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Stephen Tierney MBMG International Ltd.


What is Facebook really worth?

As many of our readers are probably aware, Facebook (FB) is about to come to market in the coming days; this will probably be the largest IPO (Initial Public Offering) of a stock ever. The IPO is estimated to raise approximately $10-$11 billion, valuing the company at between $77 and $96 billion at launch. It may even get to over a $100 billion. To put this into context, if the upper end of this range is achieved, FB will be half the size of Google and would rival the market value of and Cisco Systems Inc.

In the case of FB, the big question on everyone’s lips is, will this hyped-up investment be worth it? In a nutshell, my take would be that it is one thing to “like” FB, but it is quite another to part with one’s cash to invest given the large number of question marks over its revenue model.

Last week, FB were honest enough to warn potential investors that the long term financial outlook of the company could be threatened because there were too many people accessing FB via mobiles or tablets and they had little or no idea at the moment of how to monetize this. In fact, this led FB to alter its filing at the Securities and Exchange Commission to say that if this continued, “Our financial performance and ability to grow revenue would be negatively affected.”

In fairness to FB, they are trying to solve the problem and have, according to the UK Telegraph, launched “its own app store”. However, experts are saying that the change in the IPO is tantamount to a profits warning.

The other major problem that potential investors have is the dual class shareholding structure. This basically lets a 28 year old, Mark Zuckerberg, run the company as if it was still his own private company.

As stated above, FB is hoping to raise nearly $11 billion at the IPO Thursday and expects the share price to be around the $33 mark give or take a couple of dollars. However, also as stated previously, this may get higher as some analysts are forecasting FB may increase that prediction as investors have indicated they want to purchase more shares than the 337 million FB is launching with later this week. This is why the value of FB could well be more than $100 by the end of the week.

The FT wrote a very insightful piece on the company and brought up some of the following interesting points:

- Is FB going to be ubiquitous on the internet? I.e. will it attain the same position on the internet that Microsoft once held in personal computing?

- FB needs to own the social dimension and make it pay.

- Can FB control the digital advertising space, like Google does today?

- In Google, users ask for information on products, so targeted advertising works. Will FB users be happy to be targeted for what they profess to like?

- Running a social network is expensive, with capital expenditures running at 30% and growing.

- Free cash flow returns on assets are strong, but Google’s are twice as high.

On traditional accounting measures, the company does not appear to be listing on the cheap, with a PE of 99 being mooted as a valuation metric. If one looks at Price to Sales numbers, it is estimated to trade on 13-16 Sales, compared with the likes of Google on 5-6. The problem with companies like FB that have explosive growth rates is how does one value these companies? Google was also apparently expensive when it listed, but this did not stop the share price growing by 600% since launch.

On the plus side, with 900 million active users, Facebook is undoubtedly the market leader in social networking. But size alone in the technology space does not always mean success. FB might be large today, but what happens when it is no longer cool to have your mum (or dad, or employer) checking out your profile, not to mention the loss of privacy as advertisers start to target your shopping habits.

The company would argue it does not need to be cool, for once it reaches a certain size it will be irreplaceable, similar to what Google is now to search engines. Should the dream of a monopoly over social networks be achieved, then one could imagine a future where searching for information, reading news, watching television, writing a document or talking on the telephone are activities conducted in the Facebook world. In this scenario, a $100 billion price tag may not be that ludicrous. Facebook money anyone?

Dreams of a controlling the social networking world aside, what does one have to believe today to justify the current valuation?

The FT has done this analysis and has calculated that the business has to become far less capital intensive (inclusive of acquisitions) over time, as Google and Microsoft have done. This can be done but for margins to also stay near today’s level of about 50 percent it would be a big ask indeed. Sales would have to grow at least six fold in this period. The latter is certainly possible. For comparison, when Google had the same revenues as Facebook has now it took just seven years for them to increase another 10 times.

Bottom line, investors will need to take a leap of faith if they are to buy into the Facebook dream. This could indeed be the next Google or Apple, but it could also very well be the next Groupon, down 50% since launch. Caveat emptor!

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Stephen Tierney on [email protected]


China in your hands, part 1

Recently, my business partner, Paul Gambles who is a regular on CNBC, appeared on the Money Channel and gave his views on China:

We used to talk about the $64,000 question, but I think the current and future state of the Chinese economy is the 64 billion RMB question. Everyone has a theory about this, but the real answer is that nobody really knows.

There's a real problem in looking at the Chinese economy in that the data is very difficult to trust. We don't know how reliable the data is. Now, to some extent that's true of all economic data around the world. We don't believe the data the American or the British or the European governments produce. But it's even more so in China, partly because the government have such strong control over the data, but also because the government have such strong control over the economy as well.

In a free market, we have a good idea of what's actually going on underneath the surface of the economy. In a market like China, where the economy is very controlled, it's very difficult to know that normal market processes have been followed. When banks lend money in the States it's really determined by, or should be determined by, commercial factors and assessing the risk and return. Admittedly, that went a little bit crazy in America over the last fifteen or twenty years when financial engineering changed some of those methods, but as a general principle, what should happen in a free market is that capital will chase a return. In a controlled market like China, the government can define precisely where they want capital to go to.

America, for the past few years, has been trying to create jobs and get the unemployed back to work. In China, if they have unemployed, they could get them back to work tomorrow; they could define exactly how many jobs to create. They have the ability to do that. They have some very sophisticated people. The People's Bank of China, the central bank, has over 2000 registered economists sitting there every day figuring out which levers to pull, which buttons to press, which adjustments to make in order to make the Chinese economy function. From that point of view, it's a very efficient machine in that they can make it do exactly what they want it to do.

The real problem with that is that it doesn't have any kind of market control. In a free market, if you do something stupid, if you make a bad investment, then generally the market will catch you out; it will tell you it's a bad investment; it will price it as a bad investment and you will lose money because of it. In China, they don't really have that correction mechanism, so our biggest worry about China is that nobody really knows what's underneath, and what's actually underneath might not be what everybody expects to be there because it has because it's been so manipulated by the government and external forces.

It's been so controlled that actually the problems can be much worse than many of us realize. We won't know until we get there, but because the markets haven't been able to make their normal corrections and their normal adjustments during this last twenty years of Chinese growth, there is actually a very high risk that when we get there, the correction could be far worse than most people are talking about right now.

Everyone raves about the 8.9% GDP, but because we don't really know all the nuts and bolts that make the Chinese economy work, we don't know where that 8.9% comes from. 8.9% as a headline number actually sounds quite good, but if that's something that's been manipulated by extra stimulus and debt being forced into the system, then we don't really know the quality of that growth. If it's 8.9% of what we would call normal GDP, self-sustaining GDP that grows organically out of the economy and it's real and it's not interfered with, then in that case we would be very happy with that, but in China we don't really think that's the case.

In China, the market doesn't have any adjustment mechanism or the ability to push back, so a lot of this 8.9% could be what we would regard as being phony growth, not real growth. That's really the question for China - it's a matter of how real and sustainable is all this growth or how much of it has been manipulated?

For something like 20 years, there were two charts that went up by around 10% per year. One was the Chinese economy, and the other was Bernard Madoff's investments, and we all know that Bernie Madoff's investments weren't real.

Our worry is just how real those Chinese returns are and how much of China's growth has been induced by artificial government control and external influences. The problem with that is that if there have been externalities, that will have led to a whole bunch of problems in the system. If loans have been forced into sectors where banks really shouldn't have been lending, then we're going to end up with an enormous amount of bad debt.

To be continued…

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Stephen Tierney on [email protected]


Don’t panic … yet!

Quantitative Easing has artificially and unsustainably inflated asset prices, as my business partner, Paul Gambles, recently told Money Channel's MJ Banphot.

A lot of people are getting confused by economic news that is maybe not particularly promising, and yet they keep seeing all these risk-asset prices getting higher and higher since they bottomed out at the low point in December. Since then, we have seen a really strong rebound in risk-asset prices. You have to look at this in terms of a longer-term picture. If you look all the way back to 2008, when we had the Global Financial Crisis, since the period following the recession, the so-called great recession, we have not really seen any kind of economic activity recover the way we normally would after previous recessions.

Unemployment is still a real problem out there. I know in the States they are now saying it has come down from 9% to 8.5%, but it's reducing very slowly. If you look at the aftermath of previous recessions, unemployment has always recovered much more quickly than it is recovering this time. Now, there are a lot of people who would challenge those figures and say that the 8.5% figure is misleading and unrealistic because there are different ways of calculating unemployment; if you have been unemployed for a year in the States then they do not count you any more; if you are no longer looking for work, they do not count you. As I have said in the past, lies, damned lies and statistics.

Perhaps an even more important metric is that average wages in the US are still falling quite dramatically as well. Even if the above figures are true and actually have gone from 9% to 8.5% unemployed, the total quantum of what people earn actually is not getting any larger; consumer earnings are not getting any bigger either because salaries per person are actually getting lower. There is a real problem there in that if unemployment is getting better, it is only improving very slowly. Also, it is not really following through into the total amount of consumer earnings and, therefore, the amount of money consumers have to spend because wages are falling.

There are also other measures; if you look at GDP, American GDP for 2011 was only 2.8%. We have had something like twelve quarters now of positive GDP since the official end of the recession, but it has been very slow GDP growth.

Again, following a period of recession when economic activity is muted and people stop spending, you would normally have a catch up effect because neither people nor businesses were spending and so that really sends GDP increasing quite sharply. We have not seen that either, so we have this disconnect where real economic activity is very slow, very muted, and people can see that in the streets.

If you go to America, you get the sense of unemployment and of people worrying about their jobs, and of businesses that are really struggling to operate and to borrow money, and yet asset prices, on the other hand, have gone up really sharply since the end of the recession in 2008, probably much sharper than would normally happen following a recession or a depression.

A lot of people would say that the current asset prices are a sign of optimism, but the real problem is the disconnect between the price of assets, and the answer to that is something that we have been talking about for quite some time, and that is that risk-asset prices are really being driven by liquidity. When new capital comes into the markets, capital automatically finds its way to the best opportunities. It will go wherever the highest return is. If you have got capital yourself, you will go and place it where you think you can get the best return. All capital basically behaves in that way.

What we were concerned about in the third quarter of last year was that liquidity really seemed to be drying up. This happened, despite all the efforts of the Central Banks, despite Quantitative Easing and all the other things that bankers have done to try and force more money into a system that was not generating extra money through its own economic activity. Despite all that, we saw a couple of really alarming indicators in Quarter three of 2011.

We were watching the TED Spread and the LOIS, everyday. The TED spread is basically the difference between the interest rate that gets paid on the Treasury-Bill and the interest that gets paid on the EuroDollar, which is basically the cost of borrowing Dollars outside of the United States, and that gap was getting wider and wider all the time. Once that spread gets wider than about 50 points, that is usually a flashing red light and a sign that we might be heading into some kind of liquidity crisis.

The flashing red light went back to amber following the intervention of global central banks, most evidently manifested in the ECB's LTRO #1 and #2 programmes which have pumped one trillion Euros into Europe's weakest banks and economies - but it is a small step from there back to the danger zone. Be afraid, be very afraid... and be opportunistic too - there is a real opportunity to profit from expected dislocations - non-US investors should take a holding of Greenbacks to profit from any short term USD strength.

Above all, stay liquid. If you know where to look then there are still good gains to be had but do not get tied up into anything which will inflict severe penalties if you want a quick exit. Remember, if it sounds too good to be true then it usually is.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Stephen Tierney on [email protected]


Why is everything cyclical?

My business partner, Paul Gambles, was asked recently about the long-term seasons cycle.

“Trying to understand what the global economy has in store is something that can be very difficult for all of us. The global economy has always been a very complex animal, and although there's a lot of research and a lot of data available today, I'm not sure that most people understand it any better now than they did hundreds of years ago. There was a piece of research we came across recently that showed of 36,000 registered economists in the world, only twenty of those people actually managed to predict the biggest single global economic event of our lifetimes, which was the financial crisis of 2008. All the others simply didn't see it coming.”

At MBMG we have been doing some research as to why only 20 people managed to predict this, whereas 36,000 simply did not see it coming at all, and one factor that has emerged is that the people who seem to have the best understanding are the ones who are able to look at a very big-picture take on the economy and actually try and understand exactly where the economy is in context.

As long term readers of this column know, MBMG has long believed that the economy is cyclical and that there are four main aspects or seasons, as we call them, to that cyclicality. We see it almost as a western type year with Spring and Summer followed by Autumn and Winter. If you look at the current cycle, we think that the last Spring cycle started in 1949 when the Great Depression ended, and at that point the Dow Jones Industrial index was at about 181 points. We started to see growth; we started to see job creation; we started to see trade, and that ran for a period of probably about 17 years up until around 1966. That is when Spring ended and Summer started, and the difference between them was that economic Summer is a period when we get much more leverage, much more borrowing and people are feeling good because there is so much trade, and that brings a lot of growth and also debt into the economy. The debt fuels the growth but it also fuels inflation, and so that tends to be a period that is good for commodities and real estate, but it causes head winds and problems for bond markets and equity markets because interest rates generally tend to get raised.

We think that phase lasted until the end of the Seventies, and the Dow Jones, which had risen from 181 to 968 points in the Spring cycle pretty well went nowhere and actually fell back to about 838 by 1980. The price of gold, which in the Spring cycle had not really gone anywhere (it had moved from $31/32 to $35 an ounce), suddenly shot up to $850 an ounce in the Summer cycle. At the end of Summer, we got high interest rates and high inflation, and that tends to lead to what we call the Autumn phase of the cycle, which is where we see disinflation coming in. That is a slowdown in the inflation rate and a slowdown in the rate of leverage. It is a very healthy period for stocks, but it is quite a bad period for precious metals and commodities, so from 1980 to around 2000, we saw the Dow Jones go from 838 points up to almost 12,000 points, which is a huge leap, but we saw the price of gold fall back from $850 to $250 an ounce.

Since 2000, we have been fairly sure that the western world is in what we call an economic Winter. This is a really deflationary time and a very difficult time for most asset classes. Certainly for stocks and real estate it is not very positive, and the deflationary impact can sometimes be pretty negative for commodities as well. We think that is the phase of the cycle that the western world is in right now, but what we are not sure about is how much longer this is going to last.

We think ASEAN economies entered the economic Winter, the deflationary part of the cycle, in around 1996/97, and we think that they took a lot of the right measures. They actually dealt with a lot of the debt problems, and we think South East Asia is actually exiting the Winter cycle and will soon start a whole new Spring cycle and take off and do really well again, but we think the western world is still somewhere in the Winter cycle. Trying to understand what the global economy is going to do really depends on how close you think we are to the end of Winter and the start of Spring, or whether you think we have still got some long dark winter days ahead for the global economy.

One thing that we are very aware of is that sometimes, even in the middle of Winter, you can get one or two really nice days and you start to think that maybe Spring is starting, but then all of a sudden you find yourself out without a coat and you get drenched with rain and freezing cold. So we are a little bit worried about the effect of the QE policies the US and UK governments have been adopting and the bail-ins and bail-outs the European governments have been adopting. We are concerned that what they are doing is hiding the symptoms without really dealing with the problems or curing the disease and, therefore, it might look like we may be further ahead with the recovery and further through the Winter period and getting into Spring than we really are.

There is a very good precedent for that historically in 1931, when everyone celebrated the end of the Great Depression in the States and in the western world, and then in 1932, they had what is called the 'Tragic Year' when they actually found out that it really was every bit as bad, if not actually far worse, than they had anticipated. I think there's a little bit of a note of caution that people should be sounding about the western economies. We do not really understand how we could be coming out of the Winter cycle when there is still so much of a debt burden still hanging around those economies, and we think that they have still got a lot of work to do. Thus, we are concerned about the impact that those economies are going to have on the global economy moving forwards.

We are still concerned that the Winter for western economies looks like dragging until the end of the decade. Japanese-style lost decades or 1930/40s Great Depressions are recurrent phenomena throughout history - and generally they are made far worse by the involvement of megalomaniac politicians like Hoover, Roosevelt, Merkel and Sarkozy who cast themselves in the role of an economic King Canute, hoping to stay the economic tide simply by commanding it, but doomed to embody the inability of man to hold back the forces of (economic) nature.

"You say I can do anything," Canute said to the courtiers. "Very well, I who am king and the lord of the ocean now command these rising waters to go back and not dare wet my feet." But the tide was disobedient and steadily rose and rose, until the feet of the king were in the water. Turning to his courtiers, Canute said: "Learn how feeble is the power of earthly kings. None is worthy the name of King but He whom heaven and earth and sea obey."

It can only be hoped that those in charge will learn from history.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Stephen Tierney on [email protected]