Absolute Proof of the Social Media Bubble

In my March 22 blog post of last year entitled "Plus ça change....," I explored the Social Media Bubble that was rapidly building.  Well, that bubble is now in full manic froth.   I feared that this sector of the market would rhyme with the Internet mania of 1999.  It is April of 2012 and my fears have come fully to fruition.  Facebook has not even priced its IPO and the company has purchased Instagram -- basically a popular, virtually pre-revenue photo sharing service with roughly 13 full-time employees -- for $1 billion in cash and stock.  Ouch!

I knew the social media bubble would end badly and that companies would eventually do desperate things as advertising dollars grew tighter and capital dried up.   These events eventually unfold when companies and investors start asking for real ROIs, but I don't think we have quite reached those points in this cycle yet and I thought Facebook had solid discipline and sufficient cash to avoid desperation.  Moreover, I felt Facebook was in a better strategic position than many of the other companies in the space.  For example, I thought Groupon had a business model that was more readily susceptible to competition and less defensible; it did not have the potential for really high gross margins like Facebook and Twitter.  I expected desperation from them.  And even Twitter did not appear to have the stickiness and the time investment and engagement of its users that goes along with the Facebook model.  So I really did not expect Facebook to be the first company to do something silly like this.  I expected Facebook to be one of the last companies to fall prey to this type of deal -- not the first.  (I know one can claim that Zynga's deal for OMGPOP for $200 million was the first over-the-top social media deal, but I don't think it is in the same league.)

The really disturbing question is why did Facebook feel so compelled to pay such a high price for this company?  Instagram is the type of app that Facebook certainly could have reproduced itself in a matter of months with engineering talent it surely could have bought.  Such an app then would have been specifically tailored to the Facebook service in a mobile and desktop environment on both the iPhone and Android platforms.  Facebook's user base is incredibly large and how many Instagram users are not already Facebook users?  I cannot imaging Facebook is picking up too many new eyeballs with this acquisition.  So what if Google bought the company and Google+ got the service.  A bigger competitive threat to Facebook is perhaps an aggregator that enables users to use one interface to interact with all social media services and monitor them all for you as your personal assistant or agent.  To me the Instagram deal really smells like Mark Zuckerberg's ego.  He just got it into his head that he wanted this baby and he was willing to pay whatever price to get it.  Since Mark Zuckerberg effectively controls Facebook through his voting block, he can accomplish whatever goal he sets his mind toward with the company.

The fallout is just like it was back in 1999.  If Instagram can grow that quickly to 30 million users then some other company can figure out a way to grow that quickly as well and there will always be an excuse to pay up for growth until one cannot do so any longer.  That is what happened in 1999. And that is what is happening again now.  And just like in 1999 the numbers will assuredly trickle down as well.  If Instagram is worth $1B for 30 million users, the next company with 5 million users will be worth at least $166 million...and so on.  Eventually, you simply cannot justify the numbers, however.

News Corp. only shelled out $580 million to overpay for MySpace in 2005.  Specific Media bought MySpace for $35 million 6 years later.  I guess Rupert Murdock and his shareholders got their lession in overpayment for a bargain basement price!

Occupy K Street not Wall Street

There is a lot of talk about contrarian thinking and contrarian investing, but there are very few people who actually practice it.  It has long been true in money management that it is better for career management to be invested roughly in the same way as the rest of the crowd even if you lose money than to be out on a limb and be right and make a killing.  This is sad, but true.  Although this is no way to please your clients or to become John Paulson rich, it is certainly the best way to cover your ass and save your job.  It provides the “everyone else was doing it so how could I know” defense.  Indeed, when the financial system is at risk of collapse (e.g. Long Term Capital Management and its aftermath, Lehman Brothers and its aftermath, etc.), a practitioner of this method is unlikely to be one the unlucky few to be made an example of and so will generally be exonerated and not end up in jail or even pay the price of losing his or her job for terrible decision making.  There is also virtually no accountability for poor oversight and bad management these days.  How else can one explain why many of the individual managers at Wall Street firms have generally not suffered at all and losses continue to mount at firms such as UBS that somehow managed to blow through over $2 billion in 2011as its managers remain immune to consequences?  

Thus, it is understandable why there is public anger directed toward managers who work on Wall Street.  But although there are a host of problems with Wall Street and much could be resolved with better (not necessarily more) regulation (i.e. get rid of Sarbanes Oxley and bring back the Uptick Rule and much of The Glass Steagall Act), bankers are not a cause of one of biggest problems that the US faces; they are merely one of many agents acting in their own self-interests.  Bankers are perhaps more high profile recently than many other groups, but we could lump pharmaceutical industry executives, oil and gas industry executives and a host of others into the same categories.  One of the biggest problems we face as a nation is that our government is no longer regularly responsive to its own citizens.  It responds to K Street and not to Main Street.  Instead of occupying Wall Street, I suggest the citizens in Zuccotti Park and elsewhere should occupy K Street.

I think this is unfortunately not very likely to happen, however.  The Occupy Wall Street crew in Zuccotti Park in NYC is not a particularly articulate, organized or terribly intellectual bunch.    And today, the real bang for the corporate investment buck is entirely in lobbying and this is a great tragedy. Where else in this market can one get a 6X return on investment?    There is practically no better return on a corporate investment dollar than on K street and it does not matter whether a Democrat or Republic is in control of the White House or Congress.  This is an incredibly sad state of affairs and if we want to take back our country, it is where we should focus our reform efforts. 

Unfortunately, the Occupy Wall Street battle is probably merely a prelude to an even greater battle that we are only beginning to touch upon in the US.  Many sympathizers with the Occupy Wall Street movement skew young and I believe that there is an undercurrent of the coming demographic war that we are facing in the US.  As the young graduate with overpriced, unsustainable university debts (and are often poorly trained) and face a job market that does not provide them with sufficient economic opportunities to service those debts, they begin to question the transfer of wealth from the working populations to the retirees of this country who receive these unprecedented transfers because they now have net worths far greater than younger households than ever before.  Indeed, households headed by a person 65 or older have a median net worth 47 times greater than households headed by a person under 35, according to a new analysis from the nonpartisan Pew Research Center.  In dollars, that gap amounts to a median net worth of $170,494 for older households, compared to $3,662 for those under 35.

Government policies make this situation possible and it is not sustainable for the long term.  Wall Street certainly has its own problems, but K Street is causing Main Street real angina.  I suggest the protesters Occupy K Street instead.

The Price of Oil is Still a Tax on the US Economy, but it's improving....

Oil recently broke below $80 per barrel and it caused me to reflect on its continuing importance to the US economy even though there is so much brouhaha over the price of gold.  So much has changed and yet so little has changed since 1973 regarding oil.  The US remains heavily dependent on foreign oil and Americans have learned relatively little from the lessons of the 1970s.  Technological advances frequently require more energy – not less – even as individually powered devices become relatively more energy efficient than their predecessors.  Consumers and producers today typically use more products and services and energy use continues its slow but inexorable climb.  Although the US consumes somewhat less oil than it did a few years ago due to recent weakness in its economy, the country still consumes more petroleum than it did in the 1970s. 


And oil is by far and away the largest energy source for Americans.  So when the price of oil goes up, Americans across all industries feel a real and substantial pinch.  So what exactly is the point of the Consumer Price Index (CPI) less food and energy?  Who can survive without food and energy?  Yes, I know, this form of the CPI removes a lot of volatility, but energy has its footprint everywhere in a modern economy and has to be considered in any serious economic analysis or measure of inflation.  And the US is still heavily dependent upon oil as a source of energy.  When the price of oil goes up, it raises the costs to produce a vast array of goods and services in the US and, in effect, serves as a “tax” on the US economy on top of the federal and state taxes already imposed on oil and its derivatives including gasoline.

Since the depths of the collapse in stock market confidence in March 2009, the price of oil rose from the low $40s to the low $90s at thebeginning of this year.   Earlier in 2011, however, the price of west Texas intermediate surpassed $110 per barrel.  Recently, the price of oil per barrel has pulled back below $80.  Much of the price of oil is driven by classic economics of the underlying demand for its use versus the ability of the oil producers to supply oil to meet this demand.  But there is probably at least one additional factor in the price of this commodity that contributes to this painful oil tax on our economy we have to bear as Americans – i.e. the chance of crises, political unrest or wars in oil-producing countries or their neighboring countries that would materially disrupt the world’s oil supply.  This uncertainty adds a premium to the oil price that goes up or down depending on the perceived risks of the moment.  Recently, I believe this perceived risk and the view of future oil demand have come down and accordingly so have petroleum prices. 

Nevertheless, some types of bad news for oil are good news for much of the rest of the US economy.  The professional skinflints of America (better known as CFOs) are acutely aware of oil’s pernicious effects and are among the first to respond to the high costs of oil.  These CFOs are the vociferous critics of their suppliers who are trying to force price increases on them and are the first to come up with cost cutting measure of their own tomeet the challenges brought on by the oil tax on the US economy.  All too frequently and to the detriment of the overall economy, this has recently meant letting employees go. 

 

In corporate America, these CFOs will also be the first to notice now that oil prices are beginning to come down and ease the “oil tax burden” somewhat.  With any luck, these CFOs will inform their CEOs that they will soon have some flexibility to spend on projects near and dear to their CEO’s hearts.  If the US does not enter another recession, a sustained drop in the price of oil should enable them to invest and grow again.  If oil prices can hold in the $60 to $80 range for an extended period of time again, I believe the US will begin to build off its employment base (albeit slowly) and can create net new jobs – especially in industries such as construction, travel and transportation and agriculture/ag-bio where energy costs are high.  Watch the CFOs here.  And with oil in the $40 to $60 per barrel range, the US can witness real new job growth.  Below $40 per barrel and we are talking substantial job growth.  Unfortunately, prices below $40 per barrel would probably lead to long term problems once again.  There would probably be too little investment in future oil production and too little investment in alternative energy sources due to complacency and uncompetitive initial price points.  I guess that is too much of a good thing….

 

In sum, oil prices have an impact on the US economy that is almost the inverse of housing prices.  (See my previous blog on this topic.)  Higher housing prices and new construction can drive the economy out of its doldrums.  Conversely, lower oil prices put more money in consumers’ pockets and give corporate CFOs and CEOs the confidence to begin spending again as long as we don’t experience another banking crisis at the same time.  Such confidence can rescue the US economy as well.   With oil at over $80 per barrel, however, I think it is difficult to convince consumers to dig deep and spend while they are paying down debt or to get CEOs and CFOs to hire new people for growth instead of investing in energy efficient lighting and teleconferencing systems to avoid the high cost of travel.  It will be hard for the US economy to get going again until the price of oil falls.  When the price of oil falls and it holds, that is a positive sign for the future.