told him that in my opinion Facebook could be much larger than anything else we have ever experienced before. I thought people are not aware how big and transformative it is.
I thought it could be by far the biggest and most transformative phenomenon of our generation!
And that opinion has not changed since.
Therefore in 2012, I was eagerly awaiting Facebook’s IPO so I could profit from that transformation. I have a rule for IPOs. I usually wait 6 months after the IPO before I buy the stock. This is to avoid the initial volatility of the stock, to experience one or two earnings reports to understand how Wall Street is viewing the company and also to wait for the first round of lockups to expire. But during these 6 months I closely follow the company and the stock.
Facebook’s IPO was unique. Although there was huge anticipation for it, because of a NASDAQ glitch it had a terrible first day. Then a slew of analysts’ coverage started to point out Facebook’s shortcomings with mobile transition and lack of profit. Then there was talk of the younger generation fleeing Facebook and slowing user growth. And within a couple of months all of Wall Street was negative on the stock. Every day a new person would talk on Bloomberg and forecast Facebook’s demise. I remember how one day Mark Cuban was on Bloomberg and forecasted the end of Facebook by comparing it to MySpace.
To me this was a sign of broad confusion and misunderstanding. In investing it is important to maintain an independent view and not be swayed by the crowd.
My conviction for Facebook’s transformative future had not changed. To me it was still the biggest thing in our generation. I was just waiting for the six months to pass so I could buy. So in November 2012 I initiated my first position in Facebook at about $25 per share.
Few weeks after that I was at a BBQ. We were sitting around a big fire and the conversation turned to Facebook. Every single person in a group of ten, without exception, started making fun of Facebook and talking about its demise and comparing it to MySpace. I was wondering how all that confusion had spread. I briefly stated that I disagree. This was quickly followed by a slew of arguments against my position. I left them unanswered.
Here is what Wall Street and most non-believers misunderstood about Facebook. There were so many things that Facebook had going for itself.
- First of all Facebook was not MySpace. That was an inappropriate comparison. MySpace was a poorly run company with a buggy product and tons of distractions on it. Facebook was slick, methodical, clean and strategic in its approach.
- Facebook was much further along than MySpace. Facebook had integrated groups and businesses, which created an enormous network effect that kept spreading and reinforcing itself.
- Facebook had a young, brilliant CEO with a long-term vision. He really understood human psychology and had shown how drastically he could innovate. I had analyzed Mark Zuckerberg for some time already, as I do with all CEOs I invest in. I had also read David Kirkpatrick’s books “The Facebook Effect”. Hence I was convinced of Zuckerberg’s long-term vision and brilliance.
- Facebook’s board was full of visionary and experienced entrepreneurs, including Peter Thiel, Mark Andreessen, Reed Hastings, all of whom had lots of clout in Silicon Valley and the business world.
- Facebook was part of the broader social experience in college. This made it a very desirable workplace for every new graduate. Therefore the company had a big recruiting advantage and could get the best talent.
- Facebook’s monetization was not an issue, as the company could dial up the ads served to increase revenue. At an early stage FB just did not want to irritate consumers and was focused on user growth and engagement.
- In 2013 we had finally decided to launch the social marketplace idea discussed earlier, under the name AktiveBay. Therefore we were using Facebook Connect to streamline signups and Facebook ads to generate traffic. So it was clear to me how valuable Facebook’s network and marketing tools were to every new startup and young company.
- Facebook had become a utility, as Zuckerberg often stated. The younger generation may not consider it cool anymore but it still found utilitarian value in it, for keeping up with news and friends.
- And the mobile transition was not that big of an issue and could be solved. In addition to launching a great mobile app, Zuckerberg pollinated the company with mobile DNA by purchasing Instagram before the IPO and WhatsApp later on.
This list can go on and on, which is why Facebook was so transformative. But all these misconceptions are a great illustration of the market confusions I discussed in my introductory article.
- The market is making an inappropriate comparison to a past phenomenon (Facebook is not MySpace)
- The stock price continues declining in information vacuum after some insignificant negative news (the unfortunate IPO and the confusion after that)
- The market is thinking too short term (it is not realizing the large network effect behind the product)
- The market is paying attention to a meaningless metric (Wall Street likes profitability but disruptive companies with network effect don’t need early profitability, they need growth)
- The market is misunderstanding an important, larger dynamic involving a company (Facebook is a utility and very valuable to many stakeholders)
Over the next year Facebook stock did not move much. In late 2013 I increased my Facebook position.
The naysayers also did not stop. A friend from my MBA program mentioned with confidence that Facebook already had a billion users and could not grow anymore. A traveler in Bali said with conviction: “Mark my words, Facebook will be gone in two years”.
One sign of broader confusion is when people repeat the same arguments you hear on TV, without providing deeper reasoning or analysis.
Around the end of 2013 a friend asked me what I think about the broader stock market. He was thinking about getting out of the market, since 2013 had a big rally and there was some economic uncertainty on the horizon. I suggested that a way of dealing with it is shifting away from beta (broader economy exposure) to alpha (company specific exposure). I suggested buying Facebook as a method, because Facebook’s uncertainty was not related to the economy, it was very company specific. He did not take my advice.
Few weeks after that Facebook had a huge earnings report showing big user growth and mobile revenue growth. Since then the stock has continued its consistent outperformance. With almost every earnings report Facebook kept surprising and blowing away all expectations. It acquired WhatsApp, it rolled out Messenger and spread deeper into the social fabric with its multi-app approach.
I continued to add to my Facebook position periodically. In November 2015 Facebook became the fastest company in history to reach a market capitalization of $300 billion.
This staggering number just shows how transformative Facebook was. It is interesting to contrast this with how negative most of Wall Street was on FB just three years prior to that. Just as stated in the Netflix article, the market can completely miss a “big elephant in the room”. The key to contrarian investing is maintaining an independent conviction and catching market confusions that can easily arise.
When disruption occurs it is usually missed by the incumbents and most participants, because naturally they analyze a new phenomenon from an old perspective. Disruptors are unique and it is important to understand what makes them unique. And it is also important to pay attention to the tipping point of a disruptive phenomenon, because after that there is usually no way back.
In the next article I will discuss Amazon’s story and how it disrupted retail. Amazon’s initial disruption was more gradual and my large position in the stock involved some luck. But luck is sometimes part of the game.
Since I am a dyslexic, I am prone to spelling and grammar mistakes. Hopefully it does not distract from the substance of the article.
Thank you for reading this article :)